Many lawyers pursuing business litigation on behalf of their clients will file a whole panoply of claims rather than content themselves with a single count for breach of contract. As the law generally permits a wider range of remedies (and higher damages awards) for tort claims like fraud and tortious interference, plaintiffs seeking to enforce contract rights in court will often sue for various tort claims in addition to breach of contract. Sometimes this works and sometimes it doesn’t. Courts are guided by various principles to help them weed out contract-based claims disguised as tort claims. One such principle is known as the “source of duty” rule.
When a plaintiff alleges that the defendant violated some duty owed to him, the court will examine the source of the duty allegedly violated. If the source of the duty is a contract entered into by the parties, as opposed to common law or some provision of the Virginia or United States Code, the court will treat the claim as one for breach of contract and limit remedies accordingly. Of course, there are circumstances in which a defendant can both breach a contract and commit a tort by violating a common-law duty. It is up to the court, however, to dismiss any tort claims based on the alleged violation of a duty that exists solely by virtue of a contractual agreement. (See Preferred Sys. Sols., Inc. v. GP Consulting, LLC, 284 Va. 382, 408 (2012)).
About a month ago, the Virginia Supreme Court decided the case of S. Wallace Edwards and Sons, Inc. v. Selective Way Insurance Company, which dealt with the issue of whether claims for fraudulent inducement of contract are properly characterized as contractual or tortious in nature. The trial court had dismissed a claim for fraudulent inducement based on the source-of-duty rule, finding the claim to be contractual in nature. The Virginia Supreme Court reversed. Here’s what happened, according to the opinion:
The parties first entered into a contract for insurance coverage in 2012. Wallace Edwards (the plaintiff and the insured party) eventually asked whether it might be advisable to purchase additional coverage for cold storage, and was advised to add “spoilage coverage.” A new contract of insurance was entered into in 2015, presumably to include such additional coverage. The 2015 coverage was allegedly insufficient, and Wallace Edwards sued for breach of contract, fraud, and other claims. It claimed that the defendants made certain misrepresentations to it for the purpose of inducing it to enter into the new, 2015 agreement. In other words, it claimed the defendants fraudulently induced it to enter into the 2015 insurance agreement. The insurance company moved to dismiss the fraud claim, arguing that because the plaintiff’s claim was to merely to recover for disappointed economic expectations under the parties’ contracts, the plaintiff was limited to contract remedies and could not pursue a tort claim.
The trial court sustained the demurrer and dismissed the fraud claims, but this outcome was reversed on appeal. Looking to the source-of-duty rule, the supreme court found that the rule had “no application to a claim of fraudulent inducement of contract.” This is because “the focus of such a claim is the purportedly fraudulent actions that were perpetrated before the contract existed.” (Emphasis in original). Here, the plaintiff was claiming that the defendants committed fraud in the course of persuading the plaintiff to renew its insurance contract. The plaintiff was not claiming that the defendants failed to perform a duty that the insurance contract required them to perform. Therefore, the source of the duty was independent of the contract at issue, so the complaint had made out a proper prima facie case of fraud.
Wallace Edwards had alleged that the defendants made false statements of material fact for the purpose of inducing Wallace Edwards to enter into an insurance contract. Wallace Edwards claims it relied on those statements, entered into the contract, and suffered financial harm as a result. This was sufficient to distinguish the fraud claim from the contract claim, so the case was sent back to the trial court with instructions to permit the plaintiff to pursue both its contract and fraud claims.