Delaware Supreme Court Limits Damages for Fraud in the Absence of a Contract
February 8, 2021
Types : Alerts
This alert was authored by former associate Jackson E. Warren.
Perhaps the most important factor in deciding whether to litigate a commercial dispute is assessing available damages should you prevail. What at first blush may seem like a simple question too often becomes the centerpiece of the ensuing lawsuit, dwarfing the issue of liability itself.
Consider a relatively simple and easily repeatable scenario: A consultant provides extraordinary assistance enabling its client to buy a business for a great price. The merger generates extraordinary value for the client, and leading up to closing, its CEO repeatedly promises the consultant a commensurate and atypically high fee, even citing specific dollar figures. But amid the scramble to close the deal, the client and consultant never reach agreement as to compensation. The client changes its tune after closing, and the parties never agree on compensation, forcing the consultant to sue to recover anything.
Those basic facts led to an interlocutory appeal on an important but unsettled issue of Delaware law—what damages are available for fraud when the parties did not enter into an enforceable contract. The Delaware Supreme Court recently answered the issue, adding clarity and potentially complexity to the law of damages in Delaware.
LCT Capital, LLC v. NGL Energy Partners LP, No. 565, 2019 (Jan. 28, 2021)
The central issue on appeal was whether benefit-of-the-bargain (“BOB”) damages (as opposed to out-of-pocket (“OOP”) damages) are available for fraud in the absence of an enforceable agreement. The closest Delaware binding precedent, Stephenson v. Capano Dev., Inc., 462 A.2d 1069 (Del. 1983), held that, for fraud in general, Delaware permits the plaintiff to proceed on either theory, with BOB damages the “most common and accepted” remedy. With its opinion in LCT Capital, the Delaware Supreme Court refined this rule, holding that, except in “rare cases” and “unusual circumstances” not present in the case, BOB damages are not available in the absence of an enforceable agreement.
For orientation, a short Delaware damages refresher: Fraud damages are generally limited to “the direct and proximate result of the false representation,” and the two primary approaches to measure this are BOB damages and OOP damages. Despite what these terms might connote colloquially, under Delaware law, BOB damages are “the difference between the actual and the represented values of the object of the [fraud],” while OOP damages are “the difference between what the plaintiff paid and the actual value of the item that the plaintiff received.” BOB damages put the plaintiff in the position as if the fraud had been true, while OOP damages restore the plaintiff to its position before the fraud.
The LCT Capital Court first found that existing Delaware case law did not clearly resolve the issue, while non-Delaware case law revealed diverging approaches. To resolve the dilemma, the Court fell back on the fundamental principle that tort damages are meant to compensate the plaintiff for the harm proximately caused by the fraud and no more. The Court reasoned that, where the fraud did not cause the plaintiff to form a contract, OOP damages would typically restore what was lost and are thus the default remedy. It noted that to hold otherwise would introduce the difficulty of determining the benefit of a bargain the parties never formed.
The Court then reconciled two seemingly inconsistent Delaware cases by observing that in “unusual circumstances,” OOP damages may not make the plaintiff whole. In such circumstances, BOB damages may be appropriate even without an enforceable contract. In the prior Delaware cases, the plaintiffs had reasonably and foreseeably relied on defendants’ frauds to make decisions distinct from the failed bargain—buying property based on assurances of favorable financing and failing to procure alternate insurance based on assurances a policy had been issued. In those “rare cases,” BOB damages were appropriate because they served the same function as OOP damages: to compensate the plaintiff for the harm suffered, not to protect its expectation interest in the false representations.
In LCT Capital, the plaintiff had advanced a “unitary theory of damages” focused exclusively on the value of services provided. The Court held that OOP damages would fully compensate it for that harm. Conversely, BOB damages would impermissibly protect its expectation interests and thus were unavailable. That holding means the plaintiff could not recover what it expected to receive but only the value of services it actually provided—even when its expectation was directly based on fraudulent misrepresentations.
Putting the holding of LCT Capital into more conventional damages terminology, the Court appears to have held that a plaintiff may recover reliance damages but not expectation damages for fraud when there is no enforceable agreement. The default remedy of OOP damages will typically compensate plaintiffs’ reliance by measuring the value it lost in dealing with the defendant. BOB damages are only available to the extent a plaintiff reasonably and foreseeably relied on the fraud in making decisions distinct from the failed bargain.
- Delaware courts continue to critically examine and refine the law of damages and will not compromise the fundamental principles underlying legal remedies—even when the result appears (as it did to the trial court in LCT Capital) to be “incredibly unfair to the unique factual setting of the case in light of the reprehensible conduct of the Defendants.”
- For service providers, LCT Capital emphasizes the importance of agreeing to compensation up front because, even in the face of fraud, remedies may otherwise be limited to the fair value of services provided.
- For aggrieved parties considering litigation, LCT Capital emphasizes the importance of critically assessing all viable legal and equitable claims not only in terms of liability but also with respect to precise theories of damages.
- For potential defendants, LCT Capital reassures that Delaware courts will not bend the law to the facts or permit unwarranted windfalls to successful plaintiffs. In some instances, that may weigh in favor of a preemptory suit in Delaware when otherwise appropriate.