Clements Auto Company v. The Service Bureau Corporation

The Service Bureau Corporation, a wholly-owned subsidiary of International Business Machines Corporation, appeals from a judgment awarding SM Supply Company $480,811 in damages, the basis of the award being actionable misrepresentations made by SBC to SM in connection with the sale of data processing services.

SBC asks this Court to set aside the judgment. It contends: (1) that the trial court erred in finding that SBC had made actionable misrepresentations, and (2) that the trial court's award of damages was improper.

Diversity of citizenship is present and the amount in controversy exceeds $10,000.

We review the evidence only briefly because the trial court's opinion does so thoroughly. We accept all inferences which reasonably tend to support the conclusions of the trial court. Minnesota Amusement Company v. Larkin, 299 F.2d 142 (8th Cir. 1962).1

SBC is engaged in the business of electronic data processing, offering to the public its services in eighty-four branch offices throughout the United States. It sells data processing services in the following areas: payroll, personnel records, accounts receivable, billing, sales accounting, marketing studies, cost accounting, inventory record, budgets and general accounting.

SM operates wholesale supply houses at Mankato and Rochester, Minnesota, and at Eau Claire, Wisconsin. It operated a similar supply house in LaCrosse, Wisconsin, through 1965. It deals in automotive parts and supplies, electrical construction materials, and electronic parts, supplies and equipment. Each outlet stocks more than sixty thousand items, ranging in value from a few cents per item to hundreds of dollars per item and in quantities of from one to several thousands each. SM's volume of business exceeded $6,900,000 each year from 1962 through 1966.

The first business relationships between the plaintiff and the defendant developed in 1961. In that year, SBC agreed to furnish data processing service to a Chevrolet dealership affiliated with SM. The services proved satisfactory and led SM's president to discuss SM's inventory problems with SBC. SBC indicated that it did not, at that time, have the computer capacity to provide the required data processing services. In the summer of 1962, however, SBC informed SM that, early in 1963, it would be acquiring an IBM 1401 computer which would have the capacity to produce data processing service for SM.

SBC made a study of SM's operations during the summer of 1962, with the view of providing data processing services to SM. SBC conferred with SM frequently during the study period and subsequent thereto. In February, 1963, SM signed two contracts dated December 20, 1962, under which SBC agreed to provide certain basic data processing services to SM. The two contracts were 'accepted' by SBC in New York on April 4, 1963. Twelve additional contracts providing for additional services were signed by the parties during the succeeding four years. Processing of cards to be used in the system was initiated at the Mankato outlet in September, 1963; at the Rochester outlet in late 1963; and in the Wisconsin stores in the spring of 1964.

The nature of the data processing serices provided during the four-year relationship between SBC and SM may be conveniently categorized into three basic states. Initially, SBC automated SM's accounting and billing. At the same time, SBC used this input material to prepare certain monthly sales analysis reports and a weekly report of inventory movement. The inventory reports contained a six-week history of sales for all of SM's inventory. In August of 1964, the weekly inventory report was changed to a bi-weekly report which provided twelve weeks of history.

Second generation inventory reports began in January, 1965, and continued through December 4, 1965. These were bi-weekly reports which provided a twelve-week movement history, a record of inventory purchases, receipts and inter-branch transfers, and, for the first time, an on-hand balance of items for certain vendors selected by SM.

Finally, in December, 1965, SM signed a contract to obtain a third generation of inventory reports. These reports were to contain a detailed history for each item for the previous year, a movement history during specified months, an on-hand figure, and a computation of the number of weeks' supply of each item on hand. These reports were to be delivered beginning in January, 1966, but were not received until July, 1966, due to the discovery of an earlier programming error by SBC.

The services proved to be unsatisfactory to SM. It charges that the input method was slow and expensive, and that the reports were too error-prone and voluminous to be of use in purchasing inventory. SM finally terminated all contracts with SBC in January, 1967.

SM then brought the present lawsuit against SBC in September of 1967. It proceeded on the theories of rescission, breach of implied warranty, breach of contract, reformation and fraudulent misrepresentation. SBC counterclaimed for payments due.

