[This is a guest post from my friend professor Tina L. Stark about the recent Virginia supreme court case, MCR Federal, LLC v. JB&A, Inc., No. 161799 (Va. Dec. 14, 2017); I’ve made a couple of comments at the end.]
The Virginia Supreme Court recently issued a decision that is bad on the law and demonstrated a complete misunderstanding of the business deal and also the role of specific contract concepts and provisions in acquisitions. The Court held that a false statement in a bring-down certificate in an acquisition was not fraud but only a contractual breach. Wrong. In a bring-down certificate, a party remakes the representations and warranties that it made on signing (reps speak only as of a moment in time) so that the other party knows that what was true at signing is also true at the closing (a different moment in time.)
Some courts get hung up on the idea that representations in a contract can’t be fraudulent inducement. They reason that the representations do not precede the contract; so there’s no inducement. If that were correct, the duty of honesty in business transactions would only apply to pre-contract oral statements. That makes no sense.
Imagine that a party has the final agreement before it and sees the representations. Were they not there, the party would not sign. The party has bargained for the reps – the right to have comfort that its counterparty is honest. The existence of the representations in the contract is the inducement to sign.
The making of the representations is simultaneous with the contract’s signing. The act of signing causes the representations to be made.
Here are the facts in the case. The acquisition agreement included a condition that a party must have delivered a bring-down certificate before the other party had an obligation to close. It was a condition, not a covenant. The mere fact that it was in a contract didn’t change its character from a condition to a covenant. The party had no obligation to deliver the certificate. The court didn’t get that.
A closing certificate is intended to give a party the same rights at closing that it would have had with respect to the reps and warranties made at signing. The bring- down certificate remakes the reps but as of a different moment in time: the closing. The way it is supposed to work is that if a party is unable to [provide] a closing certificate because the representations are no longer true, that party cannot satisfy one of the conditions to close and the closing should not happen. Here’s where the duty of honesty pops up. A party has to ‘fess up that it cannot satisfy the condition. If it delivers the closing certificate knowing that it is false, that is fraud.
The court reasoned that the duty of honesty did not apply because a contract provision (the condition) addressed the issue of the bring-down certificate. So wrong. Not only did they misunderstand how conditions work, but also, they misapplied the economic loss doctrine.
In my view, the economic loss doctrine does not apply to representations and warranties. Although warranties are covenants, they are not the types of contractual duties to which the economic loss doctrine was originally intended to apply. Warranties when joined with representations are promises that the statements in the representations are true. That’s it. They have no other purpose. Parties don’t argue that the other party negligently performed its warranty duty. Therefore, no economic loss doctrine application.
Instead, I believe, the economic loss doctrine (when properly applied) applies to covenants that must be performed during a contract term. For example, if a contractor promises to perform a task in a workmanlike manner, that is contractual covenant. The economic loss doctrine would prevent a party from claiming that the contractor committed fraud by failing to properly perform. That doctrine makes sense. Were it not the case, then we would lose the separation of tort and contract and we would be back in the middle ages. At that time, courts did not recognize executory promises as enforceable. The ever clever medieval Lawyers crafted a work around. They resort to the tort writs of trespass sur le cas and deceit and claimed that a promise had been negligently performed. Eventually, the writs turned into assumpsit and with the advent of consideration, courts enforced promises in exchange for promises. (I know that the history is very summary, but the longer version is long.)
DCT comment: While I’m still digesting this new case, I agree with Tina that the Virginia supreme court’s decision does not match up well with settled business expectations about the effect of a bringdown certificate. (I‘m not yet ready, though, to endorse Tina’s position that the economic-loss doctrine should not apply to representations and warranties; I need to think about that some more.) As always, Tina’s comments are insightful and thought-provoking.