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Edward Lowry
Separation of Fraud, Breaches of Fiduciary Duty and Contract

by EDWARD LOWRY

     The Supreme Court of Virginia has long done battle to prevent causes of action for fraud from being brought where the true gravamen of the plaintiff’s complaint is a failure to observe contractual duties.

[T]he duty tortiously or negligently breached must be a common law duty, not one existing between the parties solely by virtue of the contract.

Foreign Mission Bd. v. Wade, 242 Va. 234, 241, 409 S.E.2d 144, 148 (1991), citing Spence v. Norfolk & W. R.R. Co., 92 Va. 102, 116, 22 S.E. 815, 818 (1895) . See full discussion in Appendix I - Thorny and Challenging Damages Issues: Making the Remedy Fit the Case and Proving It, Section I: “Distinguishing Between Contract and Tort.”

     A little over one year ago, however, the Court decided the case of Augusta Mutual Insurance Co. v. Mason, 274 Va. 199, 645 S.E.2d 290 (2007), which represents the furthest extent to date that the Court has gone to limit the scope of fraud. In that case, an insurance agent filed an insurance application for a client in which he misrepresented material facts. As a result, Augusta Mutual issued a home owner’s insurance policy that it claimed it would not have issued had it received a truthful application. When the house burned and Augusta refused to pay, litigation ensued. Augusta claimed breach of contract, fraud in the inducement and breach of fiduciary duty against the agent. In denying both the fraud and fiduciary duty claims, the Court has essentially held that, whatever else may be at play, if there is a contract involved and the contract contains duties that relate to the actions complained of, the only available cause of action is contract, even where the conduct induced the plaintiff to enter into a separate contract with a different individual.

     The Court turned to prior illustrative cases in which efforts had been made to base fraud claims on breaches of duties found in the contract between the plaintiff and the defendant. The Court singled out its prior decision in Richmond Metropolitan Authority v. McDevitt Street Bovis, Inc., 256 Va. 553, 507 S.E.2d 344 (1998) for particular analysis. There, a contractor submitted documents under oath stating that it had constructed the subject project according to the plans. In fact it had not. In ruling that this did not constitute fraud, the Court pointed out that the contract required that the construction be according to plans and required the submission of the documents sworn to. The actions were therefore in the nature of a breach of contract, not violation of a separate duty arising outside the contract.

The determination whether a cause of action sounds in contract or tort depends on the source of the duty violated. Because "each particular misrepresentation by [the contractor] related to a duty or an obligation that was specifically required by the . . . [c]ontract," we concluded that the contractor's misrepresentations did not give rise to a cause of action for actual fraud.

Id., at 205-206. The Court in Augusta, however, went a step further, holding

The duties that [the agent] allegedly violated by making fraudulent representations about the condition of the clients’ flue and by signing [another’s] name on the Report arose solely by virtue of the Agency Agreement between Augusta Mutual and [the agency].

Id.

     Significantly, the Court in Augusta reaffirmed that fraud in the inducement still exists:

It is true that a "false representation of a material fact, constituting an inducement to the contract, on which [a party] had a right to rely, is always ground for rescission of the contract by a court of equity" or "ground for an action for damages in a court of law."

Id., at 204, citing George Robberecht Seafood, Inc. v. Maitland Bros. Co., 220 Va. 109, 111-12, 255 S.E.2d 682, 683 (1979). The Court also acknowledged that “a single act or occurrence can, in certain circumstances, support causes of action both for breach of contract and for breach of a duty arising in tort.” Id., at 205. What the Court did not do was analyze the insurance company’s position that the agent’s fraud was inducing it to enter into a separate contract with the client based on misrepresentations. While the agent breached his contract with the insurance company, giving rise to a contract action, he also induced the entering of another contract. Arguably, the agent thereby violated the same duty the client would have violated had they made the misrepresentations on the application. The same would be true if the misrepresentations had been made by an agent of the customers. The same duty all people have at common law not to induce others to take action to their detriment based on misrepresentations.

     Query: If the customers had made the misrepresentation, presumably they could be held responsible for fraud in the inducement. Why should the insurance company have been denied tort remedies where its agent did the same thing in order to earn a commission?

