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July 31, 2013 Articles

Justifiable Reliance Standards Differ Across States

Similarities in "black letter" law conceal important differences in how states address common issues related to claims.

By Patrick Keating and Tyler Beas

Although the elements of fraud and negligent misrepresentation claims are similar across many states, those similarities in the “black letter” law conceal important differences in how states address common issues related to the claims.

Typically, a plaintiff in a fraud or negligent misrepresentation case must establish that the defendant made a material misrepresentation of fact to the plaintiff and that the plaintiff’s detrimental reliance on the misrepresentation was justifiable or reasonable. In a fraud case, the plaintiff must prove that the defendant made the misrepresentation intentionally or recklessly. See Eurycleia Partners, LP v. Seward & Kissel, LLP, 883 N.Y.S.2d 147, 150 (N.Y. 2009) (New York law; specifying elements of fraud—including an intentional misrepresentation); Engalla v. Permanente Med. Grp., Inc., 15 Cal. 4th 951, 974 (Cal. 1997) (California law; fraud established by reckless misrepresentation); Fed. Land Bank Ass’n of Tyler v. Sloane, 825 S.W.2d 439, 442 (Tex. 1991) (Texas law; negligent misrepresentation elements); Gilchrist Timber Co. v. ITT Rayonier, Inc., 696 So. 2d 334, 337–39 (Fla. 1997) (Florida law; negligent misrepresentation elements).

Although states frequently recite these elements identically, states differ in how they resolve common fact patterns. In many misrepresentation cases, defendants assert that the plaintiff’s reliance was in some manner contributorily negligent and thus not justified or reasonable. For example, the plaintiff might not have investigated the truth of the defendant’s misrepresentation before relying on it when an investigation would have revealed the truth. Alternatively, the plaintiff might have undertaken an investigation regarding the representation but did not discover the truth. In that situation, a defendant may argue either (1) that the plaintiff cannot establish reliance on the defendant’s misrepresentation because the plaintiff relied instead on the plaintiff’s own investigation, or (2) that the plaintiff’s reliance was not justified because the plaintiff conducted the investigation negligently. The discussion below explores the divergence in how different states approach these common fact patterns.

The Plaintiff Does Not Always Have a Duty to Investigate  A defendant in a fraud case may assert that the plaintiff was contributorily negligent by failing to investigate the truth of the defendant’s representation to the plaintiff. For example, the defendant may argue that it is customary for parties involved in the type of business transaction at issue to conduct due diligence and that the plaintiff acted unreasonably by not doing so. Whether this is a viable defense to a fraud claim depends on which state law is at issue.

Many jurisdictions follow the rule that a plaintiff in a fraud case may justifiably rely on a misrepresentation even if the plaintiff made no effort to investigate whether the misrepresentation was true. The law in these states is often that a plaintiff has no duty to investigate unless the plaintiff was aware of facts making it obvious that the defendant’s representation was not true. Circumstances merely raising suspicion do not trigger a duty to investigate. For example, as a general rule in California, negligence on the plaintiff’s part in failing to conduct an investigation is not a defense to an intentional tort such as fraud. The fact that an investigation would have revealed the truth will not bar a plaintiff’s recovery. See Hartong v. Partake, Inc., 266 Cal. App. 2d 942, 964–65 (Cal. Ct. App. 1968). The same is true in Florida, New Jersey, Pennsylvania, and Texas. See Butler v. Yusem, 44 So. 3d 102, 105 (Fla. 2010); Walid v. Yolanda for Irene Couture, 40 A.3d 85, 91 (N.J. Super. Ct. App. Div. 2012); Toy v. Metro Life Ins., Co., 928 A.2d 186, 207–8 (Pa. 2007); Koral Indus. v. Security-Conn. Life Ins., Co., 802 S.W.2d 650, 651 (Tex. 1990).

Other states place a duty on the plaintiff to investigate the truth of the defendant’s representation when the plaintiff is aware of facts indicating that the representation “may” be false—the plaintiff need not be aware of facts making it “obvious” that the defendant’s representation was false. By way of example, New York, Illinois, and Ohio follow this approach. See Keywell Corp. v. Weinstein, 33 F.3d 159, 164 (2d Cir. 1994) (In New York, “[w]hen a party is aware of circumstances that indicate certain representations may be false, that party cannot reasonably rely on those representations, but must make additional inquiry to determine their accuracy.”); Smith v. Ethell, 144 Ill. App. 3d 171, 174 (Ill. App. Ct. 1986) (In Illinois, if a plaintiff is put on notice that the defendant’s statements may be untrue and has “ample opportunity to ascertain the truth of the representation before he acts,” the plaintiff must then conduct an investigation.); Moore v. Daw, 1996 Ohio App. LEXIS 3763, at *13 (Ohio Ct. App. 1996) (In Ohio, “where one is put on notice as to any doubt to the truth of a representation, the person is under a duty to reasonably investigate before reliance thereon.”); see also Gibson v. Home Folks Mobile Home Plaza, Inc., 533 F. Supp. 1211, 1216 (S.D. Ga. 1982) (In Georgia, a plaintiff must exercise “ordinary diligence” to discover the truth.).