The action was tried to the court without a jury. The court filed a detailed memorandum opinion and order on March 31, 1969. Clements Auto Company v. Service Bureau Corporation, 298 F.Supp. 115 (D.Minn.1969). The court denied recovery on all grounds other than misrepresentation, but found that SBC had made one central actionable misrepresentation to SM, i.e., that the proposed data processing system would, when fully implemented, be capable of providing SM sufficient information in a form such that when properly utilized, it would constitute an effective and efficient tool to be used in inventory control. /2/

It further found that SBC had made several other specific actionable misrepresentations to SM:

(1) that the only way SM would ever get an inventory control system such as that in use at the Chevrolet dealership would be by automating the firm's accounting;

(2) that there were controls built into the system which were adequate to prevent any but a minimal number of errors;

(3) that Friden Flexowriters were a suitable input device to be used in the data processing system, that eight Flexowriters would be sufficient to do the job, that the Flexowriters could be operated by normal clerical personnel, and that the Flexowriters would produce a typed hard copy of the invoice which could be sent along with the customer's order; and

(4) that weekly sales management reports provided by the contract would allow management by exception.

It is conceded by the parties that the trial court properly relied on Hanson v. Ford Motor Company, 278 F.2d 586 (8th Cir. 1960), in enumerating the essential elements of a fraud action in Minnesota:3

'1. There must be a representation; '2. That representation must be false; '3. It must have to do with a past or present fact; '4. That fact must be material; '5. It must be susceptible of knowledge; '6. The representer must know it to be false, or in the alternative, must assert it as of his own knowledge without knowing whether it is true or false; '7. The representer must intend to have the other person induced to act, or justified in acting upon it; '8. That person must be so induced to act or so justified in acting; '9. That person's action must be in reliance upon the representation; '10. That person must suffer damage; '11. That damage must be attributable to the misrepresentation, that is, the statement must be the proximate cause of the injury.'

It is important to emphasize that, in Minnesota, the element of scienter, or intent to deceive, or even recklessness, is not necessary to actionable fraud. As the Minnesota Supreme Court stated in Swanson v. Domning, 251 Minn. 110, 86 N.W.2d 716, 720-721 (1957):

'It is immaterial whether a statement made as of one's own knowledge is made innocently or knowingly. An intent to deceive no longer is necessary. Nor is it necessary to prove that defendants knew the representations were false. '* * * It is not necessary that the statement be recklessly or carelessly made. It makes no difference how it is made if it is made as an affirmation of which defendant has knowledge and it is in fact untrue. The right of recovery in a case of this kind is based on the fact that such statement, being untrue in fact, relied upon by the other party in entering into the transaction, has resulted in the loss to him which he should not be required to bear.'

See also Berryman v. Riegert, 286 Minn. 270, 175 N.W.2d 438 (1970).

While accepting the above as a correct statement of Minnesota law, SBC raises two arguments in opposition to the trial court's finding of liability for fraud. It first argues that the trial court erred in applying the Minnesota law of fraud to the present situation. The argument is rooted in what SBC considers to be a legal inconsistency in the trial court's findings. It is developed by SBC as follows:

(1) The trial court found certain aforementioned representations made to SM to be actionable under the Minnesota law of fraud.

(2) The trial court found that these same representations did not give rise to an express warranty because there was no valid agreement by the parties incorporating these representations into the contract, and that a disclaimer in the various contracts effectively negated all implied warranties.

(3) Under the relevant law, innocent misrepresentations and warranties, either express or implied, are substantially similar in nature.

(4) The passage of the Uniform Commercial Code by the legislature evinced an intent to have that body of law control all commercial transactions.

'In short, SBC does not believe that the law of innocent misrepresentations in Minnesota can or should be read as in conflict with commercial doctrine in that state, and believes it was error for the Trial Court to do so. The Trial Court treated the facts of this case as giving different results when viewed under Minnesota Tort Law than when viewed under Minnesota Contract Law. SBC does not believe the results can or should depend merely upon the label.'

Appellant's Brief. p. 29.

SBC candidly admits that this question has never been squarely faced by the Minnesota Supreme Court, but suggests that the governing policy of the U.C.C. compels its interpretation of the relationship between contract and tort law.

We cannot agree that this argument dictates a result other than that reached by the trial court. We start with the premise that the Erie Doctrine requires the application of Minnesota law. In the absence of explicit authority from the Minnesota Supreme Court, our obligation is '* * * to determine what the Supreme Court of Minnesota would declare the Minnesota law to be were this case before it.' Village of Brooten v. Cudahy Packing Company, 291 F.2d 284, 288 (8th Cir. 1961).5

The first argument raised by SBC necessarily rests on two assumptions, both of which must be valid to sustain SBC's position:

(1) That the trial court's ruling as to the warranties was a correct assessment of Minnesota law.

(2) That the Minnesota Supreme Court would not permit the same representations to result in liability for fraud, but not for breach of warranty.

