Peter Fazio, Shari Fazio, and Eric Fazio v. Cypress/GR Houston I, L. P. Cypress/GR Houston, Inc. And Cypress Equities, Inc.

Opinion

Opinion issued April 5, 2013

In The

Court of Appeals For The

First District of Texas ———————————— NO. 01-09-00728-CV ——————————— PETER FAZIO, SHARI FAZIO, AND ERIC FAZIO, Appellants

V.

CYPRESS/GR HOUSTON I, L.P., CYPRESS/GR HOUSTON, INC., AND CYPRESS EQUITIES, INC., Appellees

***

CYPRESS/GR HOUSTON I, L.P., CYPRESS/GR HOUSTON, INC., AND CYPRESS EQUITIES, INC., Appellants

V.

PETER FAZIO, Appellee

On Appeal from the 129th District Court Harris County, Texas Trial Court Cause No. 2004-65110 EN BANC OPINION

In this suit arising from the sale of land, we examine the appropriate

measure of damages for a sale obtained through fraudulent inducement. A jury

concluded that the seller of the land had failed to disclose material information to

the buyer about the financial state of a commercial tenant who leased the land. But

the jury further concluded that the buyers suffered nothing in damages proximately

caused by the fraud, measured at the time of the sale, and it awarded no damages in

connection with the costs incurred with the termination of the tenant’s lease, nor

the legal fees the buyers incurred due to the tenant’s bankruptcy, nor the interest

expense the buyers incurred on loans they obtained to facilitate the purchase. The

trial court entered a take-nothing judgment in favor of the seller.

A majority of a panel of our court reversed the trial court, concluding that

the buyers were nonetheless entitled to damages based on the loss that the buyers

took when they sold the land three years later. The majority also concluded, with

one justice dissenting, that the buyers did not disclaim reliance on the seller’s

promise of full disclosure in a letter of intent that the seller had signed before the

sale. The seller moved for rehearing and rehearing en banc. The panel majority

granted the motion for rehearing and revised its opinion, mooting the en banc

request, but its disposition remained the same. The seller moved again for en banc

consideration. Concluding that the case warranted en banc review, a majority of

2 our court has voted to reconsider this case. See TEX. R. APP. P. 49.7. We withdraw

the panel’s August 16, 2012 opinion on rehearing and judgment, and substitute this

opinion and judgment in its place.

We hold that the trial court properly entered a take-nothing judgment,

because the jury found that no damages were proximately caused by the fraud,

measured at the time of the sale, and it found no incidental or consequential

damages relating to the sale. We further hold that the trial court properly denied the

seller’s request for attorney’s fees as the prevailing party, because the parties’

contract did not provide for a recovery for attorney’s fees incurred in defense

against claims of fraud. We therefore affirm.

Background

Peter, Shari, and Eric Fazio sued Cypress/GR Houston I, L.P., Cypress/GR

Houston, Inc., and Cypress Equities, Inc. (collectively, Cypress) for fraudulent

inducement, relating to the Fazios’ purchase, in October 2003, of commercial land

located on the frontage road of Interstate 10 in Houston. At that time, Garden

Ridge Pottery leased the site for one of its retail stores.

After identifying the land as an investment prospect, the Fazios notified

Cypress of their interest in purchasing it. In early September 2003, the parties

executed a letter of intent, signed by Peter Fazio and a representative of Cypress

Equities, in which Cypress agreed to allow the Fazios to investigate “all aspects of

3 the Property” and further agreed to provide the Fazios with “all information in

[Cypress’s] possession.” The Fazios and their brokers subsequently conducted due

diligence and inspected the property. As part of this process, they requested “every

scrap of paper” that Cypress had regarding the property. The Fazios reviewed

multiple appraisals of the property; researched the property’s primary tenant,

Garden Ridge; investigated the lease terms; reviewed Garden Ridge’s audited

financial statements; and contacted Garden Ridge’s CFO for an assessment of

Garden Ridge’s financial condition. The Fazios’ investigations revealed that

Garden Ridge was restructuring and struggling financially, but that Garden Ridge

had recently secured a line of credit for its operations to continue through the 2003

Christmas season. During their discussions with Garden Ridge’s CFO, the CFO

was optimistic that Garden Ridge could work through its financial difficulties. The

Fazios’ own lenders were not as certain, and told the Fazios that Garden Ridge was

not a viable long-term tenant. Garden Ridge’s audited financial statements, which

the Fazios reviewed, showed that Garden Ridge had defaulted on its debt

covenants and was in the process of corporate restructuring.