Effect of a Plaintiff’s Negligent Investigation  Another scenario that frequently arises in cases involving alleged misrepresentations is where, before consummating a transaction in dispute, the plaintiff undertook an investigation of the truth of the defendant’s representation. If the investigation revealed to the plaintiff that the representation was false, the general rule is that the plaintiff may not thereafter justifiably rely on the misrepresentation. See, e.g.Walid, 40 A.3d at 91 (In New Jersey, “reliance on a fraudulent misrepresentation is not justified if the recipient of the misrepresentation knows that is false . . . .”); Metro Life Ins., Co., 928 A.2d at 207 (same in Pennsylvania); Yusem, 44 So. 3d at 105 (In Florida, “a recipient may rely on the truth of a representation . . . unless he knows the representation to be false . . . .”); Koral Indus., 802 S.W.2d at 651 (In Texas, the plaintiff’s actual knowledge of the misrepresentation would have destroyed its claim for fraud.). However, when the plaintiff failed to uncover the truth because the plaintiff conducted its investigation in an unreasonable manner, states considering fraud claims have reached different conclusions regarding the proper outcome.

On the one hand, if the plaintiff is permitted to prevail only in instances where the plaintiff’s reliance was “justified” or “reasonable,” how can the plaintiff prevail if a reasonable person acting in the plaintiff’s place would have discovered the truth and thereby avoided harm? On the other hand, if the law must choose between a rule that arguably encourages negligence (by plaintiffs) or intentionally fraudulent acts (by defendants), isn’t the better policy to risk encouraging negligence rather than fraud?

This tension is seen in case law across states. Some appellate opinions follow the principle that a plaintiff’s negligent method of investigation will not relieve a defendant from liability for fraud. See Steve-Mar, Inc. v. Matvejs, 678 So. 2d 834, 837–38 (Fla. Dist. Ct. App. 1996) (Florida law); Omaha Nat’l Bank v. Mfrs. Life Ins. Co., 332 N.W.2d 196, 202–3 (Neb. 1983) (applying Nebraska law and holding that plaintiff insurer would not be held to a negligence standard in making an investigation); Ritchey v. Pinnell, 324 S.W.3d 815, 819 (Tex. App.—Texarkana 2000, no writ) (discussing conflicting approaches taken by Texas appellate courts and following the rule that the plaintiff’s investigation negates reliance on the defendant’s statement as a matter of law only if the parties renegotiated the sales contract based on the true state of affairs revealed by the investigation); but see Bartlett v. Schmidt, 33 S.W.3d 35, 38 (Tex. App.—Corpus Christi 2000, petition denied) (see parenthetical below); cf. S.C. Johnson & Son, Inc. v. DowBrands, Inc., 294 F. Supp. 2d 568, 593 (D. Del. 2003), rev’d on other grounds, 111 F. App’x 100 (3d Cir. 2004) (In the context of the sale of a business, Delaware law provides that “a buyer’s independent review or investigation will not preclude reliance on the seller’s representations unless the investigation was so thorough and complete as to be of such a character as to fully acquaint him with the essential facts.”).

Other courts side with the defendant in situations where the plaintiff conducted a negligent investigation. Some opinions reason that the plaintiff cannot justifiably rely on a misrepresentation if a reasonable investigation would have uncovered the truth; others conclude that, having conducted an investigation, the plaintiff cannot establish reliance on the defendant’s representation because the plaintiff chose to rely on its own investigation instead. See Carroll v. Dungey, 223 Cal. App. 2d 247, 254 (Cal. Dist. Ct. App. 1963) (holding that a plaintiff will not meet the justifiable reliance element if the plaintiff conducted an investigation and the investigation would, if performed with reasonable diligence, disclose the true facts); Marsh v. Hasbrouck, 831 N.Y.S.2d 554, 555–56 (N.Y. App. Div. 2007) (holding that plaintiff’s reliance was not justified where plaintiff hired a property surveyor who issued an inaccurate report that the plaintiff relied on along with defendant’s representation); see also Blanchard v. Blanchard, 839 P.2d 1320, 1323 (Nev. 1992) (generally, “a plaintiff making an independent investigation will be charged with knowledge of facts which reasonable diligence would have disclosed [because] such a plaintiff is deemed to have relied on his own judgment and not on the defendant’s representations”); Bartlett, 33 S.W.3d at 38 (“[R]egardless of the result of his investigation, the buyer’s decision to undertake [] an investigation [not interfered with by the seller] indicates that he or she is not relying on the seller’s representations about the property.”).

Conclusion  When practicing in different jurisdictions, it is always prudent not to assume that cross-state similarity in the “black letter” elements of fraud and negligent misrepresentation indicates that courts in each state will resolve the claims in a similar fashion. When representing a plaintiff faced with the right to file a lawsuit in two or more states (for example, the home state of either the plaintiff or the defendant if the defendant made the misrepresentation through an interstate communication), digging deeper into how the relevant forums resolve the fact pattern at issue may yield unexpected results.

Keywords: litigation, business torts, reasonable reliance, fraud, negligent misrepresentation, investigate, contributory negligence

Patrick Keating and Tyler Beas – July 31, 2013