Assuming, arguendo, that the trial court correctly found the warranty disclaimer valid,6 we nevertheless believe that the Minnesota Supreme Court would find liability for fraud. SBC's conclusion that liability for innocent misrepresentation cannot exist without liability for breach of warranty compels two further conclusions:

(1) A contract provision which validly negates warranties is sufficient to negate liability for innocent misrepresentation.

(2) The Minnesota Supreme Court would be willing to distinguish between innocent and intentional misrepresentations.7 Both of these conclusions appear to be contrary to the main thrust of Minnesota law.

In Ganley Bros., Inc. v. Butler Bros. Building Co., 170 Minn. 373, 212 N.W. 602 (1972), two contractors had entered into an agreement involving subletting highway construction work. The subcontractor subsequently sued the prime contractor for damages alleging, inter alia, that the contract in question was induced by false and fraudulent misrepresentations. By way of defense, the prime contractor introduced a provision in the contract which stated:

'The contractor has examined the said contracts of December 7, 1922, and the specifications and plans forming a part thereof, and is familiar with the location of said work and the conditions under which the same must be performed, and knows all the requirements, and is not relying upon any statement made by the company in respect thereto.'

Id. at 212 N.W. 602.

The trial court dismissed the fraud action on the grounds that this provision validly negated fraud. On appeal, the Supreme Court of Minnesota reversed, holding that:

'The law should not, and does not, permit a covenant of immunity to be drawn that will protect a person against his own fraud. Such is not enforceable because of public policy.'

Id. at 212 N.W. 603.

In arriving at this decision, the court specifically considered the extent of freedom of contract and concluded that it did not extend to waiver of fraud either directly or indirectly.

SBC concedes that the teachings of Ganley Bros. ard applicable where the fraud action is based on intentional conduct, but contends the rule must be different where innocent misrepresentations are the basis of the fraud action. In support of this reading, it refers us to the court's statement that:

'Language is not strong enough to write such a contract. Fraud destroys all consent. It is the purpose of the law to shield only those whose armor embraces good faith.'

Id. at 202 N.W. 603.

A close reading of Ganley Bros. leaves us uncertain whether the fraud considered in that case included an element of bad intent. In any event, we do not believe that this gratuitous language sets out the controlling factor in determining the effect of an exculpatory contract provision on an action in fraud. In the case of National Equipment Corporation v. Volden, 190 Minn. 596, 252 N.W. 444 (1934), the Minnesota Court dealt with a fraud action based on misrepresentations in the sale of a 'dumptor,' a piece of construction equipment used in earth moving operations. The court first cited Ganley Bros., Inc. v. Butler Bros. Building Co., supra, for the proposition that parole evidence was properly introduced to prove that the contract had been procured by fraudulent representations. It then went on to find that fraud had been committed and, in so doing, relied on its earlier opinion in Helvetia Copper Co. v. Hart-Parr Co., 137 Minn. 321, 163 N.W. 665 (1917), for its definition of fraud. In Helvetia Copper, the court had specifically held that an action in fraud required no showing of scienter:

'The damage to plaintiff, arising from the fact that * * * (the representations were false) * * * is the same whether the representations * * * were known to be false by defendant, and made with intent to deceive, or whether they were made innocently and in perfect good faith. The good faith of defendant is no defense. 'Defendant was the manufacturer of the engine, and presumptively possessed of knowledge of its condition and whether the improvements suggested would overcome the defects theretofore complained of. The representations were unqualified and must be treated as assertions of a fact within the knowledge of defendant, the falsity of which constitutes fraud as a matter of law.'

Id. at 163 N.W. 667.

The court in National Equipment then faced the issue pertinent here. The sales contract contained a provision that:

'* * * no representations made by an agent not included herein shall be binding * * *.'

The court followed Ganley Bros. in finding the contract provision ineffective to negative the fraud action:

'A party who makes fraudulent representations to induce another to make a contract cannot escape liability for his fraud by incorporating a disclaimer of fraud in the contract.'

Id. at 252 N.W. 445.

Considering the court's definition of fraud and the fact that we can find no indication in the opinion that deceitful intent was in fact demonstrated, we believe this decision must be read as holding that a general disclaimer clause is ineffective to negate reliance on even innocent misrepresentations. This view is further supported by Goldfine v. Johnson,208 Minn. 449, 294 N.W. 459 (1940), wherein the court relied on the decision in National Equipment in ruling that the question of reliance was for the jury. The dispute involved the sale of a tractor and the court made the following observations:

'The contract was that defendant should take the tractor 'as it is.' Thereby, the question of warranty is ruled out. Defendant places sole reliance upon his allegation of fraud. 'If the representations in question were false, as they have been found to be by the jury, they were fraudulent.'

