### No. 12601 INTHE SUPREME COURT OF THE STATE OF 

### MONTANA 1974

DONALD G. DUNLAP and THELMA DUNLAP, Plaintiffs and Counter-Defendants

and Appellants,

CHRIS NELSON and THERESE 

### E. NELSON, Defendants and Counter-Plaintiffs

and Respondents.

Appeal from: District Court of the First Judicial District, Honorable Gordon E. Bennett, Judge presiding. Counsel of Record: ForAppellants: 

### Gough,Booth, Shanahanand Johnson,Helena,Montana Cordell Johnson argued, Helena,Montana ForRespondents: 

### Keller,Reynolds and Drake, Helena,Montana Paul 

### F. Reynolds argued, Helena,Montana



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# ':3.974 Filed: 

### Submitted: May 20, 

### 1974 Decided:

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Clerk

### Mr. Justice Gene B. Daly delivered the Opinion of the Court. This is an appeal from an action in equity for rescission of a contract on grounds of failure of consideration and fraudulent inducement heard in the first judicial district by the Hon. Gordon R. 

### Bennett. From a judgment denying rescission, the appellants bring this appeal. Appellants, Donald G. Dunlap and Thelma Dunlap (hereinafter referred to as buyers) purchased from respondents, Chris Nelson and Therese 

### E. Nelson (hereinafterreferred to as sellers) in April of 1971, a marina facility located at Cave Bay on Canyon Ferry Lake near Helena,Montana. The facility is situated on property owned by the State of Montana and managed by the Montana Fish and Game Commission. Buyers became aware that sellers were offering the marina facility for sale through an advertisement in the Los Angeles Times. Buyers were at that time living in Anaheim, California, where Dunlap was employed as a barber and his wife managed an apartment building. Buyers met with sellers' son,Norman Nelson, in California to discuss the matter. Buyers later went to Norman Nelson's house in Pacific Palisades, California,where they met with Norman and sellers to discuss the sale. Buyers, in late March 1971, inspected the marina facilities. Sellers offered the property for $125,000. Buyers responded with

a counteroffer of $75,000, which was accepted and the parties on

or about May 19, 1971, entered into a contract entitled "Escrow Agreement". There are three areas of 

### dispute in the facts as they

concern the negotiations and later the action for rescission:

(1) Back taxes on the marina property, (2) 

### liability insurance

on the property, and (3) 

### the future leasehold from the Fish andGame Commission. There were back taxes owing on themarina property at the time of thepurchase. Buyers contend that atthe initial meeting between buyers and sellers that sellers represented to buyers that before the sellers could sellthe property they would return toMontana and "straighten out the taxes". Sellers' son, Norman Nelson, denied any such representation and testified that it was hisunderstanding that tax responsibility was that of a former marina owner, Louie Faas, and that sellersmight possibly be responsible for them if Faas did not pay them. Buyers did not check the tax records in Lewis and Clark County to see if the taxes

### werepaid before purchasing the marina. On September 24, 1971, fivemonths afterthe salewas made, sellersbrought

a quiet titleaction inLewis and Clark County and judgment was rendered in 

### sellers' behalf which determined the back taxes on the marina property. These taxes 

### werepaid on December 3, 1971, by sellers. It isbuyers1contention that 

### sellers represented tothem that the property was covered by insurance, including liability insurance, and it would be possible for the buyers to take over the existing insurance until it was necessary torenew the policy. It was later discovered by the buyers that there

### was no liability insurance coverage on theproperty. Sellers, however, testify that they have no recollection of any such conversation. Sellers' son, Norman, had no recollection of any discussions inreference to insurance, although it is possible that the subject wasmentioned but not indetail. He testified that the firsttimehe recalled any conversation in reference toinsurancewas inAugust, 1970, and that discussion took place between himself and his father only, that he first learned that there was no liability insurance inAugust, 1971.Paragraph 10 of the escrow agreement provided that buyers were to secure for themselves adequate public liability and property damage insurance coverage. Paragraph 11 required the deposit of the insurance policy orpolicies required with the escrow papers. Paragraph 13of the escrow agreement sets forth that failure of the buyers tomaintain insurance is a basis for default. Buyers upon leaningthatthere was no liability insurance sought toobtain a policy but claim that they 