Despite its agreement in the letter of intent to provide to the Fazios “all

information in its possession,” Cypress did not disclose to the Fazios that, in

February 2003, Garden Ridge had sent a letter to Cypress stating that it was

“restructuring” and needed “to reduce our occupancy costs at your premises.”

4 Cypress also did not disclose that Garden Ridge had sought a 30% rent reduction

for the I-10 property as well as a similar reduction for another property owned by a

separate Cypress entity and leased to Garden Ridge. Finally, Cypress failed to

disclose that in early September 2003, Cypress’s own lender was concerned about

the financial condition of Garden Ridge and had asked that Cypress’s President,

Chris Maguire, execute a personal guaranty for the $5,704,000 loan that it had

made to Cypress that had been formerly secured only by the property. Maguire

eventually signed the guaranty—on September 25, one day after Cypress sold the

land to the Fazios.

The parties executed the final purchase agreement on September 24, 2003

for a price of $7,667,000. The agreement contained various provisions disclaiming

the Fazios’ reliance on representations made by Cypress to the Fazios.

Garden Ridge paid its rent in October, November, and December, but it

defaulted on its rent in January 2004, and shortly thereafter declared bankruptcy.

Once in Chapter 11 bankruptcy protection, Garden Ridge rejected its lease. The

Fazios attempted, unsuccessfully, to re-lease the land. They later sold it in 2007 for

$3,750,000.

The jury found that Cypress Equities, but neither of the other Cypress

entities, had defrauded the Fazios. It attributed 100% responsibility for any harm to

5 the Fazios to Cypress Equities, but it found that the Cypress entities operated as a

single business enterprise.

The trial court instructed the jury on two measures of direct damages, and

various measures of incidental and consequential damages. The trial court’s two

measures for actual damages were distinctly different: Jury question 2(1) instructed

the jury to determine “[t]he difference between the price the Fazios paid for the

Property and the amount they received when they sold the Property”; to this

question, the jury answered $3,961,524.60, which is the actual difference in the

two amounts. Question 2(2), in contrast, instructed the jury to determine “the

difference, if any, between the price the Fazios paid for the Property and the value

of the Property at the time the Purchase Agreement was executed”; to this

question, the jury answered $0. In response to each of four instructions on

incidental and consequential damages, the jury also answered $0. But, finding clear

and convincing evidence of fraud, the jury awarded $667,000 in exemplary

damages.

Both parties moved for judgment in the trial court. Among other grounds,

Cypress argued that the Fazios were not entitled to a judgment based on the jury’s

answer to question 2(1) because it was an improper measure of damages, and that

it, Cypress, was entitled to judgment based on the jury’s answer to question 2(2), in

which the jury awarded nothing under the proper measure of damages. The Fazios

6 requested judgment on the jury’s verdict for the amount the jury found in answer to

question 2(1), plus exemplary damages. After extensive post-verdict briefing, the

trial court entered a take-nothing judgment for Cypress and denied Cypress’s

request for attorney’s fees.

The Fazios appeal the trial court’s judgment against them on their claim for

fraudulent inducement, contending that the trial court erred in disregarding the

jury’s liability and damages findings in their favor. They contend that the trial

court instead should have disregarded the damages questions the jury found against

them. Cypress also appeals, challenging the trial court’s denial of its motion for

attorney’s fees.

Damages

A. Standard of Review

The Fazios challenge the trial court’s judgment disregarding question 2(1),

arguing that the question was a proper measure of damages. A trial court should

disregard a jury finding if the jury question to which the finding responds is legally

defective; the answer to a legally defective question is immaterial to the judgment.

