RPLR Jan 2018

                                                                          Imputing Knowledge in Fraud Claims

                                                                                           Roger Bernhardt

To: Younger Associate

From: Older Practitioner

I have studied your description of the new matter of Robin v Orson (a/k/a RSB Vineyards, LLC v Orsi (2017) 15 CA5th 1089, reported at p 19), which you propose that our office should accept. As I understand it, our prospective client, Robin, purchased some commercial property that included a new residence that Orson had had built on it, but that had been so poorly constructed that Robin was forced to demolish it just 1 year after she purchased it (only 4 years after it had been constructed and 2 years after it was put in use). I can understand why Robin is aggrieved, but I am not persuaded that we should take her case or encourage her to pursue it.

I concur with you on your relative unconcern about Robin’s rather desultory inspection of the property (which Orson will surely characterize as a lack of due diligence), and I do wish she had put greater effort into prepurchase inspections, but I agree that this rather casual examination will not hurt too much if we can show that she otherwise has a good case. It is the merits of that case of which I am skeptical.

Breach of Contract

I do not think that Robin has much of a breach of contract claim. I find no provision of the contract that we can persuasively contend Orson breached. His contractual obligation was only to convey good title to the property, not to improve it or do any construction on it. I know that Orson was also contractually obliged to disclose all material facts and defects about the property, but those disclosure obligations refer to those “known” to him, which does not make any nondisclosure per se actionable, but instead forces us to prove that Orson had knowledge, which—as you know—he denies. Indeed, this would probably make a great fraud case—more on this issue below—if we could prove that he knew about the defects he did not disclose to her.

Negligence and Warranty

Nor do I think we would get very far by claiming there was any negligence or breach of warranty, because I find no provisions in the contract imposing any construction obligations or warranties of new construction on Orson. You have not suggested there are any implied warranties in a case such as this, but do let me know if you have any in mind. Without them, I do not put much hope in a negligence or breach of contract or warranty claim against Orson as the seller. I would be glad to consider negligent construction claims against the architect or engineer or contractor, but you will have to give me more background about privity and statute of limitations issues before we agree those claims will fly.

I have read the reports of our investigator, Manny, but they reach two significant negative conclusions. First, Manny says that Orson denies having made any affirmative representations to Robin about the condition of the property, which Robin does not dispute, and which devastates her claims of intentional or negligent misrepresentation. No jury is likely to find a seller guilty of misrepresentation, intentional or negligent, when the evidence shows that neither he nor his broker said anything to the buyer.

Concealment

I have expressed this worry to you before and you have countered that Orson could be guilty of intentional concealment even if he did not make any affirmative representations. Good thinking, but showing that the construction was defective and that Orson did not disclose that to Robin does not automatically make a case for fraud. If we intend to convince a jury that Orson was guilty of intentional concealment, we are going to have to show not only his silence but also that he had actual or constructive knowledge of the deficiencies. In light of Orson’s declaration of ignorance of any construction defects (and Robin’s admission that she has no evidence to contradict his assertion), how are we going to stop Orson from keeping Robin’s claim of intentional misrepresentation away from a jury?

“Seller Should Have Known”

You argue that we could say Orson might be guilty of misrepresentation by not disclosing construction defects that he had to have known about even if we cannot prove that he actually knew of them, i.e., that a seller “should have known” (as opposed to “actually had known”) of defective construction. It is true that Manny reported that although Robin provided him with no evidence suggesting that Orson had any actual knowledge of the problems, she “did demonstrate that the deficiencies were so severe that his construction professionals should have been aware of them.” (Oh, if Manny were only an attorney!) But can we contend, as Manny argues, that this kind of constructive knowledge can be imputed to Orson and thus make him liable for not disclosing it? Manny’s argument might well fly for students in my Property course, who regularly believe that a good case for fraud can be made by simply showing that a seller (or landlord) should have known about what he failed to disclose, negligent failure to investigate or disclose being equivalent to lying in their minds. But I fear that judges will continue to instruct jurors that commercial sellers do not have a duty to investigate the properties they sell (in California, only residential brokers do), meaning that people like Orson are unlikely to be found guilty of fraud for failing to disclose defects that they might have discovered if they had investigated more competently. Our legal system might perhaps work more equitably (if somewhat less efficiently) if sellers of used housing were required by the laws of negligence to inspect and disclose (or, even better, to warrant what they were selling), but that is not the way it is.