### were unable todo so. Thereafter buyers had a letter of rescission dated July 9, 1971, sent to sellers. July 22, 1971, sellers obtained

a policy of insurance for personal liability for the marina facilities. Atthe 

### timeof the sale, themarina property was under a ten-year lease from the Fish and Game Department, which ran until 1980. The sellers assured buyers that they could get a ten-year lease with a ten-year renewable option. Paragraph 30 of the escrow agreement provided: "It

### is alsoexpressly provided and understood by and between the parties hereto that the sale of allof the property here involved by Sellers toBuyers 

### is expressly conditioned on the granting of a ten-year lease or permit by the State of Montana toBuyers for theuse and occupancy of said real property forming the sitefor use as a resort site. It 

### is further agreed that if such lease orpermit is not granted, that the buyers may, attheir option, declare this agreement null and void and of no force and effect except that 

### as tothe down payment or $12,500.00 which has been made by Buyers to Sellers, ashereinabove setforth, an equitable portion thereof 

### willbe refunded by Sellers to Buyers, Sellersbeing permitted toretain somuch thereof aswill compensate them fairly and adequately for their lossof time, profits and inconvenience in the premises. It is further agreed that if the parties cannot decide upon the division of said down payment, they 

### will submit thematterstoarbitration, each party selecting an arbitrator and these two selectinga third. The decision of a majority of said arbitrators on said question shallbe binding on the parties hereto." Buyers 

### were not granted a ten-year lease, but only a five-year lease by the Fish and Game Commission. Buyers present the following four issues for review:

### 1. Whether buyers are entitled to rescind the contract for material failure of consideration? 2. Whether buyers are entitled to rescind contract, based on fraud in the inducement? 3. Whether district court erred in admitting evidence of insurance obtained after notice of rescission had been given? 4. What expenditures should properly be allowed in order to make buyers whole? The buyers contend that because of the representation by the respondents concerning the matters of back taxes and liability insurance that they were fraudulently induced into the

escrow agreement. We defined fraud in Cowan v. Westland Realty Company, 162 Mont. 379, 512 P.2d 714, 716, 30 St.Rep. 707,as follows: "In Lee v. Stockmen'sNat. Bank, 63 Mont. 262, 284, 207 P. 623, this court set down the elements which the plaintiff must prove to make out a prima facie case of fraud: (1)A 

### representation; (2) its falsity; (3) itsmateriality; (4) the speaker's knowledge of its falsity, or ignorance of its truth;

(5)his intent that it should be acted upon by the person and in the manner reasonably contemplated;

(6) 

### the hearer's ignorance of its falsity; (7) his reliance upon its truth; (8)

### his right to rely thereon; and (9) his consequent and proximate injury.

## " The buyers maintain that had they known the back taxes had not been "straightened out" they would not have come to Montana in the first place to inspect the marina facilities. This Court could get involved in a semantical discussion of the possible meanings of the phrase "straightened out". We feel,however, that it will suffice to say that since the back taxes were paid 5 

### or 6months before this rescission action was brought, the entire question ismoot. Further a close examination of the record fails to disclose sufficient credible evidence to meet the standard established in Cowan. As we stated in Ray v. Divers, 72 Mont. 513,

### " 

## * * 

## * Generally the representations must relate toa fact, asdistinguished from the expression of an opinion (citing case), though an exception tothat rule is illustrated inComo Orchard Co. v. Markham, 54 Mont. 438, 171P. 274, and, of course, the representations must be made with respect toa 

### material matter; that is, one which affects the complaining party ina substantialdegree (citingcase). ~ll of these elements 

### are fullycomprehended inthe more general 

### terms: Representation, falsity, scienter, deception, and injury. (citingcase)" (Emphasis added.) The evidence in support of buyers' allegation of fraudulent inducement as it pertains to the policy of liability insurance f a i l s t oestablish knowledge on the part of the seller as 

