I often write here about things that may be surprising to know when it comes to fraud claims. Here we go again.
The courts treat specific provisions of a contract differently when deciding whether to give effect to those provisions before the final adjudication of the fraud allegations. I explain below.
Contracts can be challenged based upon a claim that they were in some way induced by fraud. Remedies for fraud include pecuniary loss resulting from the fraud or rescission of the contract, rendering it invalid or void. If the contract is challenged for fraud, can provisions of that contract be recognized and validated by the courts before the fraud claim is determined? On the flip side, can any provisions of the contract be disregarded based upon fraud allegations even before those fraud allegations are decided? This is where the surprising part comes in.
Different Treatment of Arbitration and Jury Waiver Provisions
The courts treat an arbitration provision in a contract (requiring the parties to the contract to resolve their disputes in arbitration) differently from a provision in a contract in which the parties waive a jury and require a judge to decide their disputes. With the arbitration clause, as I have explained in a prior post, “a broad arbitration provision is separable from the substantive provisions of a contract such that the agreement to arbitrate is valid even if the substantive provisions of the contract were induced by fraud.” (Citing Markowits v Friedman, 144 A.D.3d 993 (2d Dep’t 2016).) As the Markowitz court continued: “The issue of fraud in the inducement affects the validity of the arbitration clause only when the fraud relates to the arbitration provision itself, or was part of a grand scheme that permeated the entire contract” [for which the plaintiff] must…“establish that the agreement was not the result of an arm’s length negotiation, or the arbitration clause was inserted into the contract to accomplish a fraudulent scheme.”
On the other hand, as I explained in my post on jury waiver clauses, courts will disregard a contractual jury waiver provision merely if a party claims the contract was induced by fraud and seeks rescission of the entire contract – even before the merits of that fraud claim is decided. Therefore, the jury waiver can be disregarded altogether based simply upon the allegation of fraud.
Forum Selection Clause Effective
A new decision of the Appellate Division, First Department, gives effect to a contractual forum selection clause even though the contract in which it was contained was challenged for fraud. In Confederación Sudamericana de Fútbol v International Soccer Mktg., Inc., 2018 NY Slip Op 03639 (1st Dep’t Decided on May 22, 2018), at plaintiff’s request, the contract was revised to include a Paraguayan forum selection clause in which the parties agreed to the courts of Paraguay as the forum for the hearing of any dispute related to the contract. The New York County Commercial Division dismissed the case by enforcing this forum selection clause, even though plaintiff had challenged the contract as the result of fraud. The First Department affirmed, observing in relevant part:
Notwithstanding the larger backdrop of fraud against which this dispute arises, plaintiff failed to show that the forum selection clause should be invalidated on grounds of fraud. It was plaintiff that demanded the revisions to the forum selection clause, and plaintiff knew all along that the revisions were being made. Nor does the record show that Bridgestone [apparently a related party who was then no longer a party to the case] was defrauded, given the evidence of [defendant] Danis’s communications with Bridgestone representative Matias Borges about the need to revise the forum selection clause. Moreover, Danis attested that she understood that Borges was the appropriate Bridgestone contact, and plaintiff failed to show that she knew, or should have known, otherwise.
Allegations of fraud can have different consequences on various provisions of contracts. Courts are not always consistent in their treatment of contractual dispute-resolution provisions when fraud is alleged. Jury waiver provisions can be disregarded even with the mere allegation of fraud, while arbitration and forum selection clauses are more difficult to avoid based upon fraud.