Seeking Remedies to False Representations

By John S. Mrowiec

Sometimes parties make false representations of prior payment to vendors or the like to gain payment.

The false representation is a breach of contract, might constitute the tort of fraud and might violate a statute. Some statutes might provide for the award of attorneys’ fees or treble damages.

What remedies does the nonbreaching party have for the false representations? Might a contract clause limit those remedies even for intentional fraud or deception?

These issues were discussed involving Indiana law in The State Group Industrial (USA) Ltd. v. Murphy & Associates Industrial Services, Inc., 2007 Ind. App. LEXIS 2949 (Ct. App. Dec. 28, 2007).

Texas Water Project

The State Group Industrial (USA) Ltd. was the prime contractor for the U.S. Army Corps of Engineers’ Sabine-Neches Waterway Project in Beaumont, Texas. The project included a control system with probes to identify the salinity content of the water. Depending on the data from salinity probes manufactured by Falmouth Scientific, a control panel would cause gates on the dam to open or close to regulate salt water infiltration.

The contractor entered into a subcontract with Murphy & Associates Industrial Services Inc. as subcontractor to submit drawings and to supply, install, test and perform start-up engineering for various portions of the control system. The subcontractor prepared a bill of materials, which included salinity probes. The subcontractor intended to purchase some of the materials from vendors.

The subcontract contained a milestone payment schedule. In addition to a down payment, among the relevant milestones were payments upon “approval of submittal drawings,” “receipt of equipment at [subcontractor],” “equipment delivery/shipment to customer,” “completion of installation and testing” and “receipt of final deliverables.”

Rather than “approval of drawings” and “[subcontractor] receipt of equipment,” the subcontractor submitted an invoice for payment for allegedly achieving “submittal of drawings” and “[subcontractor] ordering equipments.” At the time of the invoice, there had been no discussion of changing the payment milestone definitions. Nor had the subcontractor ordered the materials.

After receiving the invoice, the contractor requested proof of the subcontractor’s ownership of the materials that was a condition of the owner’s payment to the contractor. In response, the subcontractor supplied the contractor with documentations representing that the subcontractor had paid in full and that no other party had a claim on the materials.

As of 107 days after the invoice, the contractor had not paid. The subcontractor sent a dunning letter demanding payment.

Over the next few months, the contractor made payments to the subcontractor. The subcontractor did not make its initial payment to the probe supplier until after the subcontractor received the last payment from the contractor.

The subcontractor did not ship materials to the site until 3.5 months after receiving the last of the contractor’s payments. The shipment did not include the salinity probes or necessary cabling.

The contractor sent two letters and met with the subcontractor about the missing materials. The subcontractor nevertheless asked for final payment.

Thereafter, the contractor wrote asking to review the software programming developed by the subcontractor. One month later, the contractor sent a 48-hour deficiency notice requesting supply of the salinity probes and cabling.

The subcontractor refused to supply the probes and cabling. The subcontractor said it would begin software and start-up procedures only if the contractor placed in escrow alleged finance charges and labor cost increases. The subcontractor also claimed, for the first time, that the salinity probes were not part of the subcontract.

Replacement Hired, Suits Filed

The contractor hired a replacement subcontractor and spent $141,943 above the subcontract balance for the probes and otherwise to complete the subcontractor’s scope. The subcontractor sued the contractor for breach of contract for the allegedly unpaid amounts.

The contractor counterclaimed. The contractor raised not only the usual breach of contract claim but also fraud and violation of the Indiana Crime Victims Statute, I.C. 34-24-3-1.

The statute provides: “If a person suffers a pecuniary loss as a result of a violation of IC 35-43 [deception] . . . the person may bring a civil action against the person who caused the loss for” treble damages, costs and reasonable attorneys’ fees.

The trial court found that the subcontractor had breached the subcontract by not providing the probes and cabling. Therefore, the trial court awarded a judgment to the contractor for the $141,943 in costs to cover for the unsupplied materials.