See Spencer v. Eagle Star Ins. Co., 876 S.W.2d 154, 157 (Tex. 1994); Williams v.

Briscoe, 137 S.W.3d 120, 124 (Tex. App.—Houston [1st Dist.] 2004, no pet.).

Similarly, a trial court should disregard a jury finding if the evidence is legally

insufficient to support it, or if a directed verdict would have been proper because a

7 legal principle precludes recovery. TEX. R. CIV. P. 301; see Fort Bend Cnty.

Drainage Dist. v. Sbrusch, 818 S.W.2d 392, 394 (Tex. 1991); Williams, 137

S.W.3d at 124; John Masek Corp. v. Davis, 848 S.W.2d 170, 173 (Tex. App.—

Houston [1st Dist.] 1992, writ denied).

B. Measuring Direct Damages

There are two measures of direct damages in a fraud case: out-of-pocket and

benefit-of-the-bargain. Formosa Plastics Corp. USA v. Presidio Eng’rs &

Contractors, Inc., 960 S.W.2d 41, 49 (Tex. 1998) (citing Arthur Andersen & Co. v.

Perry Equip. Corp., 945 S.W.2d 812, 817 (Tex. 1997)). Out-of-pocket damages

measure the difference between the amount the buyer paid and the value of the

property the buyer received. Leyendecker & Assocs., Inc. v. Wechter, 683 S.W.2d

369, 373 (Tex. 1984). Benefit-of-the-bargain damages measure the difference

between the value of the property as represented and the actual value of the

property. Id. Both measures are determined at the time of the sale induced by the

fraud. Id.; Arthur Andersen, 945 S.W.2d at 817; Woodyard v. Hunt, 695 S.W.2d

730, 733 (Tex. App.—Houston [1st Dist.] 1985, no writ); Highland Capital Mgmt.,

L.P. v. Ryder Scott Co., No.01-10-00362-CV, 2012 WL 6082713, at *7–8 (Tex.

App.—Houston [1st Dist.] Dec. 6, 2012, no pet. h.).

Losses that arise after the time of sale may be recoverable as consequential

damages in appropriate cases. Formosa Plastics, 960 S.W.2d at 49 n.1 (citing

8 Arthur Andersen, 945 S.W.2d at 817). Consequential damages must be foreseeable

and directly traceable to the misrepresentation and result from it. Arthur Andersen,

945 S.W.2d at 816. An investor may not “shift the entire risk of an investment to a

defendant who made a misrepresentation” if the loss is unrelated to the

misrepresentation and due to market fluctuations or the chances of business. Id. at

817; see Sw. Battery Corp. v. Owen, 115 S.W.2d 1097, 1098 (Tex. 1938). Jury

instructions on consequential damages must be explicitly premised on findings that

the losses were foreseeable and directly traceable to the misrepresentation. El Paso

Dev. Co. v. Ravel, 339 S.W.2d 360, 366–67 (Tex. App.—El Paso 1960, writ ref’d

n.r.e.); Turner v. PV Int’l Corp., 765 S.W.2d 455, 464 (Tex. App.—Dallas 1988,

writ denied).

The jury instructions in this case included two questions on direct damages,

questions 2(1) and 2(2). Jury question 2(1) instructed the jury to determine the

difference between the actual price that the Fazios paid for the property and the

actual price at which they sold it more than three years later, without consideration

of any fluctuations in value absent any fraud. Because the question does not isolate

the reduction in value attributable to the fraud, it asks a math word problem of

basic subtraction, and is not a proper measure of damages.

In contrast, jury question 2(2) has it right, because that question parallels the

rule for calculating out-of-pocket damages. Question 2(2) properly instructed the

9 jury to determine the difference between the fraud-induced price that the Fazios

paid for the property and the actual value of the property they received when they

purchased it. See Leyendecker, 683 S.W.2d at 373; Arthur Andersen, 945 S.W.2d

at 817. And, the question correctly focused the jury on the time of the sale, because

direct damages for fraud, including out-of-pocket damages, are properly measured

at the time of the sale induced by the fraud—in this case, when the purchase

agreement was executed—and “not at some future time.” Woodyard, 695 S.W.2d

at 733; see Leyendecker, 683 S.W.2d at 373; Arthur Andersen, 945 S.W.2d at 817.

