Opinion ID: 63256
Heading Depth: 2
Heading Rank: 2

Heading: Texas Common-Law Fraud Claims[4]

Text: Dorsey alleged in his complaint that the Defendants made affirmative false representations and failed to disclose material facts. Under Texas law, to state a claim for common-law fraud based upon an affirmative false representation, Dorsey must allege that the Defendants made a material misrepresentation, which was false, and which was either known to be false when made or was asserted without knowledge of the truth, which was intended to be acted upon, which was relied upon, and which caused injury. Johnson & Johnson Med., Inc. v. Sanchez, 924 S.W.2d 925, 929-30 (Tex. 1996). To state a claim for common-law fraud based on nondisclosure, Texas law requires Dorsey to allege that the Defendants concealed or failed to disclose a material fact that they knew Dorsey was ignorant of or did not have the opportunity to discover, that they intended to induce him to take some action by concealing or failing to disclose the material fact, and that he suffered as a result of acting on the Defendants' nondisclosure. Bradford v. Vento, 48 S.W.3d 749, 754-55 (Tex. 2001). However, for there to be actionable nondisclosure fraud, there must be a duty to disclose. Newby v. Enron Corp. (In re Enron Corp. Sec., Derivative & ERISA Litig.), 388 F.Supp.2d 780, 788 (S.D.Tex.2005) (citing Texas case law). A duty to disclose may arise where one makes a representation and fails to disclose new information that makes the earlier representation misleading or untrue. . . . Id. The district court dismissed all of Dorsey's common-law fraud claims, finding that Dorsey failed to plead scienter adequately pursuant to Rule 9(b). Although the PSLRA's stricter scienter requirement does not apply to state-law fraud claims, Rule 9(b) nevertheless incorporates an element of scienter; however, after examining Dorsey's pleadings, the district court found neither sufficient allegations of motive nor any identifying circumstances that indicated the Defendants' conscious behavior. See Herrmann Holdings Ltd. v. Lucent Technologies Inc., 302 F.3d 552, 565 (5th Cir.2002). As an initial matter, we hold that Dorsey's state-law fraud claims against CAM and CEC were properly dismissed; indeed, Dorsey does not allege that CAM and CEC made any false representations. He also fails to link them to the alleged misrepresentations in the PPM. Dorsey failed to allege in his complaint facts to support his assertion that H. Barnes, an officer and director of CAM and CEC, acted on behalf of those companies when he drafted the PPM. The PPM was issued by PEI to sell PEI's promissory notes. Even if H. Barnes were liable for fraud involving PEI, CAM and CEC are not liable for fraud merely because one of their officers committed fraud while wearing a different corporate hat. Without commenting on the district court's assessment that Dorsey did not sufficiently allege motive, we do not agree with the district court's conclusion that Dorsey's allegations were insufficient to plead fraudulent intent on the part of the Defendants. This court has repeatedly stated in cases governed by the PSLRA that normally an officer's position with a company does not suffice to create an inference of scienter. Nathenson v. Zonagen Inc., 267 F.3d 400, 424 (5th Cir.2001). In Rule 9(b) cases, the same standard should arguably apply; to hold otherwise would effectively eliminate the scienter requirement for corporate officers. But even in federal cases governed by the PSLRA's heightened requirements for pleading scienter, we have recognized that there can be a number of special circumstances which, taken together with an officer's position, may support a strong inference of scienter. Id. at 424-25; see also Goldstein v. MCI WorldCom, 340 F.3d 238, 246 (5th Cir.2003). For example, in Nathenson, investors filed a securities fraud class action against a biopharmaceutical company, its CEO, and two outside directors alleging, among other things, that the defendants misrepresented to investors that one of the company's patents covered a potential product in order to inflate the company's share price artificially. 267 F.3d at 405-06. Although we agreed with the district court's dismissal of most of the investors' claims, we held that the circumstances alleged, when considered cumulatively, provided a strong inference of scienter with respect to the CEO and the company. See id. at 425. Those circumstances included the facts that the company was essentially a one-product company with its future prospects substantially dependent on that one product, the acquisition of the patent for that product was crucial for the company, the CEO publicly stated that the company's patent covered the product even when the company had ample opportunity to discover whether or not that was actually the case, and the company itself was smallit had less than forty employees. See id. This case presents similar special circumstances that, when considered together, lend themselves to a sufficient inference of scienter. In paragraph 15 of his complaint, Dorsey alleged that [b]ecause of their executive and board positions, defendants [H.] Barnes and J. Barnes knew of the false representations and material omissions adversely effecting [sic] the purchasers of [promissory notes], and were aware that the accurate information was being actively concealed from [them]. Dorsey further alleged that the Defendants' fraudulent intent was demonstrated by the fact that, at the time he purchased his promissory notes in February 1998, PEI had allegedly already failed to obtain security interests for loans it made to CHF. PEI was essentially a one-trick pony: it made loans to CHF. If CHF defaulted on its loans, PEI's ability to pay the interest and principal on its promissory notes was dependent upon having security interests in CHF's real estate. PEI had no employees, but was managed by CHF, a company with only eight employees. Neither of the companies had extensive operating histories nor significant assets. H. Barnes served as president and director of PEI and CHF, and maintained day-to-day operational control of both businesses. J. Barnes was vice-president and a director of CHF. Those circumstances indicate that H. Barnes and J. Barnes knew or were severely reckless in not knowing whether PEI had failed to make secured loans to CHF at the time Dorsey purchased his promissory notes in February 1998, suggesting that Dorsey sufficiently pleaded scienter for his common-law fraud claims against H. Barnes, J. Barnes, PEI, and CHF. Therefore, we reverse the finding of the district court regarding Dorsey's common-law fraud claims against H. Barnes, J. Barnes, PEI, and CHF with respect to Dorsey's initial purchase of promissory notes in February 1998.