How to Prove Fraud in a Texas Business Dispute

The six elements of fraud in Texas

The Texas Supreme Court lists the elements of common-law fraud this way: a material representation was made; it was false; when it was made the speaker knew it was false or made it recklessly without knowledge of its truth and as a positive assertion; the speaker made it with the intent that the other party act on it; the other party actually and justifiably relied on it; and the reliance caused injury. The list appears in JPMorgan Chase Bank v. Orca Assets (Tex. 2018) and in decades of earlier opinions.

Each element has to be proven. A case that is strong on five and silent on one fails. The rest of this article walks through what a court looks for on each, because the practical question is never "was I lied to" but "what can I show."

Element 1: a material representation of fact

The statement must be about a fact, and it must be one that a reasonable person would consider important in deciding whether to do the deal. Materiality is rarely contested when the statement concerns revenue, customers, title, condition, licensing or the existence of a contract. It is contested when the statement was peripheral, or when the plaintiff would have closed anyway.

Evidence: the statement itself, in its original form. An email, a pitch deck, a financial package, a term sheet, a text message, a recorded call, or a witness who heard it. Who said it, to whom, on what date. If the statement was oral and there is no writing, the case can still proceed, but it will turn on credibility, so contemporaneous notes and any follow-up email that repeats the statement become important.

Element 2: the statement was false

Falsity is measured at the moment the statement was made. A statement that was true then and became false later is not fraud, although a later duty to correct can arise in some relationships.

Evidence: the independent record of what was true. Bank statements against the represented revenue. The customer's termination letter against the claim that the account was secure. The county records against the claim that the property was unencumbered. Inspection reports, tax returns, payroll records, the other side's own internal emails produced in discovery. The strongest falsity evidence comes from the defendant's own files, which is why document requests and subpoenas matter so much in fraud cases.

Element 3: the speaker knew, or did not care

This is the element that separates fraud from an honest mistake and from negligent misrepresentation. The plaintiff must show the speaker knew the statement was false, or made it recklessly, meaning as a positive assertion without any knowledge of whether it was true.

Direct proof of knowledge is rare. Nobody writes "I know this is false" in the deal file. Texas courts allow knowledge to be proven circumstantially, and juries routinely find it from what the speaker had access to and what the speaker did.

Evidence: documents the speaker had seen before speaking that contradict the statement. The speaker's position in the company and what that position would have known. Internal emails discussing the real situation. The timing of the statement relative to bad news. Inconsistent statements to different audiences, such as a lender told one number and a buyer told another. A pattern of similar statements to others.

Element 4: intent that the plaintiff rely

The statement must have been made to induce action. This element is usually satisfied by context: a statement made during negotiation of a deal was made so the other side would do the deal. It becomes contested when the statement was made to someone else and reached the plaintiff indirectly, or when the statement was made after the deal was already signed.

Evidence: when and to whom the statement was made, and what the speaker wanted from the listener at that time. A statement in a due diligence response speaks for itself.

Element 5: actual and justifiable reliance

Reliance has two parts, and the Texas Supreme Court treats them separately. The plaintiff must have actually relied, meaning the statement was a real factor in the decision. And the reliance must have been justifiable.

Justifiable reliance is where sophisticated plaintiffs lose fraud cases. In Orca Assets the court held that reliance was not justifiable as a matter of law where the plaintiff, an experienced oil and gas company, ignored multiple red flags and relied on an oral assurance that was contradicted by the written documents. The court said that either red flags alone or a direct contradiction between the representation and the contract can defeat justifiable reliance before a jury ever hears the case.

Three situations recur:

• The contract says the opposite. A plaintiff who signed a document stating one thing cannot ordinarily claim to have relied on an oral statement of the other.
• A disclaimer of reliance. A clause stating that the party is not relying on any representation outside the written agreement can bar the claim, if it is clear and unequivocal. A standard merger clause does not have that effect. This is covered in detail in the article on fraudulent inducement in Texas.
• Red flags. Warning signs that a reasonable person in the plaintiff's position would have investigated. The more sophisticated the plaintiff, the more the court expects.

Evidence: the decision-making record. Board minutes, deal memos, the valuation model showing which inputs came from the defendant's statements, and testimony from the people who decided. On the justifiable side, the due diligence that was done, the questions that were asked, and the answers that were given.

Element 6: injury caused by the reliance

The plaintiff must have suffered a loss, and the loss must be traceable to the reliance. Texas recognizes two measures of direct fraud damages: out-of-pocket (what was paid less what was received) and benefit-of-the-bargain (value as represented less value received). Consequential damages are available when proven with reasonable certainty.

Evidence: the purchase price and how it was calculated, a valuation of what was actually received, and documentation of costs incurred because of the false statement. In most business fraud cases of any size this is where a forensic accountant or valuation expert enters; how they are used is explained in forensic accountants in fraud litigation.

Example

Suppose a Fort Worth manufacturer buys a supplier after the supplier's owner represents, in a written diligence response, that there are no pending warranty claims. After closing, the buyer receives three warranty demands dating from before the sale and finds, in the supplier's email server it now owns, a message from the owner to his plant manager two weeks before the response: "Hold the warranty letters until the deal closes." That one email does most of the work on elements two, three and four. The buyer's own deal model, which assumed zero warranty reserve, carries element five. The cost of honoring the three claims, plus the difference in value, carries element six.

The burden of proof

Liability for fraud is decided by a preponderance of the evidence, the ordinary civil standard. It is a common misconception that fraud must be proven by clear and convincing evidence; in Texas that heightened standard applies to the recovery of exemplary damages under section 41.003 of the Civil Practice and Remedies Code, not to the fraud finding itself. A plaintiff who wants exemplary damages must also obtain a unanimous jury on both liability for and the amount of those damages.

In federal court, a fraud claim must also be pleaded with particularity under Federal Rule of Civil Procedure 9(b): the complaint must state the who, what, when, where and how of the alleged misrepresentation. Texas state courts do not impose the same pleading rule, but a vague fraud petition invites an early motion and a demand for specifics.

Preserving the evidence before you accuse anyone

Fraud cases are won on documents that existed before the dispute. Before sending a demand or filing suit, a business should secure every version of the statement, the independent records that show the truth, and its own decision file. If the business now controls the defendant's former systems, as a buyer often does after an acquisition, those systems should be preserved intact and reviewed with counsel, because they may contain the evidence of knowledge that otherwise never surfaces. General guidance on what to keep is in what evidence to save before suing.

When the facts are assembled, a litigator can tell you which elements are solid, which need discovery, and whether the better claim is fraud, negligent misrepresentation, statutory fraud, or breach of contract with fraud held in reserve. Tina Wysk handles fraud and misrepresentation claims for plaintiffs and defendants in Dallas state and federal courts.