     Contrast Augusta with Sea-Land Service, Inc. v. O'Neal, 224 Va. 343, 297 S.E.2d 647 (1982). In Sea-Land, the plaintiff desired to change jobs within the same company. She was told by the employer that she could be hired for the new position if she first resigned from her current position. She did and the employer reneged. The plaintiff then sued and obtained judgment against the employer for both breach of contract and fraud. The Supreme Court affirmed, holding with respect to the fraud count that “promises which are made with a present intention not to perform” qualify as fraud. The plaintiff was allowed to collect not only contract damages, but also tort damages for future earnings “based upon her former position as a sales representative” and for embarrassment or humiliation.

     Query: Why was not the failure to hire her a breach of an oral contract to hire her in her new position? And if it was, why would that not be breach of a duty under that new contract which barred her from suing in tort? Why is Augusta different in principle from Sea-Land?

     In a later case, Sartin v. Mazur, 237 Va. 82, 85-85, 375 S.E.2d 741 (1989), the Court seems to have walled Sea-Land into a very narrow passageway based on its unique facts. In Sartin, the plaintiff, who was employed by a different employer was offered a job by the defendant. She accepted and resigned her employment. The defendant then reneged. One might think this was a slam dunk in light of Sea-Land. Not so. The Court held that the offer to hire was not conditioned on her first resigning her current job, as was the case in Sea-Land (how was she to accept the new job without resigning the old job?). The Court also observed that the new job was an employment at will hiring and that she could have been immediately terminated if she had been hired. This too seems to have been a distinction without a difference. In Sea-Land, the Court went to pains to point out that the new offered position did not specify whether it was employment at will, but employment at will under Virginia law is the default presumption unless there is a contract specifying otherwise.

Query: Why was a promise with no intent to perform actionable in Sea-Land, but not in Sartin?

Separation of Fiduciary Duty and Contract. The Court in Augusta next went on to deliver a similar blow to causes of action for breach of fiduciary duty by holding that, where the breach arises out of a contractual relationship, there is no cause of action in tort for the breach. Curiously, the Court first reaffirms all of its prior pronouncements on the existence of fiduciary duties in contractual situations. For example:

[T]he duties that [the agent] allegedly violated are nothing more than the fiduciary duties an agent owes to his or her principal. See Horne v. Holley, 167 Va. 234, 241, 188 S.E. 169, 172 (1936) ("[A]n agent is a fiduciary with respect to the matters within the scope of his agency."). "A fiduciary relationship exists in all cases when special confidence has been reposed in one who in equity and good conscience is bound to act in good faith and with due regard for the interests of the one reposing the confidence." H-B Ltd. P'ship v. Wimmer, 220 Va. 176, 179, 257 S.E.2d 770, 773 (1979); see also Ferguson v. Gooch, 94 Va. 1, 6, 26 S.E. 397, 399 (1896). "[I]ncorporated in every contract between a fiduciary and his principal is an obligation, imposed by law upon the fiduciary, to disclose anything known to him which might affect the principal's decision whether or how to act." Owen v. Shelton, 221 Va. 1051, 1054, 277 S.E.2d 189, 191 (1981).

Id., at 207. The Court then observed that, had it not been for the agency agreement, the agent would have no fiduciary relationship whatsoever to the insurance company and proceeds to revolve to a position that, for this reason, a cause of action ex contractu is inappropriate:

"The law of torts provides redress only for the violation of certain common law and statutory duties involving the safety of persons and property, which are imposed to protect the broad interests of society." Filak v. George, 267 Va. 612, 618, 594 S.E.2d 610, 613 (2004). Any fiduciary duty allegedly breached in this case existed solely because of the contractual relationship between Augusta Mutual and [the agency], and in turn, its employee, [the agent]. Therefore, we hold that Augusta Mutual failed to assert a valid claim for breach of fiduciary duties.

Id., at 208.

     Query: What is left for causes of action for breach of fiduciary duty? What fiduciary relationships exist outside of those established by contract?

     Query: Is not the concept of breach of fiduciary duty itself a common law concept? Query: Where the fiduciary relationship arises out of contract, is there any less need to protect the principal from the damages caused by a breach of those duties than in a non-contractual situation? And why would such situations not be included in “the broad interests of society?”

