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Wednesday, October 26, 2005

The Relationship between Merger Clauses and Fraudulent Inducement

Is a claim of fraudulent inducement based on pre-contractual representations defeated by a merger clause? A recent case holds that "it depends."

In an insurance case, Magistrate Judge Pepe of the Eastern District of Michigan held that “representations of fact made by one party to another to induce that party to enter into a contract” are not “wiped away” by a merger clause. Otherwise, a savvy but shady character could commit fraud in the inducement and protect herself with a merger clause. However, in the situation where “collateral agreements or understandings between two parties . . . are not expressed in a written contract,” those oral agreements are eviscerated by a merger clause, even if they were the product of fraud.

Judge Pepe noted that, then, the question is “when does fraud invalidate an entire contract, and when is it such that it provides no remedy or recourse if there is a written contract with a merger clause?” His answer:

fraud will invalidate a contract when a party’s assent to said contract is induced through justified reliance upon a fraudulent misrepresentation. A merger clause can render reliance unjustified as to agreements, promises or understandings related to performances that are not included in the written agreement.

The court held that the "key element" in cases involving merger clauses is:

whether one justifiably relied on the representations of another when the parties’ written agreement clearly stated that by signing the document they were agreeing that the document made up the parties’ entire agreement regarding the terms of the contract and its performance standards.

Star Ins. Co. v. United Commercial Ins. (E.D. Mich. Sept. 30, 2005).

[Meredith R. Miller]

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