### set forth inthe trialcourt's finding of factNo. 4 below: "During the three day period referred toin Finding #3, Chris Nelson or his son, Norman, acting ashis agent represented toplaintiffs either that Chris Nelson had a policy of publicliability insurance in force, which policy could be transferred toplaintiffs, or that he could secure such a policy. Though there is evidence on both sides of-the question, a preponderance of the credible evidence indicates that Chris Nelson believed he had liability insurance on the property atthis time." (Emphasis added.) Knowledge on thepart of the person making the representation, atthe time 

### it was made, and knowledge that it was false, 

### is necessary to support a finding of fraud. Without it, the buyers fail intheir proof. Lee v. Stockmen's Nat. Bank, 63 Mont. 262, 207 P. 623. The admission into evidence that sellers obtained liability insurance on the premises inquestion after the letterof rescission was sent by the buyers has been argued by the buyers

asimmaterial evidence and error. This being an equity action tried to the court and the subject matter under consideration by the court being fraud, the court has wide discretionwith respect to admission of evidence either toprove ordisprove the allegation

### of fraud. Berberian v. Martin, 214 A.2d 189 (R.I. 1965).In Koch v. Rhodes, 57 Mont. 447, 452, 188 P. 933, we held: "Where fraud 

### is alleged, great latitude of proof is allowed, and every fact or circumstance from which a legal inference of fraud may be drawn 

### is admissible. (Citing cases.)

## " Therefore under these circumstances the trialcourt did not abuse its discretion. Buyers next contend that their failure toobtain a 10- year renewable lease from the Fish and Game Commission amounted toa failure of consideration for the escrow agreement. Buyers further contend that sellers'failure todemand arbitration under paragraph 30 of the escrow agreement, their failure toplead arbitration

### as a defense and their counterclaim amounted to a waiver of the arbitration clause inthe contract, and citeas authority: E. I. DuPont De Nemours & Co. v. Lyles & Lang Const. Co., 219 F.2d 328; Trubowitch v. Riverbank Canning Co., 30 Cal.2d 335, 182 P.2d 182; Finlayson v. Waller, 64 Ida. 618, 134 P.2d 1069; and Anderson v. Twin City Rapid Transit Co., 250 Minn. 167, 84 N.W.2d 593. The cases from the foreign jurisdictions cited to support waiver arenot factually inpoint with the problem we have before the Court. The 

### cases cited dealwith suitsbrought in lieu of arbitration and concern the subject matter which the arbitration clause 

### was designed tocover. The case before us, however, not only deals with the subject matter of the arbitration clause, i.e. failure toobtain a 10-year renewable lease from the Fish and Game Department, but alsodeals with fraudulent inducement inthe entering of the escrow agreement. Sellers argue that because buyers areclaiming rescission

on the grounds of fraudulent inducement, it would have been nonresponsive todemand arbitrationunder paragraph #30. For if rescission resultsbecause of fraudulent inducement, they argue, so would any right toarbitration.Neither buyers nor 

### sellers cite any authority directly

on the question of whether an arbitration clause concerning failureof consideration iswaived under these circumstances when fraudulent inducent is alsopleaded tovoid the contract that contains the clause. Corbin on Contracts, 81444, p. 449 states: 

### " 

## * * * The fraud of one party, inducing the other's assent tothe whole, makes thewhole voidable atthe latter'soption; after a proper avoidance, the right toan arbitration falls along with allother rights created by the other promises that were made. In caseswithin thisparagraph, the remedies for enforcement of arbitration agreements arenot available, including the enforcing order authorized by an arbitration statute. Before issuing such an order the court must know that legal duty to arbitrate exists; this is an issue thatthe court itself must decide." When a party toa contract attempts rescission of that contract because of fraudulent inducement and that issue does not come within the purview of the arbitration clause, the court must firstdetermine if the contract is valid before it can grant relief through arbitration. In 

### re Kinoshita & Co.. 287 F.2d 951 (2nd Cir. 1961); Atcas v. Credit Clearing Corporation of America. 292 Minn. 334. 197 N.W.2d 448; Interocean Shipping Co. v. National Shipping and Trad. Corp., 462 F.2d 673 (2nd Cir. 1972). Under these circumstances, the Court having found no fraudulent inducement torescind the contract, 

### we find no abuse of discretion by the trial court acting in equity in ordering the 

### termsof the contract enforced. The judgment of the



# ---- Justice Weconcur:

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