N.C. Business Court Digs into Pleading Requirements in Tossing Three Misrepresentation-Based Claims

A “failed deal” or contract often gives rise to claims for breach of contract, fraud, and/or negligent misrepresentation. Each claim presents its own path to relief. And that path is replete with obstacles, beginning with pleading requirements unique to each claim. Even a “simple” breach claim can become complex, particularly when tangled with other misrepresentation-based claims. For instance—if a party promises not to make false statements in a contract, but then does, is that a breach of contract, fraud, or both? What if the misrepresentations are made during negotiations versus in the contract itself? And what role, if any, does the parol evidence rule play in this analysis? The Business Court grappled with these questions, among others, in Value Health Sols. Inc. v. Pharm. Research Assocs., Inc., 2019 NCBC 68 (N.C. Super. Ct. Sept. 6, 2019). See Order and Opinion.[1]

Take-Aways:

• Whether fraud in the contract has occurred requires looking no further than the contract itself, at least where the contract is “clear and unambiguous.”
• When pleading fraud, “reliance” should be pled like any other element—with particularity, which in this context means showing why the reliance was reasonable under the circumstances.
• A duty of care arises where one party controls the information in question, but only where the other party has made diligent efforts to obtain it.

Background

The defendants in Value Health (“PRA”) conducted clinical trials “all over the world” and comprised “one of the world’s leading global contract research organizations (CRO).” Id. ¶ 2. As a CRO heavyweight, PRA needed software capable of managing their large-scale clinical trials. And they thought they had found the solution in plaintiffs’ product—which fittingly was called the “Solution.” Id. ¶ 3.

Plaintiffs made a number of representations to PRA regarding the capabilities of the Solution and various product “enhancements” needed to integrate the Solution with PRA’s existing software system. Id. ¶¶ 4-6, 9.  Based on these representations, PRA agreed to purchase the Solution from plaintiffs pursuant to an asset purchase agreement (“APA”). Id. ¶ 7. The APA included a provision, perhaps best described as a “No Fraud” clause, in which plaintiffs essentially agreed they had not misrepresented or omitted material facts in the APA. Id. ¶ 24.

After performance of the APA went south, each party asserted that the other had breached and made material misrepresentations in connection with the APA. Plaintiffs filed suit, and PRA asserted counterclaims, including for breach of contract, fraud, and negligent misrepresentation based on plaintiffs’ alleged pre-contract misrepresentations. Id. ¶¶ 10, 17.

Judge McGuire addressed plaintiffs’ motion to dismiss PRA’s counterclaims in the Business Court’s 68^th opinion of 2019.

Analysis

1. Breach of Contract – the “No Fraud” clause

First, what exactly did plaintiffs agree to do under the No Fraud clause? The No Fraud clause provided that:

No representation or warranty by [plaintiffs] in this Agreement and no statement contained in the Schedules to this Agreement or any certificate or other document furnished or to be furnished to [PRA] pursuant to this Agreement contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained therein, in light of the circumstances in which they are made, not misleading.

Id. ¶ 24. Breaking down this painfully-worded provision, plaintiffs represented essentially two things in the No Fraud clause:

• Plaintiffs did not make any false statements in the APA; and
• Plaintiffs did not omit information from the APA that, as a result of the omission, made any statement in the APA misleading.

See id. ¶ 31. Put more simply, plaintiffs promised not to commit fraud in the APA. And this qualification—“in the APA”—made a difference in the Court’s analysis.

In particular, PRA alleged that plaintiffs breached the No Fraud clause by “failing to correct” certain pre-contract misrepresentations, including that (i) certain “milestones” relating to the Solution would be achieved within 18 months of closing the APA; and (ii) certain product enhancements to the Solution had already been implemented. Id. ¶ 25. PRA argued that plaintiffs’ failure to correct these misrepresentations were “omissions” that “made statements contained in the APA false.” Id. ¶ 25.

But plaintiffs did not make any promises in the APA to do these things. There was “no express language in the APA that any of the Product Enhancements were already implemented”; nor did the APA “contain any promise . . . that the Milestones would be achieved within eighteen months of the Closing.” As such, “Plaintiffs’ failure to correct any [such] representation . . . [was] not an omission of ‘a material fact necessary to make the statements contained [in the APA] . . . not misleading.’” Id. ¶¶ 32-33.

The parol evidence rule also factored into the analysis. The Court determined that the No Fraud clause was “clear and unambiguous,” meaning that (although not explicitly articulated by the Court) extrinsic evidence was not relevant in interpreting the No Fraud clause. Id. ¶¶ 30-31.  Elaborating further (and again, not explicitly articulated by the Court), this effectively meant that in considering whether the plaintiffs had breached the APA by “failing to correct” alleged pre-contract misrepresentations, there were no pre-contract misrepresentations to consider; the parties had a final written agreement (the APA), which, in turn, rendered any pre-contract negotiations, understandings, or agreements irrelevant. In short, PRA could not prove a breach of the APA by pointing to these (irrelevant) pre-contract representations.[2]

Accordingly, PRA’s contract claim failed to allege any breach of the APA, and was dismissed for failure to state a claim.

