Source-of-Duty Rule May Apply to Bar Fraud Claim Inextricably Entwined with Contractual Duties

If you sue someone for fraud, you can win punitive damages in addition to regular compensatory damages. If you’re suing only for breach of contract, punitive damages are a no-go. As punitive damages can add up to $350,000 to the value of the plaintiff’s claim, plaintiffs naturally try to add fraud claims to their breach-of-contract lawsuits whenever possible. The “source of duty” rule, however, limits the circumstances under which plaintiffs can pursue such a strategy. The rule provides that tort claims (like fraud) can only be pursued if the source of the duty allegedly breached is the common law and not a contract entered into between the parties. The Virginia Supreme Court has clarified in recent years that if a fraudulent misrepresentation is made within a contract, the plaintiff is limited to contract remedies, but if a misrepresentation is made for the purpose of inducing another party to enter into a contract, a separate fraud claim can be pursued.

If a fraudulent misrepresentation is made before a contract even comes into existence, it’s a pretty good bet that you’re dealing with a separate fraud claim and won’t be limited to contract remedies. After a contract is formed, however, it can be tricky to determine the source of the duty violated. One reason for this is that courts have applied the source-of-duty rule to exclude fraud claims when they are based on misrepresentations that are closely related to promises made within the contract, even if the misrepresentations are not made expressly therein. (See Tingler v. Graystone Homes, Inc., 834 S.E.2d 244, 257–58 (Va. 2019) (noting that “a putative tort can become so inextricably entwined with contractual breaches that only contractual remedies are available)). If a fraudulent act “arises out of” a contractual relationship and the damages caused by the fraud also arise out of that relationship, that can be enough for application of the source-of-duty rule.

The Fairfax Circuit Court was faced with this issue recently in EvansStarrett PLC v. Goode. EvansStarrett is a law firm that previously represented Marvin E. Goode and Preferred General Contracting Company in a construction dispute. They won an arbitration award of $246,985.58 that included an award of $145,000 in attorneys fees. The actual amount of legal fees owed to EvansStarrett, according to the complaint it eventually filed against its former clients, was $228,098.17. A deal was reached after the arbitration award to have the entire amount wired to EvansStarrett’s client trust account by a date certain. Mr. Goode, however, persuaded EvansStarrett to allow the settlement payment to go directly to Preferred General Contracting’s bank account, by allegedly promising to immediately wire the law firm the amount owed upon receipt of the settlement payment. When Preferred General Contracting received the settlement funds, it sent EvansStarrett only $145,000, the amount of fees awarded by the arbitrator. The law firm sued for the difference, and after initially suing only for breach of contract, asked for leave to add a count for fraud.

The court looked to the source-of-duty rule and concluded that the alleged misrepresentation by Mr. Goode could not fairly be said to fall outside of the contractual relationship between Mr. Goode and his law firm. If Mr. Goode owed legal fees to EvansStarrett, it reasoned, it was because of the contract that existed between them, not the common law. The court therefore refused to allow the law firm to add a fraud claim to its complaint. The noted that “the fact that the representation by Defendant Preferred was knowingly false is of no moment” considering the misrepresentation was “related to a duty that arose under the contract.”