The trial court also found that the subcontractor knowingly made numerous false or misleading statements or representations with the intent to obtain payment. These constituted deception under I.C. 35-43-5-3, Murphy & Associates, 2007 Ind. App. LEXIS 2949, *7, 9.

Nevertheless, the trial court declined to award treble damages or attorneys’ fees to the contractor under the statute because of an exculpatory clause in the subcontract. The subcontract provided:

“The remedies specified in this agreement shall constitute [the Contractor’s] sole and exclusive remedy in the event of any alleged default, negligence, breach of contract or any other legal or equitable claim that may be brought against [Subcontractor]. Under no circumstances shall [the Subcontractor] be liable for any loss of profits or for special, consequential or exemplary damages, even if [the Subcontractor] knows or should have know of the possibility [*14] of such damages. In any event, it is expressly understood and agreed that the total liability, if any, of [the Subcontractor], for any action taken or omitted under the terms of this Agreement, shall be limited to the total payment amount received by [Subcontractor] for the performance of this Agreement,” Murphy & Associates, 2007 Ind. App. LEXIS 2949, *13-14.

The trial court concluded, “[t]he [Subc]ontract entered into between the parties does not provide for reimbursement of legal fees in the event that [Subcontractor] is [*8] found to be in breach. The [Subc]ontract also limits [Subcontractor’s] liability to actual damages and excludes loss of profits, special, consequential or exemplary damages,” Murphy & Associates, 2007 Ind. App. LEXIS 2949, *7 8.

Crime Victims’ Statute Studied

The contractor appealed, and the appellate court analyzed the Indiana Crime Victims Statute.

The statute neither requires a criminal conviction nor proof of deception beyond a reasonable doubt, Murphy & Associates, 2007 Ind. App. LEXIS 2949, *9 citing Gilliana v. Paniaguas, 708 N.E.2d 895, 899 (Ind. Ct. App. 1999). Yet, recovery under the statute “is not based on a breach of contract, but must be predicated on an independent tort,” Murphy & Associates, 2007 Ind. App. LEXIS 2949, *14 citing I.C. 34-24-3-1.

As ruled by the trial court, the effect of the subcontract’s clause was to permit a party to contract out of liability for a future unknown tort. The contractor argued that result was against public policy.

The Murphy & Associates appellate court found that although there was “no Indiana decision indicating that a party may not contract against liability for intentional tortuous acts, this rule has a general consensus among our sister states,” Murphy & Associates, 2007 Ind. App. LEXIS 2949, *10-11 citing Atkins v. Swimwest Family Fitness Center, 691 N.W.2d 334, 340 (Wis. 2005); Dargis v. Paradise Park, Inc., 819 N.E.2d 1220, 1232 (Ill. Ct. App. 2004).

Regardless, even if somehow the subcontract’s clause was not contrary to public policy, the appellate court concluded the clause did “not even purport to bar recovery under” the statute “under principles of contract construction,” Murphy & Associates, 2007 Ind. App. LEXIS 2949, *13. Reasoning under the rule of Indiana law that nonspecific indemnification clauses will not be enforced to release parties for their own negligent acts, the court stated the subcontract’s clause would need to be specific for the subcontractor even to have the possibility of avoiding the consequences of its fraudulent conduct, Murphy & Associates, 2007 Ind. App. LEXIS 2949, *15-16 citing Powell v. American Health Fitness Center, 694 N.E.2d 757-761-62 (Ind. Ct. App. 1998).

Recognized that Indiana courts have upheld release clauses “where the damages ‘are inherent in the nature of the activity,’” Murphy & Associates declined to hold that “the risk that a party to a contract will commit the crime of deception is inherent in the nature of business transactions,” Murphy & Associates, 2007 Ind. App. LEXIS 2949, *16, n. 5.

Murphy & Associates held that the subcontract did not protect the subcontractor from liability under the statute stemming from the subcontractor’s intentional misrepresentation. Accordingly, the appellate court remanded the case to the trial court with instructions to exercise its discretion whether to award damages and the amount of damages to the contractor for violation of the Crime Victims Statute, Murphy & Associates, 2007 Ind. App. LEXIS 2949, *17.