Id. at 294 N.W. 460.

There is no indication that the disclaimer of warranty negates reliance on false representations made with or without intent to deceive.8

The only situation in which the Minnesota courts have held that a contract provision negatives a claim of fraud is where the provision explicitly states a fact completely antithetical to the claimed misrepresentations. For example, in Vint v. Nelson, 267 Minn. 490, 127 N.W.2d 177 (1964), the plaintiff sued pursuant to signed contract for a real estate broker's commission. The defendants cross-claimed for reformation of the contract alleging that they had been induced to sign the contract by false and fraudulent representations that the contract was cancellable on thirty days' notice. The plaintiff denied making the alleged statements and the contract itself provided in part:

'* * * said exclusive agency to remain in effect for the period of Six months from the date hereof and and thereafter until revoked by thirty days notice in writing. * * *'

Id. at 127 N.W.2d 178.

In this case, the court held that the parole evidence exception of National Equipment Corp. v. Volden, supra, and Ganley Bros., Inc. v. Butler Bros. Building Co., supra, was inapplicable where:

'* * * the testimony offered to establish fraud related to matters known to be covered by the written agreement and to the claim that plaintiff had represented that contractual provisions having reference thereto would not be effective.'

Vint v. Nelson, supra at 127 N.W.2d 181. See generally, City of St. Paul v. Dahlby, 266 Minn. 304, 123 N.W.2d 586 (1963); Skelton v. Grimm, 156 Minn. 419, 195 N.W. 139 (1923). But see, Weise v. Red Owl Stores, Inc., 286 Minn. 199, 175 N.W.2d 184 (1970).

The representations complained of here do not relate to or contradict any specific substantive contract provision as in Vint v. Nelson, supra. The provision SBC seeks to invoke is merely a general integration and disclaimer clause which falls within the rule established in National Equipment Co. v. Volden, supra.

It is also worthwhile to note that a student article in the 1939 Minnesota Law Review would apparently agree with our conclusion as to the effect of a general disclaimer clause. Note, 23 Minn.L.Rev. 784 (1939). The article, entitled 'Contractual Disclaimers of Warranties,' is primarily concerned with various methods used by courts to nullify the effect of contract disclaimer provisions. After considering the orthodox approaches then used by courts, expecially the Minnesota Supreme Court, in contract cases, the author suggests.

'There is one other possible solution for the problem. If the buyer were to bring a suit in tort for deceit instead of in contract for breach of warranty, the action should not be defeated by a provision waiving warranties. Although in a majority of the American courts the purchaser undoubtedly would not be able to prevail if he could not prove scienter, a few states headed by Minnesota, do not make that requirement.'

Id. at 798.

While the author concedes that this approach would not generally be effective where no affirmative representations had been made, it is undisputed that the present action is based on affirmative oral and written statements.

SBC's argument that the passage of the Uniform Commercial Code would lead the Minnesota Court to a contrary result is unpersuasive. The U.C.C. did not become effective in Minnesota until July 1, 1966. Minn.Stat. 336.10-105 (1966). Since the contracts in question were signed and primarily performed prior to that date, it is highly likely that the Minnesota Supreme Court would decide this case on the basis of the preexisting law. See, Dougall v. Brown Bay Boat Works and Sales, Inc., 287 Minn. 290, 178 NW.2d 217 (1970).

Secondly, and more importantly, we do not believe that there are any indications that the passage of the U.C.C. would, in fact, alter the Minnesota law of fraud. The Uniform Commercial Code itself provides that:

'Unless displaced by the particular provisions of this chapter, the principles of law and equity, including the law merchant and the law relative to * * * fraud, misrepresentation * * * or other validating or invalidating cause shall supplement its provisions.'

Minn.Stat. 336.1-103 (1966). See also, Minn.Stat. 336.1-721 (1966). Cf., Thorton Bros. v. Reese, 188 Minn. 5, 246 N.W. 527 (1933).

Further, the Uniform Commercial Code was, in part, a replacement for the Uniform Sales Act which had been the basis of existing commercial law in Minnesota since 1917. Laws 1917, Chapter 465 (Minn.). A governing policy of national uniformity in commercial transactions was a motivating influence in the passage of both of these uniform acts. Moreover, the passage of the U.C.C. did not substantially alter Minnesota law as to disclaimer of warranties.9 These factors tend to undercut SBC's contention that the passage of the U.C.C. would alter the relationship in Minnesota between the law of fraud and the law of warranty. Similarly, the fact that the U.C.C. has not brought a radical change to Minnesota contract law would give added authority to the earlier decisions of the Minnesota Court.