The jury responded that such damages were $0. It found other sorts of incidental

and consequential damage to be $0 as well, in questions 2(3), 2(4), 2(5), and 2(6).

The Fazios did not challenge the legal sufficiency of any of these findings.

The Fazios contend, and the dissents agree, that jury question 2(1) instructed

the jury on a proper measure of damages, and thus the trial court erred in

disregarding it. The dissent cites Henry S. Miller Co. v. Bynum to support its

position that fraud damages need not be measured at the time of sale, but may be

measured as the loss on the Fazios’ investment three years after the sale. 836

S.W.2d 160, 162–63 (Tex. 1992). But more than a decade ago, our court cast a

similar erroneous interpretation of Bynum to hold that the plaintiff in a fraud action

could recover the loss on its investment, and not merely time-of-sale damages,

when the plaintiff invested in a business that went bankrupt just over a year later.

10 The case was Arthur Andersen & Co. v. Perry Equip. Corp., and the Texas

Supreme Court reversed our court. See 898 S.W.2d 914 (Tex. App.—Houston [1st

Dist.] 1995), rev’d, 945 S.W.2d 812 (Tex. 1997). In Arthur Andersen, the Texas

Supreme Court expressly rejected such an interpretation, holding that, under the

common law measure of fraud damages, direct damages must be measured at the

time of the sale that induced the fraud. Arthur Andersen, 945 S.W.2d at 817. It

further held that losses beyond the difference between the amount the plaintiff paid

and the value it received at the time of sale could be recovered only as

consequential damages. Id. Jury question 2(1) does not measure damages that were

foreseeable and directly traceable to the misrepresentation, and thus, as the Fazios

concede, was not an instruction on consequential damages. See Ravel, 339 S.W.2d

at 366–67. The jury found $0 damages in response to four measures of incidental

and consequential damages on which it was instructed.

Because jury question 2(1) did not instruct the jury on a valid measure of

damages, and the jury found zero in damages in response to the proper instructions

on direct and consequential damages, the trial court properly disregarded the

damages found in response to question 2(1) and accorded judgment based on the

jury’s zero damages finding in answer to questions 2(2) through 2(6).

11 C. Rescission Damages

The Fazios also contend that jury question 2(1) instructs the jury on a

rescission or restitution measure of damages. Out-of-pocket damages, if properly

measured, are restitution damages. Baylor Univ. v. Sonnichsen, 221 S.W.3d 632,

636 (Tex. 2007) (per curiam). Rescission is a type of remedy in a fraud claim, but

it is not a proper remedy if the amount the plaintiff pays for the property is equal to

its value at the time the plaintiff purchased the property. Bryant v. Vaughn, 33

S.W.2d 729, 730 (Tex. 1930) (holding that plaintiff had no right to rescind in fraud

action where jury found that value of property received by plaintiff was equal to

amount plaintiff paid for property); see also Cruz v. Andrews Restoration, Inc., 364

S.W.3d 817, 823 (Tex. 2012) (“[A] rescission award requires a showing of actual

damages.”); Grundmeyer v. McFadin, 537 S.W.2d 764, 769 (Tex. Civ. App.—

Tyler 1976, writ ref’d n.r.e.); Tex. Indus. Trust, Inc. v. Lusk, 312 S.W.2d 324, 327

(Tex. Civ. App.—San Antonio 1958, writ ref’d). A plaintiff seeking to rescind a

transaction induced by fraud “must surrender any benefits received” in the

transaction, as “rescission is not a one-way street. It requires a mutual restoration

and accounting, in which each party restores property received from the other.”

Cruz, 364 S.W.3d at 824, 826 (citing Tex. Emp’rs Ins. Ass’n v. Kennedy, 143

S.W.2d 583, 585 (1940)).