2. Fraud

PRA’s fraud claim appeared more promising. Unlike with the contract claim, PRA could rely on plaintiffs’ pre-contract representations to support their fraud claim. (Recall that parol evidence can be used to prove fraud. Franco v. Liposcience, Inc., 197 N.C. App. 59, 71, 676 S.E.2d 500, 507, aff’d, 363 N.C. 741, 686 S.E.2d 152 (2009).)

But there was one problem: PRA did not sufficiently plead the element of “reliance.”

In particular, a fraud claim requires showing not only reliance on the alleged misrepresentations, but also that the reliance was reasonable. And “[r]eliance is not reasonable where the plaintiff could have discovered the truth of the matter through reasonable diligence but failed to investigate. Value Health, 2019 NCBC at ¶ 51 (citation omitted).

In other words, reliance requires pleading facts to show that the “true facts” could not have been discovered through reasonable diligence. Id. And the facts pled should show the steps taken to discover the true facts and/or why the true facts were not discoverable through reasonable investigation. This effectively “heightened” pleading standard for the reliance element is consistent with the heightened pleading standard for fraud generally.

The Court concluded that PRA’s “reliance” allegations fell short. The allegations did not show that PRA had undertaken reasonable efforts to discover the true facts regarding plaintiffs’ alleged misrepresentations. Nor were facts pled to suggest that PRA could not have discovered the truth through reasonable investigation. Id. ¶¶ 49-52. Indeed, with respect to reliance, PRA alleged only that PRA had “relied upon [plaintiffs’] representations in entering into the APA” and that “[h]ad [plaintiffs] not made these representations and omissions, PRA would not have entered into the APA.” ECF No. 5 ¶¶ 53-54.

Because these allegations failed to adequately plead reliance, the fraud claim was dismissed for failure to state a claim.

3. Negligent Misrepresentation

PRA’s negligent misrepresentation claim fared no better. While such a claim can be useful where fraudulent intent is difficult to prove (or lacking), intent was not the issue here. The issue, again, was that PRA failed to sufficiently allege reliance on the alleged misrepresentations, and, like fraud, negligence misrepresentation requires a showing of reliance. Value Health, 2019 NCBC at ¶ 51 (citations omitted).

But even aside from reliance, this claim failed for a separate reason: PRA failed to allege that plaintiffs owed them a duty of care.   Id. ¶ 46.

Like any negligence claim, negligent misrepresentation requires showing a duty of care owed to the claimant. Id. ¶ 37 (citation omitted). As relevant to PRA’s negligence claim, a duty of care arises in commercial transactions where the seller is “the only party who had or controlled the information at issue” during the parties’ negotiations, “and the buyer had no ability to perform any independent investigation.” Id. ¶ 47 (citation omitted).

Here, PRA did not allege that plaintiffs were the only party that “had or controlled” information relating to the Solution. Nor did PRA allege that they were unable to investigate and discover any information they needed relating to the Solution. Instead, PRA alleged that they were “a large, sophisticated CRO who negotiated the APA with Plaintiffs for a period of more than a year, frequently providing Plaintiffs with input as to the functionality required from the Solution and engaging in regular interactions with Plaintiff during the development of the software.” Id. ¶ 48. Essentially, PRA’s allegations showed that they were in a position to access, or at least attempt to access, the information needed to verify plaintiffs’ representations, but nonetheless failed to “undert[ake] any due diligence efforts related to the purchase of the Solution.” Id. ¶ 49.

Accordingly, because PRA did not adequately allege a duty of care, or reliance, this claim was also dismissed.

Conclusion

In the end, PRA’s misrepresentation-based claims were dismissed for several reasons—none of which was that no misrepresentations had been made. The “merits” were never reached because the pleadings, according to the Court, did not allow it. Value Health thus underscores the importance of adhering closely to the case law and what courts require when pleading these oft-asserted claims.

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[1] In addition to the three misrepresentation-based claims described here, the Court addressed (and allowed to proceed) two additional claims unrelated to the misrepresentations.

[2] Although the Court applied Delaware law to interpret the APA (pursuant to the parties’ choice of law provision), the result and application of the parol evidence rule would likely be the same under North Carolina law. Compare Carlson v. Hallinan, 925 A.2d 506, 522 (Del. Ch. 2006) (“The parol evidence rule bars the admission of ‘preliminary negotiations, conversations and verbal agreements’ when the parties’ written contract represents ‘the entire contract between the parties.’”) (citation omitted), with Jones v. Jones, ___ N.C. App. ___, ___, 824 S.E.2d 185, 199 (2019) (“Where the parties have put their agreement in writing, it is presumed that the writing embodies their entire agreement,” and “parol testimony of prior or contemporaneous negotiations or conversations inconsistent with the writing . . . is incompetent.”) (citations omitted).

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