In viewing these earlier decisions, we believe it is relevant that the Minnesota Court has stated that:

'The fact that one who has been defrauded has a remedy on the contract or on a guaranty or warranty is not any impediment or defense to an action for the fraud or deceit. * * *'

Osborn v. Will, 183 Minn. 205, 236 N.W. 197, 200 (1931). See also, Hedin v. Minneapolis Medical & Surgical Inst., 62 Minn. 146, 64 N.W. 158 (1895).

On other occasions, the Minnesota Court has reiterated the differences in the law governing breach of warranty and the law governing fraud. E.g., Hemming v. Ald, Inc., 279 Minn. 38, 155 N.W.2d 384, 386-387, n. 2 (1967) (time period in which rescission allowed); Lehman v. Hansord Pontiac Co., 246 Minn. 1, 74 N.W.2d 305, 311 (1955) (measure of damages). It has never indicated that these distinctions do not obtain where the subject matter is governed by the U.S.A. or the U.C.C. In National Equipment Corporation v. Volden, supra, the court was faced with a fraud action. Two other decisions, including one by the Minnesota Court following Wisconsin law, had recently awarded purchasers relief for breach of warranty in situations substantially similar to that facing the court. See, National Equipment Corporation v. Moore, 189 Minn. 632, 250 N.W. 677 (1933); Hughes v. National Equipment Corporation, 216 Iowa 1000, 250 N.W. 154 (1933). The Minnesota Court in Volden, however, refused to place any reliance on these cases since they were contract actions rather than fraud actions.

Finally, in attempting to predict what the Minnesota Supreme Court would decide were this case before it, we are influenced by the persistent and consistent efforts of that court in providing easy access to an action for fraud. Beginning at least with Schlechter v. Felton, 134 Minn. 143, 158 N.W. 813 (1916), the Minnesota Reports are replete with decisions which uphold the action for fraud which SBC now asks us to limit. In its two most recent decisions concerning fraud actions, the court reaffirmed the broad remedial features of the Minnesota law of fraud. Berryman v. Riegert, supra; Weise v. Red Owl Stores, Inc., supra. In our view, we would distort the established body of Minnesota law were we to hold that under the U.C.C., an action for fraud, based on innocent misrepresentation, could not be maintained where the contract validly disclaimed all warranties. The Minnesota Supreme Court is free to make its own decision. All we decide is that, on the basis of the factors we can find, it would decide as we have.

SBC argues alternatively that even if the trial court was correct in applying the Minnesota law of fraud to this situation, it erred in finding that the representations proven by SM met the requirements for actionable fraud. Specifically, SBC contends that the representations found actionable by the trial court cannot be considered 'past or present facts susceptible of knowledge' or that they were such that SM 'was induced or justified in acting upon' them. See, text accompanying n.4, supra.

We believe that the trial court was correct in finding that the representations as a whole were more than mere predictions and that SM relied upon them in entering into the contract.

We have previously stated the central representation to be 'that the proposed data processing system would, when fully implemented, be capable of providing SM sufficient information in a form such that when properly utilized, it would constitute an effective and efficient tool to be used in inventory control.' While this statement is in a sense a prediction of what the system will do, it is also, under existing Minnesota law, a statement of the inherent capabilities of a particular product.

Minnesota decisions have traditionally held manufacturers to a high standard with respect to statements about their products. In National Equipment Corporation v. Volden, supra, the manufacturer's representative went to the purchaser's construction site, observed his operations and then stated that the equipment in question 'would keep up with and surpass any other machine then being used by the (purchaser) and that it would work in cooperation with (the) other machines and equipment.' The court found that such a statement would support a fraud action, stating:

'This was more than mere sales or trade talk. It was vital to defendants' operations that their machinery should work in harmony and that one piece should not impair the effectiveness of another. Plaintiff was possessed of knowledge of the machine and its capabilities, and its false assertion * * * that the (machine) would do a certain amount of work and coordinate with the machines already owned by defendants, was an assertion of fact and constituted fraud.'

Id. at 252 N.W. 445.

Similarly, in Wisconsin Mystic Iceless Refrigerator, Inc. v. Minnesota Mystic Iceless Refriegerator, Inc., 180 Minn. 334, 230 N.W. 796 (1930), the court found liability for statements that a refrigerator would preserve foods in the warmest