12 Jury question 2(2) properly instructed the jury on out-of-pocket damages. In

finding no out-of-pocket damages in response to that question, the jury found no

restitution damages. See Sonnichsen, 221 S.W.3d at 636. The jury’s finding of no

actual damages—that the amount the Fazios paid for the property equaled the

value of the property when the Fazios purchased it, and that the Fazios suffered no

consequential damages—precludes a money judgment based on a rescission

theory. See Bryant, 33 S.W.2d at 730; Cruz, 364 S.W.3d at 823. Pursuant to a

proper measure of rescission damages, the Fazios would have to reduce any

amount of damages by whatever benefit they received in the transaction. See Cruz,

364 S.W.3d at 824. As the jury found that the Fazios received property equal in

value to what they paid for it, and that the fraud did not proximately cause money

damages under a proper measure, rescission is not a supportable remedy. See id.

Question 2(1), in any event, does not ask about fraud-induced losses, albeit at a

later time; rather, it asked the jury to mechanically subtract the price for which the

Fazios sold the property three years later from the original purchase price. We hold

that the trial court properly disregarded the jury’s answer to question to 2(1), as it

did not measure rescission or restitution damages. Spencer, 876 S.W.2d at 157

(holding that jury question is immaterial and jury’s answer should be disregarded if

question is legally improper).

13 D. Exemplary Damages

Finally, because the jury found no direct or consequential damages, the

Fazios could not recover exemplary damages. See Wright v. Gifford-Hill & Co.,

Inc., 725 S.W.2d 712, 714 (Tex. 1987) (“When a jury fails to find a plaintiff has

sustained actual damages, the plaintiff is foreclosed from recovering exemplary

damages.”); see also Sec. Inv. Co. of St. Louis v. Fin. Acceptance Corp., 474

S.W.2d 261, 270 (Tex. Civ. App.—Houston [1st Dist.] 1971, writ ref’d n.r.e.). The

trial court therefore properly disregarded the jury’s award of exemplary damages.

Attorney’s Fees

Cypress requested that the trial court award it attorney’s fees pursuant to

section 7.3 of the purchase agreement, which requires,

[i]n the event either party hereto is required to employ an attorney in connection with claims by one party against the other arising from the operation of this Agreement, the non-prevailing party shall pay the prevailing party all reasonable fees and expenses, including attorney’s fees incurred in connection with such transaction.

The Fazios sued Cypress for common-law fraud, statutory fraud in a real estate

transaction, and fraudulent inducement, but not for breach of contract. The trial

court directed a verdict on the first two fraud claims, leaving the jury to decide

only the fraudulent inducement claim. Cypress presented evidence that its

14 attorney’s fees through judgment in the trial court were $987,934.64 and its

expenses were $53,703.58. The trial court denied Cypress’s request for fees.

Although the Fazios’ claims against Cypress sound in tort, Cypress contends

that it may avail itself of the contractual remedy of attorney’s fees, because the tort

claims asserted against it should be read to “arise from the operation of” the

purchase agreement. The Fazios respond that Cypress reads the contract too

broadly, and the provision at issue cannot require it to pay attorney’s fees to a party

defending against a tort claim that arose before the parties executed their

agreement.

Standard of review

We review the trial court’s construction of an unambiguous contract de

novo. J.M. Davidson, Inc. v. Webster, 128 S.W.3d 223, 229 (Tex. 2003); MCI

Telecomms. Corp. v. Tex. Utils. Elec. Co., 995 S.W.2d 647, 650–651 (Tex. 1999).

If a term is not defined by the parties, we use the term’s plain, ordinary, and

generally accepted meaning unless the instrument shows that the term has been

used in a technical sense. Heritage Res., Inc. v. NationsBank, 939 S.W.2d 118, 121

(Tex. 1996).

