Statutory Fraud in Real Estate and Stock Transactions in Texas

What section 27.01 says

Section 27.01 of the Texas Business and Commerce Code is titled "Fraud in Real Estate and Stock Transactions." It applies to a transaction involving real estate or stock in a corporation or joint stock company, and it defines fraud in two ways:

• A false representation of a past or existing material fact, made to a person for the purpose of inducing that person to enter into a contract, and relied on by that person in entering into the contract.
• A false promise to do an act, when the promise is material, made with the intention of not fulfilling it, made to induce the contract, and relied on by that person in entering into the contract.

A person who makes either kind of statement is liable to the person defrauded for actual damages. The statute then adds two tiers of exemplary liability and a mandatory fee award, each discussed below.

Why it is easier to prove than common-law fraud

Common-law fraud requires the plaintiff to prove that the speaker knew the statement was false, or made it recklessly. Section 27.01(b) does not. A false representation of material fact that induced the contract and was relied on is enough for actual damages. The speaker's state of mind becomes relevant only when the plaintiff asks for exemplary damages.

That difference changes real estate and share-sale litigation considerably. A seller who repeated a figure from an old appraisal, or a shareholder who described the company's contracts from memory, may defend a common-law fraud claim by arguing honest belief. Under section 27.01 that defense does not reach the actual damages claim. The seller's knowledge still matters, but only to how much is owed. The remaining elements, materiality, inducement and reliance, are proven the same way as in any fraud case; see how to prove fraud in a Texas business dispute.

The false-promise branch is different. Section 27.01(a)(2) requires that the promise was made "with the intention of not fulfilling it," which is the same promissory fraud standard as the common law. A promise that was simply broken is not statutory fraud either.

Attorney's fees, expert fees and costs

Section 27.01(e) provides that any person who violates the section is liable to the person defrauded for reasonable and necessary attorney's fees, expert witness fees, costs for copies of depositions, and costs of court. This is the statute's most practical feature. Texas follows the American rule, and a plaintiff who wins a common-law fraud case ordinarily pays its own lawyers. A plaintiff who wins under section 27.01 does not, and the fee award includes the cost of the valuation or forensic expert the case usually requires. The flip side is equally practical: a defendant facing a section 27.01 claim is facing the plaintiff's fees as well as its damages, which changes the settlement calculus from the first demand letter.

Exemplary damages for actual awareness

Section 27.01(c) makes a person who makes a false representation or promise "with actual awareness of the falsity thereof" liable for exemplary damages, and provides that actual awareness may be inferred where objective manifestations indicate that the person acted with it. In other words, the knowing liar faces punitive exposure; the careless one does not.

Chapter 41 of the Civil Practice and Remedies Code still governs the award. Under section 41.003(c), when a statute authorizes exemplary damages for a specified mental state, the plaintiff must prove that mental state by clear and convincing evidence. The cap in section 41.008 applies, and the jury must be unanimous. The mechanics are covered in punitive damages for fraud in Texas.

Liability of a third party who knew and benefited

Section 27.01(d) reaches beyond the speaker. A person who has actual awareness that someone else's representation or promise is false, fails to disclose the falsity to the person defrauded, and benefits from the false statement, is liable for exemplary damages. Actual awareness may again be inferred from objective manifestations.

This provision is aimed at the participant who did not speak but profited: the partner who heard the misstatement and took a share of the proceeds, the agent who knew the disclosure was wrong and collected the commission. It is one of the few places in Texas law where silence by a non-fiduciary who stood to gain is independently actionable.

Example

Suppose a Dallas investor buys all of the shares of a closely held corporation that owns three self-storage facilities. The seller's stock purchase agreement represents that "all facilities are in compliance with applicable zoning." One facility has been operating under a zoning variance that expired two years earlier, and the city has sent two notices. The seller says he never read the notices; his property manager, who received them, is also a 10 percent shareholder and received 10 percent of the price. The buyer has a section 27.01 claim for actual damages against the seller regardless of what he read, a claim for exemplary damages against the seller if objective evidence shows he knew, a claim for exemplary damages against the property manager under subsection (d) for knowing, staying silent and benefiting, and a fee award against whoever is found liable.

Which transactions count

The statute applies to transactions involving real estate and stock in a corporation or joint stock company. Texas courts apply that list as written. Sales of land, buildings, leases and other interests in real property qualify; so do sales of corporate shares, which is why section 27.01 appears in so many disputes over the purchase of a closely held company. Deals that involve neither, such as an asset purchase with no real estate, a service contract or a loan, must be pleaded as common-law fraud.

Statutory fraud and the DTPA

Since 2015, section 27.015 provides that a violation of section 27.01 relating to the transfer of title to real estate is a false, misleading or deceptive act under the Deceptive Trade Practices Act, but only for the public remedies pursued by the Attorney General and local prosecutors. It does not create a private DTPA claim for the buyer, and it does not apply to claims governed by chapter 27 of the Property Code. A business buyer's own DTPA rights depend on the consumer definition and the transaction-size exemptions explained in can a business sue under the Texas DTPA.

Defenses and limits

Statutory fraud is still fraud. The defenses that defeat a common-law claim defeat it too: the statement was an opinion rather than a representation of existing fact; it was true when made; the plaintiff did not rely on it; reliance was not justifiable given red flags or a contract term saying the opposite; or an enforceable disclaimer of reliance covers the statement. Texas courts generally apply the four-year fraud limitations period in section 16.004(a)(4) of the Civil Practice and Remedies Code to statutory fraud claims. And because the statute defines fraud as a statement made "for the purpose of inducing that person to enter into a contract," it does not reach statements made after the contract was signed; those are addressed, if at all, under common law.

When to involve a litigator

Section 27.01 is one of the first things a Texas litigator checks in a real estate or share-sale dispute, from either side. For a plaintiff it can mean a recoverable fee award and a claim that survives an honest-mistake defense. For a defendant it means the exposure includes the other side's lawyers and experts, and that early evaluation of the actual-awareness evidence is worth the effort. Tina Wysk handles real estate disputes and fraud claims arising from business and share sales in Dallas state and federal courts.