“Somebody Should Have Known”

Perhaps we can show that somebody had some actual knowledge, even if it was not Orson, the seller. There is no mention of any broker in the picture, but Manny argues that the architect, structural engineer, or general contractor (all employed by Orson) “should have known” of the defects (even if none of them would admit to actually knowing of those defects). Can we, from that, impute to Orson some kind of knowledge, and thereby establish a basis for imposing on him a legal duty to disclose defects to Robin, even if he didn’t know of them himself? In other words, can we say that because Orson’s contractor should have known of the defects, Orson therefore should have informed Robin about them?

Imputing Knowledge From Somebody

We might perhaps be able to impute any actual knowledge that the architect, engineer, contractor, or their employees actually had, but not if all of those persons deny knowing anything. We are unlikely to get very far with such imputations if all we can say is that those persons should have known. I read in a recent case that “only where the circumstances are such that the defendant ‘must have known’ and not ‘should have known’ will an inference of actual knowledge be permitted.” That statement probably reflects a common judicial view and means, I think, that we will be able to get this case to a jury only if the trial judge is persuaded that, despite their denials, those employees “must” have known about the defects, not just “should” have known. That is possible, but we ought to warn Robin about its unlikelihood.

My next concern is that, even if we think a court and jury could conclude that the seller’s employees must have known of construction defects, those employees are not currently defendants in this proposed action. I do not think it is likely to help our case to name them as defendants who should themselves have spoken to Robin. But, as against Orson, how do we get from showing that because some of his employees must have known of the construction defects, a jury is therefore justified in finding that Orson himself can be imputed with having such knowledge of those defects (and therefore liable for not telling Robin about them)? Some jurors may likely conclude that some of the construction crew probably knew about the deficiencies, but once those jurors are instructed that the only knowledge they may impute to Orson from his employees is actual knowledge or knowledge that those employees must have acquired, that instruction will make any meaningful imputation hard to accomplish.

This prompts me to suggest that you might consider, if we go further in this matter, whether we can make out a case for Robin against the construction crew, probably for negligence. The fact that she was not in privity of contract with those persons is a complication. You should make sure you pay attention to the time limitations of CC §§895–945.5 (the Builder’s Right to Repair Act).

Knowledge by Nonprofessionals

We also have to deal with Manny’s further conclusion that these defects “would have been apparent only to a professional who was familiar with structural engineering and commercial building code requirements.” How are we going to be able to impute knowledge of defects, even under a “must have known” standard, to a seller who is not himself engaged in construction activity, but rather in viticulture? Could a jury be instructed that the “sheer number and severity of the structural defects” (Manny’s language) can allow a nonprofessional like Orson to be imputed with knowing of the defects?

Knowledge by Nonagents

I have one final worry, although I admit this one may be too subtle to worry about. Assuming we can persuade a jury that Orson’s architect or engineer or contractor knew or must have learned of the defective construction, did those persons acquire this knowledge or learn these facts in the right capacity? They may have discovered the deficiencies while they were working for Orson, but were they his agents at the time they acquired (or should have acquired) their knowledge?

The Restatement Third of Agency (§1.01, Comment (c)) says “[n]ot all relationships in which one person provides services to another satisfy the definition of agency.” Specifically, CC §2295 defines an agent as “one who represents another ... in dealings with third persons.” This representation requirement is crucial, as expressed in Restatement Third of Agency §1.01, Comment (c):

It has been said that a relationship of agency always “contemplates three parties—the principal, the agent, and the third party with whom the agent is to deal.” [Citation.] It is important to define the concept of “dealing” broadly rather than narrowly. For example, a principal might employ an agent who acquires information from third parties on the principal’s behalf but does not “deal” in the sense of entering into transactions on the principal’s account. In contrast, if a service provider simply furnishes advice and does not interact with third parties as the representative of the recipient of the advice, the service provider is not acting as an agent.

This means that we have two hurdles to overcome to impute knowledge from the construction crew members to the seller. First, we need to show that these employees must have learned of the defects (rather than should have learned of them). Second, we have to show that they must have learned of those defects while they were acting as agents of Orson in dealings with others (rather than while engaged in some other activity). See Trane Co. v Gilbert (1968) 267 CA2d 720, 726, a rather old decision that noted, for purposes of knowledge imputation, an architect who acts as an agent when supervising construction is nevertheless only an independent contractor when preparing plans and specifications. (Although the Trane court justified making this distinction, I am not so sure it proves anything in Robin’s case, but it is nevertheless worrisome.)

As you can surmise, I see many difficulties in this case. We are sure to have to bear the expense of fighting off a summary judgment motion. Indeed, we may even lose on it!

 

41 Real Property Law Reporter 15 (Cal CEB Jan. 2018) © The Regents of the University of California, reprinted with permission of CEB