Analysis

Cypress compares the prevailing party provision in the purchase agreement

to prevailing party provisions in other agreements that provide for the recovery of

15 attorney’s fees in claims “related to” the agreement, which courts have interpreted

to permit recovery of attorney’s fees in fraudulent inducement claims. See Robbins

v. Capozzi, 100 S.W.3d 18, 26–27 (Tex. App.—Tyler 2002, no pet.) (holding party

entitled to recover attorney’s fees for successfully defending fraud and DTPA

claims under contract provision for such fees when agreement allowed their

recovery by “[t]he prevailing party in any legal proceeding brought under or with

respect to the transaction described in his contract”); Rich v. Olah, 274 S.W.3d

878, 888 (Tex. App.—Dallas 2008, no pet.) (holding that fraud and DTPA tort

claims related to contract for purpose of provision awarding attorney’s fees when

contract provided for recovery by “prevailing party in any legal proceeding related

to this contract”). Other prevailing party provisions that do not use the “with

respect to” or “related” language have been construed more narrowly. See, e.g.,

Oat Note, Inc. v. Ampro Equities, Inc., 141 S.W.3d 274, 280–81 (Tex. App.—

Austin 2004, no pet.) (holding that prevailing party in misrepresentation claim

could not recover attorney’s fees under provision allowing party to recover

attorney’s fees if it “prevails in any litigation to enforce this Contract”). The

language in this agreement is somewhere between the more broadly worded

“related to” or “with respect to” and the more narrow “to enforce”.

“Arising from the operation” of an agreement is more limited than “related

to” an agreement. “Arising” means to originate or stem from. BLACK’S LAW

16 DICTIONARY 122 (9th ed. 2009). “Operation” refers to the act or process of

functioning or performing or “being in or having force or effect.” See MERRIAM

WEBSTER’S COLLEGIATE DICTIONARY 869 (11th ed. 2003); BLACK’S LAW

DICTIONARY 1201 (9th ed. 2009). Thus, “arising from the operation” of the

agreement means originating from the performance of the agreement or the legal

effect and obligations imposed by the agreement. See, e.g., Pagel v. Pumphrey, 204

S.W.2d 58, 64 (Tex. Civ. App.—San Antonio 1947, writ ref’d n.r.e.) (explaining

that operation of agreement is its legal effect and obligations that it imposes on the

parties); Cont’l Sav. Ass’n v. U.S. Fid. & Guar. Co., 762 F.2d 1239, 1245 (5th Cir.

1985) (referring to contract’s “operation” parties’ performance of legal obligations

imposed by contract). The language of section 7.3 of the purchase agreement more

closely resembles the limited “to enforce” than the expansive “to relate.”

The Fazios’ claims are based on a failure to disclose information that

Cypress promised to disclose before the parties ever entered into the purchase

agreement. This is not a dispute about performance under the agreement or a suit

for its breach. See Formosa Plastics, 960 S.W.2d at 47 (“[A]n independent legal

duty, separate from the existence of the contract itself, precludes the use of fraud to

induce a binding agreement.”). While a contract undoubtedly can affect the scope

of a legal duty to not commit fraud and is essential in determining the measure of

damages for fraudulent inducement, the tort itself in this instance does not arise

17 from the contract’s operation—it was a pre-contract tort to induce a sale. The

parties did not choose to allow for recovery of fees incurred in defending against

extra-contractual tort claims by including torts or claims more broadly “relating to”

the agreement. We hold that the Fazios’ claims against Cypress do not “arise from

the operation” of the purchase agreement; hence, the trial court correctly ruled that

Cypress is not entitled to attorney’s fees for defending against these claims.

18 Conclusion

The trial court properly entered a take-nothing judgment, because the jury

found no actual damages under their correct measurement. The trial court properly

denied Cypress’s request for attorney’s fees, because the Fazios’ fraud and

fraudulent inducement claims arose from conduct that occurred before the

purchase agreement’s execution, and not from its operation, and the agreement’s

attorney’s fees provision does not encompass torts or extra-contractual claims. We

therefore affirm the judgment of the trial court.

Jane Bland Justice

Justice Bland, joined by Chief Justice Radack, and by Justices Massengale, Brown, and Huddle, for the en banc court.

Justice Massengale, concurring.

Justice Keyes, joined by Justices Jennings, Higley, and Sharp, dissenting.

Justice Jennings, joined by Justices Keyes, Higley, and Sharp, dissenting from granting of en banc reconsideration.