The age-old expression “get it in writing” reflects the wisdom that it is risky to rely on a handshake as the only evidence of a deal. Getting it in writing is also important when private company owners document transfers to investors. This is particularly true if majority owners want to prevent later fraud claims by investors based on statements allegedly made to them before they purchased their interest in the business. In this context, majority owners should consider including “no-reliance” provisions in contracts with investors, because courts are increasingly willing to hold that these contract terms will preclude future investor fraud claims.
A no-reliance provision confirms that an investor is not relying on any promises or representations that are not set forth in the investment documents. The investor is thus acknowledging that he/she is relying solely and exclusively on written representations that were made before the investment took place. While there are some exceptions under federal securities laws, a no-reliance provision in the investment documents generallyprovides both the majority owner and the company with a compelling defense to later fraud claims by investors.
Key Texas Case Law
The Texas Supreme Court first upheld a no-reliance provision 20 years ago to reject fraud claims in Schlumberger Tech. Corp. v. Swanson, 959 S.W.2d 171, 177 (Tex. 1997). In Schlumberger, the Court held that a no-reliance provision in the parties’ settlement agreement barred a claim that the settlement was induced by fraud, because this provision confirmed that no party was relying on the statements or representations of any other party in entering into the settlement agreement. An important distinction with regard to the disclaimer at issue in Schlumberger, however,was that it applied only to past disputes between the parties.
Less than five years ago, the Supreme Court considered whether a no-reliance disclaimer that the parties included in their agreement before a dispute arose would bar a fraud claim based on statements made before they entered the agreement. SeeItalian Cowboy Partners, Ltd. v. Prudential Ins. Co. of Am., 341 S.W.3d 323 (Tex. 2011). The issue in Italian Cowboy was whether a disclaimer of representations in a lease contract would preclude a fraud claim.
The relevant lease provisions provided as follows:
14.18 Representations. Tenant acknowledges that neither Landlord nor Landlord’s agents, employees or contractors have made any representations or promises with respect to the Site, the Shopping Center or this lease except as expressly set forth herein.
14.21 Entire Agreement. This lease constitutes the entire agreement between the parties hereto with respect to the subject matter hereof, and no subsequent amendment or agreement shall be binding upon either party unless it signed by each party . . .
The Court in Italian Cowboy (with three justices dissenting) held that these provisions did not prevent the tenant from pursuing a claim for fraudulent inducement for two reasons. First, the lease contained only a standard merger clause (combining all discussions into one agreement) rather than an actual no-reliance provision. Second, the Court held that the parties’ intent to negate reliance was not expressed in “clear and unequivocal language”—repeating the Schlumberger standard. The decision in Italian Cowboy was nevertheless significant because it opened the door to applying and enforcing no-reliance clauses outside the settlement-agreement context provided that the agreement contained the “magic words” to “clear[ly] and unequivocal[ly] . . . disclaim reliance and preclude[e] a claim for fraudulent inducement . . . .” See also Pelco Constr. Co. v. Chambers County, Texas, 01-14-00317-CV, 2015 WL 5211531, at *9 (Tex. App.—Houston [1st Dist.] Sept. 3, 2015, no pet.) (“Standard merger clause provisions that the contract supersedes prior representations [are] not sufficient to act as a bar to a fraudulent inducement claim.”) (citing Italian Cowboy).
More recently, a Texas appellate court enforced a no-reliance clause in a lease as the basis for rejecting commercial tenants’ fraud claim. SeeDragon Fish LLC v. Santikos Legacy Ltd., No. 04-11-00682-CV (Tex. App.—San Antonio, May 2, 2012, no pet.). The tenants in Dragon Fish sued their landlord and the developer claiming they were defrauded by marketing materials they received representing that residences would be included in the development to support retail traffic. The appellate court upheld the dismissal of the tenants’ fraud claim, holding that the following clause barred reliance on the alleged representations:
Landlord and Tenant hereby acknowledge that they are not relying upon any brochure, rendering, information, representation or promise of the other, or an agent or broker, if any, except as may be expressly set forth in this lease.
Just last year, another Texas appellate court found that the following two provisions in an employment agreement, when read in combination, constituted the required “clear and unequivocal language necessary to defeat reliance” and thereby preclude a fraud claim:
This Agreement contains the entire agreement and understanding between Employee and [Employer] with respect to the subject matter hereof and supersedes all prior understandings, arrangements, representations, warranties and agreements between the parties, whether oral or written, with respect to the same . . . .
* * *
Employee hereby expressly warrants and represents that, before entering into this agreement, that [sic] they have read, informed themselves [sic] of and understand all the terms, contents, conditions and effects of all provisions of this agreement, that no promise or representation of any kind has been made, except for those expressly stated in this agreement and that they are entering into this agreement on a knowing and voluntary basis.
Dresser-Rand Co. v. Bolick, 14-12-00192-CV, 2013 WL 3770950, at *10 (Tex. App.—Houston [14th Dist.] July 18, 2013), petition for review abated (Jan. 17, 2014)
The law continues to evolve, but the Texas Supreme Court has enforced “no-reliance” provisions in contracts to bar fraud claims based on representations allegedly made before the parties’ agreement, and appellate courts have followed suit. As a result, majority owners may wish to consult with their counsel to discuss including no-reliance provisions in their investment documents. That discussion should include a review of the following six factors that courts evaluate when deciding whether to enforce no-reliance provisions:
- Were the terms of the contract negotiated, rather than boiler plate;
- During negotiations, did the parties discuss the issue now in dispute;
- Was the investor represented by independent counsel;
- Did the parties deal with each other in an arm’s length transaction;
- Were the parties knowledgeable in business matters; and
- Was the parties’ intent to negate reliance expressed in clear and unequivocal language?
When these factors are present, a no-reliance provision may be enforced to bar an investor’s later claim for fraudulent inducement.