No. 12601 

IN THE 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: 

For Appellants : 

Gough, Booth, Shanahan and Johnson, Helena, Montana 

Cordell Johnson argued, Helena, Montana 

For Respondents : 

Keller, Reynolds and Drake, Helena, Montana 

Paul F. Reynolds argued, Helena, Montana 

SL$ ': 3.974 

Filed : 

Submitted: May 20, 1974 

Decided : Mp I 1 7974 

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 (hereinafter referred 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 and 
Game Commission. 

There were back taxes owing on the marina property at 

the time of the purchase. Buyers contend that at the initial 

meeting between buyers and sellers that sellers represented to 

buyers that before the sellers could sell the property they 

would return to Montana and "straighten out the taxes". Sellers' 

son, Norman Nelson, denied any such representation and testified 

that it was his understanding that tax responsibility was that 

of a former marina owner, Louie Faas, and that sellers might 

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 were paid before purchasing the marina. On September 24, 1971, five months after the sale was made, sellers brought 

a quiet title action in Lewis and Clark County and judgment was 

rendered in sellers' behalf which determined the back taxes on 

the marina property. These taxes were paid on December 3, 1971, 

by sellers. 

It is buyers1 contention that sellers represented to them 

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 to renew the policy. 

It was later discovered by the buyers that there was no liability 

insurance coverage on the property. 

Sellers, however, testify that they have no recollection 

of any such conversation. Sellers' son, Norman, had no recollection of any discussions in reference to insurance, although it is 

possible that the subject was mentioned but not in detail. He 

testified that the first time he recalled any conversation in 

reference to insurance was in August, 1970, and that discussion 

took place between himself and his father only, that he first 

learned that there was no liability insurance in August, 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 or policies required with the escrow 

papers. Paragraph 13 of the escrow agreement sets forth that 

failure of the buyers to maintain insurance is a basis for default. Buyers upon leaningthat there was no liability insurance sought to obtain a policy but claim that they were unable 

to do 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. 

At the time of the sale, the marina 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 also expressly provided and understood 

by and between the parties hereto that the sale 

of all of the property here involved by Sellers 

to Buyers is expressly conditioned on the granting of a ten-year lease or permit by the State 

of Montana to Buyers for the use and occupancy 

of said real property forming the site for use as 

a resort site. It is further agreed that if such 

lease or permit is not granted, that the buyers 

may, at their option, declare this agreement null 

and void and of no force and effect except that 

as to the down payment or $12,500.00 which has 

been made by Buyers to Sellers, as hereinabove 

set forth, an equitable portion thereof will be 

refunded by Sellers to Buyers, Sellers being 

permitted to retain so much thereof as will 

compensate them fairly and adequately for their 

loss of 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 the matters to arbitration, each party selecting an arbitrator and 

these two selecting a third. The decision of 

a majority of said arbitrators on said question 

shall be 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's Nat. 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) its materiality; (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 6 months before this rescission action was brought, the entire 

question is moot. 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 to a fact, as distinguished from the 

expression of an opinion (citing case), 

though an exception to that rule is illustrated in Como Orchard Co. v. Markham, 54 

Mont. 438, 171 P. 274, and, of course, the 

representations must be made with respect 

to a material matter; that is, one which 

affects the complaining party in a substantial degree (citing case). ~ll of these 

elements are fully comprehended in the more 

general terms: Representation, falsity, scienter, 

deception, and injury. (citing case)" (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 o establish knowledge on the part of the seller as 

set forth in the trial court's finding of fact No. 4 below: 

"During the three day period referred to in 

Finding #3, Chris Nelson or his son, Norman, 

acting as his agent represented to plaintiffs 

either that Chris Nelson had a policy of public liability insurance in force, which policy 

could be transferred to plaintiffs, 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 at this time." 

(Emphasis added.) 

Knowledge on the part of the person making the representation, 

at the time it was made, and knowledge that it was false, is 

necessary to support a finding of fraud. Without it, the buyers 

fail in their 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 in question after the letter of 

rescission was sent by the buyers has been argued by the buyers 

as immaterial 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 discretion with respect 

to admission of evidence either to prove or disprove 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 trial court did not abuse 

its discretion. 

Buyers next contend that their failure to obtain a 10- 

year renewable lease from the Fish and Game Commission amounted 

to a failure of consideration for the escrow agreement. Buyers 

further contend that sellers'failure to demand arbitration under 

paragraph 30 of the escrow agreement, their failure to plead 

arbitration as a defense and their counterclaim amounted to a 

waiver of the arbitration clause in the contract, and cite as 

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 are not factually in point with the problem we have before 

the Court. The cases cited deal with suits brought in lieu of 

arbitration and concern the subject matter which the arbitration 

clause was designed to cover. The case before us, however, not 

only deals with the subject matter of the arbitration clause, i.e. 

failure to obtain a 10-year renewable lease from the Fish and Game 

Department, but also deals with fraudulent inducement in the entering of the escrow agreement. 

Sellers argue that because buyers are claiming rescission 

on the grounds of fraudulent inducement, it would have been nonresponsive to demand arbitration under paragraph #30. For if rescission results because of fraudulent inducement, they argue, so 

would any right to arbitration. 
Neither buyers nor sellers cite any authority directly 

on the question of whether an arbitration clause concerning 

failure of consideration is waived under these circumstances 

when fraudulent inducent is also pleaded to void the contract 

that contains the clause. 

Corbin on Contracts, 81444, p. 449 states: 

" * * * The fraud of one party, inducing the 

other's assent to the whole, makes the whole 

voidable at the latter's option; after a proper 

avoidance, the right to an arbitration falls 

along with all other rights created by the 

other promises that were made. In cases within 

this paragraph, the remedies for enforcement of 

arbitration agreements are not 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 that the court itself must 

decide." 

When a party to a 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 

first determine 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 to rescind the contract, we find no abuse 

of discretion by the trial court acting in equity in ordering 

the terms of the contract enforced. 

The judgment of the 

---- 

Justice 

We concur: 

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Chief Justice