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What types of damages are available if someone fraudulently induces you to enter into an agreement?
If you are damaged by a material misrepresentation that you reasonably relied upon in entering into an agreement, you can recover certain damages. The trick is to know which damages to pursue as not all damages are created equal.
Today’s newspapers are filled with stories about people and companies being defrauded. Whether it be investments, contracts for goods and services, or partnerships, lawsuits are filed every day alleging fraud claims. But litigants must beware – damages sought based on a fraud claim are not one-size-fits all. In fact, as reflected in a case involving a Baylor coach, the particular damages sought can lead to the unraveling of a fraud case.
If you enter into an agreement based on a fraudulent representation and are damaged, you have two remedies: (1) maintain the contract and recover damages for the fraud; or (2) rescind the contract, return what you purchased, and receive back what you paid.
Damages for fraud are divided into two categories, direct damages and consequential damages. An example of consequential damages would be foreseeable profits from other business opportunities that were lost as a result of the fraudulent misrepresentation. Direct damages can be measured in one of two ways: (1) out-of-pocket damages; and (2) benefit-of-the-bargain damages.
Out-of-pocket damages are measured by the difference between the value expended versus the value received, allowing the defrauded party to recover based on the actual injury suffered. Benefit-of-the-bargain damages are measured by the difference between the value as represented and the value received, allowing the defrauded party to recover profits that would have been made had the bargain been performed as promised.
Because the issue of whether certain damages should be considered out-of-pocket or benefit-of-the bargain is not always clear, the Texas Supreme Court has weighed in on this topic on several occasions. For example, in Formosa Plastics Corp. USA v. Presidio Eng. & Contractors, Presidio, a foundation contractor, received an invitation to bid on a Formosa expansion project. The invitation contained various representations regarding delivery of material and scheduling. Based on the representations, Presidio submitted a bid of $600,000 to complete the job. After Presidio learned that the representations were false and incurred damages relating to the representations, it brought a fraudulent inducement claim against Formosa and sought $1.3 million in damages.
Presidio calculated its $1.3 million damage figure by taking the $831,000 it spent on labor, materials and equipment used on the job, divided this amount by the original expected cost for the job of $370,000, and multiplied by its bid price of $600,000. The Texas Supreme Court rejected Presidio’s damage model stating that it was speculative and that Presidio may not have gotten the project if it bid $1.3 million as two of the other three competing bids were less than $1.3 million.
Instead, the Court calculated Presidio’s out-of-pocket damages as $231,000 (its $831,000 cost minus the $600,000 it received). Alternatively, Presidio could recover benefit-of-the-bargain damages of $461,000 (bid price of $600,000 less expected cost of $370,000 for a profit of $230,000, plus $831,000 in actual cost, less $600,000 actually paid).
As in the Formosa case, benefit-of-the-bargain damages may often be larger than out-of-pocket damages. Beware, however, that benefit-of-the-bargain damages may be harder to prove and, in some cases, may not be recoverable at all.
A former Baylor University coach discovered this fact in a 2007 Texas Supreme Court ruling. Tom Sonnichsen was hired as the women’s volleyball coach in 1989. In May 1995, Baylor administrators allegedly told Sonnichsen that they planned to enter into a two-year written contract with him. Baylor never presented Sonnichsen with the contract and in December 1995 it informed him that he would not receive a contract for 1996-97 but would be paid through May of 1996.
Sonnichsen sued Baylor for breach of its oral promise to enter into a two-year contract with him and for fraud based on its promise to provide him with a two-year contract. The Texas Supreme Court held that the statute of frauds (providing that a contract not fully performable within one year must be in writing) barred Sonnichsen’s breach of contract claim. The Court further held that when a fraud claim arises from an unenforceable contract, the statute of frauds bars benefit-of-the-bargain damages. The statute of frauds does not, however, bar the recovery of out-of-pocket damages.
The question then became whether the damages sought by Sonnichsen were benefit-of-the-bargain damages (which were not recoverable) or out-of-pocket damages (which were recoverable).
The damages sought by Sonnichsen were (1) the inability to obtain employment during the 1996-1997 season, (2) the lost opportunity to advance his career and increase earning capacity, (3) lost revenues from a 1996 summer volleyball camp at Baylor, and (4) loss of tuition benefits by which he could have completed his master’s degree at Baylor’s expense.
The Court held that all of the damages sought by Sonnichsen were benefit-of-the-bargain damages as they were not based on something he parted with or lost during his actual contract term, but were benefits he did not receive as expected or would have received had his employment with Baylor continued. Because the damages sought by Sonnichsen were unrecoverable benefit-of-the-bargain damages as opposed to recoverable out-of-pocket damages, his fraud claim failed.
These cases show that damage calculations relating to fraud claims can be complex. To avoid heartache later, be sure to engage in a rigorous review of applicable case law when preparing the damage model you intend to use in a case.