Dismissal of Fraud Claims via the Economic Loss Rule: Part III of Our Series on Oracle/NetSuite ERP Litigation
By Pam Fulmer and Sara Schlesinger*
This blog post is a continuation of our series on litigating fraud and breach of contract claims related to failed Enterprise Resource Planning (ERP) software installations against Oracle and its subsidiary NetSuite. ERP software is a business planning and management tool and is provided by companies (or subsidiaries of companies) including NetSuite, Oracle, SAP and other software publishers. In a previous blog post, we discussed how Oracle has sought to defeat fraud claims related to failed ERP installations by arguing that any alleged misrepresentations by Oracle were non-actionable puffery. This blog post delves into the economic loss rule that Oracle similarly uses to attack fraud claims and suggests some best practices to ensure fraud claims stick.
As discussed in previous blogs, customers of NetSuite have sued the company alleging that NetSuite overpromises to ERP customers in pre-contract negotiations and fails to deliver a functional ERP product. Customers seeking relief from such unfair business practices may want to consider bringing fraud claims, in addition to breach of contract claims against NetSuite if the facts support it. There are many reasons why asserting a fraud claim can be advantageous. Fraud claims can support punitive damages awards, unlike contract claims. The threat of punitive damages can be a powerful incentive for encouraging a settlement and speedier resolution for aggrieved customers. Further, the customer’s contract may specifically limit, disclaim, or foreclose (1) liability for breaching certain representations or warranties; or (2) certain damages which may be available under a fraud claim. Fraud claims may be more likely to succeed than breach of contract claims due to these limitations or simply due to the applicable law. Moreover, fraud claims can allow a plaintiff to seek recission and unwinding of the contract in question.
When asserting fraud claims, smart pleading is important to ensure that the opposing party cannot defeat the claim on a motion to dismiss or demurrer. Defendants like NetSuite have used the economic-loss rule, among other strategies, to ask courts to strike down fraud claims brought with breach of contract claims (for an example, see Grouse Rivers Motion to Dismiss, Docket Entry 25).
What is the economic-loss rule and why is it important to plead around?
The economic-loss rule bars fraud claims if the plaintiff’s claims for relief only assert economic losses related to broken contractual promises. As seen in the 2004 Supreme Court case Robinson Helicopter Co. v. Dana Corp., this doctrine polices the line between tort and breach of contract claims by preventing fraud claims that are redressable under contract law unless the purchaser suffered “harm above and beyond a broken contractual promise.” However, a party that entered a contract due to fraudulent inducement can recover in both contract and tort law. The Supreme Court noted this exception to the economic loss rule in Robinson Helicopter Co., amongst other exceptions. Each exception discussed arises from either (1) a duty completely independent of the contract; or (2) conduct that is “both intentional and intended to cause harm.”
Now for the non-lawyers, what is fraudulent inducement? In a nutshell, fraudulent inducement is when a party intentionally lies to another party to encourage them to enter a contract, and the deceived party decides to enter the contract based on the false representations.
Grouse River Outfitters Ltd. v. NetSuite, Inc. illustrates the fraudulent inducement exception in the context of ERP agreements with NetSuite. Grouse River, an outdoor sporting supply company, contracted with NetSuite to license ERP software to help run its business. Grouse River later asserted (1) fraudulent misrepresentation, (2) negligent misrepresentation, and (3) fraud in the inducement claims—among other claims including breach of contract—against NetSuite in the Northern District of California, where most lawsuits brought involving Oracle or NetSuite are litigated (to read the claims, see Grouse Rivers First Amended Complaint, Docket Entry 9).
NetSuite moved to dismiss the negligent misrepresentation claim, arguing that the claim should be barred because Grouse River had only asserted economic losses. The court dismissed the fraud claims on another basis but concluded that the economic loss rule did not preclude Grouse River’s negligent misrepresentation claim, noting that each of Grouse River’s three fraud claims “allege that NetSuite’s misrepresentations induced [Grouse River] to enter the subject contracts.” The court cited portions of Grouse River’s First Amended Complaint which asserted (i) that NetSuite induced and intended for Grouse River to rely on representations that NetSuite knew or should have known were false; and (ii) that Grouse River was entitled to recission of the contract and damages “as a direct and proximate result of NetSuite’s false representations which induced Grouse River to enter into [the contracts]” (emphasis added). According to the court, the fraud claims asserted more than just a failure by NetSuite to keep their contractual promises and were “independent of” the breach of contract claim.
Barrett Business Services, Inc. v. Oracle America, Inc. (Case No. CGC-19-572474) is another example of how to avoid economic loss rule issues while pleading fraud alongside breach of contract for failed ERP installations. As detailed in a previous blog post, Barrett Business Services (“BBSI”) sued Oracle and its partners Kbase Technologies, Cognizant Worldwide, and Cognizant Technology for negligent misrepresentation, breach of contract, and other claims over a failed ERP installation.
In the original complaint’s negligent misrepresentation claim, BBSI emphasized the defendant’s false representations, BBSI’s reliance on the misrepresentations, and the damage BBSI suffered due to this reliance. While the claim mentions that BBSI entered contracts with the defendants “as a result” of the misrepresentations, and that the contracts “were procured through misrepresentations,” the claim seems to emphasize damage to BBSI due to reliance on false statements by the defendants more so than fraudulent inducement by the defendants itself. In a demurer, Oracle asserted that BBSI’s negligent misrepresentation claim was barred by the economic loss rule because their breach of contract claims, and negligent misrepresentation claim relied upon the same allegations that the ERP software was unable to meet BBSI’s business requirements. In essence, BBSI seemed to be claiming the same issues arose from the misrepresentations and the breach of contract.
BBSI then amended the complaint, making clear in negligent misrepresentation claims that BBSI was “induced” to enter the relevant contracts “as a proximate result of” the defendants’ misrepresentations and suffered damages “as a direct and proximate result of Defendants’ misrepresentations.” The phrasing more clearly rested BBSI’s negligent misrepresentation claims on fraudulent inducement to contract itself, rather than on broken promises from the resulting contract. Oracle’s answer to the amended complaint did not assert any economic loss rule arguments against the negligent misrepresentation claims.
Grouse River, and Barrett Business Services contain lessons for aggrieved ERP customers seeking to assert fraud alongside breach of contract claims. The fraud claims that focused on fraudulent inducement caused by false representations were able to either avoid or survive economic loss rule challenges in these cases. This highlights the importance of differentiating between the bases for the fraud claims (misrepresentation leading to fraudulent inducement) and the breach of contract claims (broken contractual promises) in pleadings against parties responsible for failed ERP installations.
* Sara Schlesinger is a rising 2L law student at Northwestern University School of Law and is a 2022 summer law clerk for Tactical Law Group LLP.
By Tactical Law Attorneys and From Time to Time Their Guests