     An overly narrow reading of Augusta would require a finding that all breaches of fiduciary duty which arise out of an agency relationship must sound solely in contract. Such a reading, however, would seem to be contrary to the Supreme Court of Virginia's rulings in numerous cases, both before and after Augusta. For example, in Banks v. Mario Industries, 274 Va. 438, 650 S.E.2d 687 (2007), a case decided subsequent to Augusta, the Plaintiff employer brought a tort action claiming that certain former at-will employees and independent sales representatives conspired to harm its business via a newly-formed competing business. The employer included counts for tortious interference with business relations, common law and statutory conspiracy, breach of fiduciary duty, misappropriation of trade secrets and conversion. In ruling that the breach of fiduciary duty claims were properly submitted to the jury, the Court held that:

Cook was an employee of Mario and admitted he owed Mario a duty of loyalty. Banks admitted that she was Mario's agent and that she owed a duty of loyalty to Mario. These party admissions combined with the fact that Banks' job was to faithfully represent Mario's interests in her territory, support the claim of a fiduciary duty.

Id., at 453. Thus, the Court specifically held that violations of the duties which are an inherent part of the employment and agency contracts can and do establish breaches of fiduciary duty.

     Banks is consistent with the Virginia Supreme Court's decisions prior to Augusta as well. In Advanced Marine Enterprises v. PRC Inc., 256 Va. 106, 501 S.E.2d 148 (1998), the Virginia Supreme Court also affirmed what was clearly a tort remedy where the chancellor below “awarded punitive damages . . . for breach of fiduciary duty, intentional interference with contractual relations, and intentional interference with prospective business and contractual relations.” In that case, 29 former employees conspired to resign en masse in violation of their contractual duties under non-competition agreements and their duty of loyalty as employees. Id., at 124, cited with approval in Wilkins v. Peninsula Motor Cars, 266 Va. 558, 561, 587 S.E.2d 581 (2003). In Feddeman & Company v. Langan Associates, 260 Va. 35, 46, 530 S.E.2d 668 (2000), the Court reversed a trial Court which had set aside a plaintiff’s verdict. The jury had awarded $3,300,000 for breach of fiduciary duty (by director defendants whose duties in that regard arise out of their contractual relationship with the corporation), usurpation of corporate business opportunity, intentional interference with contract and business expectancies and common law conspiracy to interfere with contractual relations and business expectancies. Clearly, then, the Virginia Supreme Court has affirmed and continues to affirm that a cause of action exists for the tortious breach of fiduciary duties regardless of whether there is a preexisting contractual relationship between the parties.

     Hopefully, Augusta will be viewed in light of its own facts to understand the intent of the Court which certainly demonstrates no intention to sweepingly overrule longstanding precedent that one standing in a fiduciary relationship must not act against the interests of his principal, even when that relationship is formed by a contract. Each of the cases recited above in which a tort remedy for breach of fiduciary duties was affirmed, decided both before and after Augusta, also involved fiduciary duties formed out of contractual relationships, as indeed the vast majority of fiduciary relationships are. Just as with its treatment of fraud, the Court in Augusta was focused on the source from which the particular duties arose. In the fraud section of the opinion, the Court held as it did because "each particular misrepresentation by [the contractor] related to a duty or an obligation that was specifically required by the . . . [c]ontract." Augusta at 205 206, quoting Richmond Metropolitan Authority v. McDevitt Street Bovis, Inc., 256 Va. 553, 507 S.E.2d 344 (1998). Similarly, in dealing with fiduciary duty, the Court held:

But for the existence of the Agency Agreement, neither Jones nor Lee Curtis would have owed any fiduciary duty to Augusta Mutual. That certain of those fiduciary duties arose by implication does not alter the result. See O'Connell v. Bean, 263 Va. 176, 181, 556 S.E.2d 741, 743 (2002). As we previously explained:
"If the cause of complaint be for an act of omission or non feasance which, without proof of a contract to do what was left undone, would not give rise to any cause of action (because no duty apart from contract to do what is complained of exits) then the action is founded upon contract, and not upon tort."

Id., at 207-208. The agent in Augusta owed his duties to the insurance company solely because of his contract with the company.

     It is difficult to say how the Courts will interpret Augusta both with respect to fraud and breach of fiduciary duty, but it is sure to generate much discussion both in and out of the courts.

For additional information, Contact Maggie Pearson, MichieHamlett, 434.951.7265 or by Email

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