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Jan 10 2017

Just a Mistake or Fraud?

January 10, 2017 (Houston)

James SmithBy James Smith – “Environmental Alert” (Schirrmeister, Diaz-Arrastia, Brem LLP)

A seller represents that equipment meets certain technical specifications, when the equipment does not.  The particular equipment was not tested prior to the sale, and the seller claimed that it did not realize that the specific equipment did not meet the specifications.  This was a breach of contract, but was it also fraud?

According to a mid-level Texas court of appeals, yes, because the seller knew that the manufacturing facility had a history of making defective equipment, and failed to tell the buyer about these manufacturing issues.

Jury Found Fraud Due to Non-Disclosure

In JSC Nizhnedneprovsky Tube Rolling Plant v. United Resources, the Corpus Christi Court of Appeals upheld a fraud finding against JSC Nizhnedneprovsky Tube Rolling Plant (“NTRP”), for the sale of pipe that did not meet API P-110 specifications.

NTRP argued that its representation that the pipe met the API specification was not fraud, because it did not know that the particular pipe sold to United Resources (“UR”) did not meet the API specifications.  The Court stated that NTRP’s knowledge that the manufacturing facility had a history of making defective pipe that did not meet the specifications created a duty for NTRP to disclose this to UR.  NTRP’s failure to disclose was fraud.

The jury assessed, and the appellate court upheld, over $200,000.00 in exemplary damages against NTRP as a result of the fraud, in addition to the actual damages.

Silence Can be Fraud

Contracting parties must disclose material information that they have that they know their counter party does not have and does not have equal opportunity to obtain, or they commit fraud.  In this case, NTRP knew that the manufacturing facility (in Ukraine) was having difficulty producing pipe that met specifications; it was fraud not to tell UR of these difficulties.

Truth Is Not an Absolute Defense to Fraud

Even statements that are completely true can be fraud, if they create a false impression, and lure someone into a deal that full disclosure would have prevented.  Generally, disclosure of some information leads to a duty of full disclosure, even if the partial disclosure was completely true.

Checklist to Avoid Fraud

Some steps (not exhaustive) to avoid fraud:

  • Make truthful representations;
  • Verify that all material representations have been examined and confirmed (so that if a mistake is made, it will be an innocent mistake and not fraud);
  • Determine materiality from the counter party’s perspective, and treat a representation as material when in doubt;
  • Review the context to ensure that the counter party could not be under a false impression or ignorant of key facts; and
  • If some information is given, fully disclose, so that the counter party cannot later claim false impression or that key facts were withheld.

For a copy of the appellate court’s opinion click here.

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