Contract Negotiation Causes Businesses to Waive Fraud as a Contract Defense

By Robert Lotz, Former Senior Editor

A contract defense of fraud, the scary F word in the business world, may be waived unknowingly. Business owners who negotiate contracts that include a waiver-of-defense clause may be found to waive fraud as a defense. An example of a waiver-of-defense clause is: no defense of any kind or nature is available to Lessor.

Courts analyzing whether a waiver-of-defense clause waives fraud as a defense are scarce. Generally, a fraud defense is only waived if the waiver-of-defense clause is sufficiently specific to encompass the fraud defense.[1] In other words, “an analysis of the language of the waiver is necessary” to determine whether the defense of fraud has been specifically waived.[2] Thus, the waiver language must specifically include a waiver for fraud, if not, a fraud defense is still valid.[3]

The Sixth Circuit analyzed this argument and found a wavier that precluded the “‘right to assert defenses ‘including but not limited to . . . issues of fraud[,]’” specifically precluded a fraud defense.[4] However, broad waivers that include fraud are likely to be enforced when parties are sophisticated and negotiated the contract.[5]

In MBIA Insurance Corporation v. Royal Indemnity Company,[6] defendants were precluded from asserting a fraudulent inducement defense by a broad waiver that provided that the obligation to pay was “absolute and unconditional” because the waivers were “sculpted by parties of exquisite legal and financial sophistication[.]”[7] “The MBIA court also discussed ‘obvious risks’ of fraud and found it ‘unimaginable’ that a party with the ‘experience and knowledge’ of the party subsequently claiming fraud ‘would not have realized it was assuming that risk when it agreed to [no-reliance] language.’”[8] Thus, when parties are sophisticated and negotiate the contract, broad boilerplate waivers are likely to be enforced, which precludes asserting a fraud defense.

A sophisticated party might be defined as “commercial parties who had the ability to walk away freely[,]”[9] “sophisticated parties to negotiated commercial contracts[,]”[10] “an experienced commercial entity[,]”[11] and “sophisticated parties with equal bargaining strength[.]”[12] Whether a party negotiated the contract is determined by the clause, i.e., whether it is boilerplate or carefully crafted by the parties.[13]

In summary, case law supports that a waiver-of-defense clause must expressly preclude a fraud defense in order to bar it. An exception to this rule applies if the parties are sophisticated and negotiated the contract clause. Thus, parties to a transaction should pay close attention to waiver-of-defense clauses or risk barring fraud as a defense.

[1] See, e.g., JP Morgan Chase Bank v. Liberty Mut. Ins. Co., 189 F. Supp. 2d 24, 28 (S.D.N.Y. 2002) (holding that a broad disclaimer does not preclude the defenses of fraudulent inducement or fraudulent concealment); PGA Mktg., Ltd. v. Windsor Plumbing Supply, Inc., 124 A.D.2d 576, 507 N.Y.S.2d 721 (N.Y. 1986) (stating that a broad waiver “of the right to assert any defense, offset or counterclaim” would not preclude a defense of fraud in the inducement).

[2] See, e.g., Dakota Partners, L.L.P. v. Glopak, Inc., 2001 ND 168, 634 N.W.2d 520, 524 (N.D. 2001); Sec. Holding v. Johnson, 57 S.D. 163, 231 N.W. 536, 538 (S.D. 1930) (determining that a defendant is not automatically estopped from raising a fraudulent inducement defense, even if contract contained a waiver-of-defenses clause); Shelby Elec. Co. v. Forbes, 205 S.W.3d 448, 455 (Tenn.App.2005) (defendants allowed to assert fraud defense when they agreed to waive “any defenses” and did not negotiate terms); Mfrs. Hanover Trust Co. v. Yanakas, 7 F.3d 310, 317-18 (2d Cir. 1993) (holding that a boilerplate “absolute and unconditional” guaranty did not waive a claim of fraudulent inducement against alleged perpetrator of fraud).

[3] See id.

[4] Commer. Money Ctr., Inc. v. Illinois Union Ins. Co., 508 F.3d 327, 343 (6th Cir.2007).

[5] Id. at 343-44 (citing MBIA Ins. Corp. v. Royal Indemn. Co., 426 F.3d 204, 214-216 (3d Cir.2005)).

[6] 426 F.3d 204, 214-18 (3d Cir. 2005).

[7] Id. at 215.

[8] FMC Techs., Inc. v. Edwards, No. C05-946C, 2007 U.S. Dist. LEXIS 42512, at *20 (W.D. Wash. June 12, 2007) (quoting id., at 217).

[9] ABRY Partners V, L.P. v. F&W Acquisition LLC, 891 A.2d 1032, 1056 (Del. Ch. 2006).

[10] Id. at 1057.

[11] Id.

[12] Id. at 1060.

[13] Compare Norton v. Poplos, 443 A.2d 1, 7 (Del. 1982) (discounting “‘boiler plate’ found in the merger clause”), with Great Lakes Chem. Corp. v. Pharmacia Corp., 788 A.2d 544, 555 (Del. Ch. 2001) (“carefully negotiated disclaimer language” made by “highly sophisticated parties, assisted by industry consultants and experienced legal counsel”).