Effect of Failure to Read Legal Documents

This issue arises in securities litigation because plaintiff investors often claim that the defendant seller of an investment (usually a broker or investment adviser) made misleading statements, or withheld material information, about an investment. However, the seller of the investment typically asserts a document (like a prospectus) contains adequate disclosures and is signed by the investor. 

To defend against claims of securities fraud, sellers of securities will argue that buyers cannot sue the sellers for failing to disclose facts or making misleading statements when all of the material facts and risks are accurately disclosed in a document that the sellers gave the buyers and which the buyers signed. Many times, these documents even contain “integration clauses” wherein plaintiffs, by their signatures, represent that they are not relying on any oral statements and that the document contains the parties’ entire agreement. When sellers of securities raise this defense, it is often called the “prospectus defense.” See Philip M. Aidikoff, et. al, The Prospectus Defense: Defeating It As A Matter of Fact and Law, 16 PIABA B.J. 343 (2009). This article addresses the laws that form the basis of the prospectus defense and then discusses claims that investors can make to overcome the prospectus defense.

“‘It is a bedrock principle of contract law that an individual who signs a contract is presumed to have read the contract and is bound by its contents.’” In re Marriage of Sachs v. Sachs, 2016 WL 7489761, at *2, ¶ 11 (Ct. App. Dec. 30, 2016) (quoting 84 Lumber Co. v. Smith, 356 S.W.3d 380, 383 (Tenn. 2011)).

A fundamental premise of the prospectus defense is that sellers of securities cannot be liable for failing to disclose something that is plainly disclosed in documents that the buyer signed. Judge Posner of the Seventh Circuit Court of Appeal so held in Carr v. CIGNA Sec., Inc. where he stated: “If a literate, competent adult is given a document that in readable and comprehensible prose says X (X might be, ‘this is a risky investment’), and the person who hands it to him tells him, orally, not-X (‘this is a safe investment’), our literate, competent adult cannot maintain an action for fraud against the issuer of the document.” 95 F.3d 544, 547 (7th Cir. 1996).

Judge Posner found this rule necessary to “provide sellers of goods and services, including investments, with a safe harbor against groundless, or at least indeterminate, claims of fraud by their customers,” because “without such a principle, sellers would have no protection against plausible liars and gullible jurors.” Id. See also Whitney Co. v. Johnson, 14 F.2d 24, 26 (9th Cir. 1926) (“If one can read his contract, his failure to do so is such gross negligence that it will estop him from denying it, unless he has been dissuaded from reading it by some trick or artifice practiced by the opposite party.”) (quoting Chicago, St. P., M. & O. Ry. Co. v. Belliwith, 83 F. 437, 439 (8th Cir. 1897)); Garcia v. Santa Maria Resort, Inc., 528 F. Supp. 2d 1283, 1296 (S.D. Fla. 2007) (“Quite simply, Plaintiffs should not be rewarded for consciously choosing not to read their Purchase Contracts . . . all plaintiffs are bound by the provisions of contracts they have executed, irrespective of whether they bother to read them”); Wilks v. Manobianco, 237 Ariz. 443, 447, ¶ 15 (2015) (holding failure to read defense may be submitted to jury to assess comparative negligence).

The rule mentioned above may be a defense to a plaintiff’s claims of common law fraud, negligence, and/or claims arising under federal securities fraud, but it does not bar claims arising under A.R.S. § 44-1991, which forbids fraud in the purchase or sale of securities. Plaintiffs who bring claims under A.R.S. § 44-1991(A) are held to a lesser standard and are not presumed to have read a prospectus or other disclosure documents. See Trimble v. Am. Sav. Life Ins. Co., 152 Ariz. 548, 553 (Ct. App. 1986) (“The [Arizona securities fraud] statutes do not require investors to act with due diligence; nor do we find any judicial authority in Arizona for such a requirement. To the contrary, defendants have an affirmative duty not to mislead potential investors. This requirement not only removes the burden of investigation from an investor, but places a heavy burden upon the offeror not to mislead potential investors in any way.”). Accord Aaron v. Fromkin, 196 Ariz. 224, 227, ¶ 15 (Ct. App. 2000) (holding Arizona’s securities fraud statute imposes “affirmative duty not to mislead” on those selling securities). As to claims brought under A.R.S. § 44-1991(A), sending an accurate and truthful prospectus or other documents to an investor does not shield the seller from liability for misstatements made prior to or after sending the documents. See In re Nat'l Century Fin. Enterpr., Inc., Inv. Litig., 541 F. Supp. 2d 986, 1004 (S.D. Ohio 2007) (denying motion to dismiss complaint alleging Arizona securities violations after holding language in documents sent to plaintiffs cannot “preclude Plaintiffs from showing that they justifiably relied on [defendant’s] alleged misrepresentations” made prior to sending documents to plaintiffs). 

Because plaintiffs who bring claims under A.R.S. § 44-1991 are not presumed to have read a prospectus, the plaintiffs’ failure to do so is not a defense. See A.G. Edwards & Sons, Inc. v. McCullough, 764 F. Supp. 1365, 1370 (D. Ariz. 1991), rev'd on other grounds by A.G. Edwards & Sons, Inc. v. McCullough, 967 F.2d 1401 (9th Cir. 1992) (holding that “it is clear to the Court that contributory negligence is no defense to Defendants’ state law claim”).

Statute of Limitations

Though giving a client a prospectus does not shield a seller from liability for claims arising under A.R.S. § 44-1991, delivery of a prospectus may cause the statute of limitations to begin to run sooner. Claims brought under A.R.S. § 44-1991(A) must be “brought within two years after discovery of the fraudulent practice on which the liability is based, or after the discovery should have been made by the exercise of reasonable diligence.” A.R.S. § 44-2004(B). This statute imposes a duty on the plaintiff to exercise reasonable diligence in discovering fraud, and reading a prospectus would alert a buyer of securities that what the seller of the security said contradicted the prospectus. Therefore, sellers of securities may argue that a plaintiff should have discovered any alleged fraud after receiving a copy of a prospectus. See Calvi v. Prudential Sec., Inc., 861 F. Supp. 69, 72 (C.D. Cal. 1994) (dismissing plaintiff’s claims as time-barred because the “plaintiff was provided with documents detailing the risks involved in each of the investments she purchased—and in fact signed forms stating that she had read the material given to her—and because the warnings in these documents directly conflicted with her broker’s alleged representations, plaintiff was on inquiry notice of her claims”). This argument has been widely accepted. Some notable cases include:

• Kaufman v. Guest Capital, LLC, 386 F. Supp. 2d 256, 269 (S.D.N.Y. 2005) (“courts have imposed inquiry notice on plaintiffs who recklessly shirked their responsibilities to read relevant documents; failed to investigate glaring inconsistencies in representations; or otherwise ‘buried’ their heads in the sand in the face of palpable falsities”). 
• Condos v. United Ben. Life Ins. Co. of Omaha, Neb., 93 Ariz. 143, 145-46 (1963) (dismissing claims that contradicted written agreement brought by a plaintiff who could not read because “[a]n illiterate may not turn his disability into a sword with which to improve his own rights at the expense of others”). 
• Franze v. Equitable Assurance, 296 F.3d 1250, 1254 (11th Cir. 2002) (holding that claims were barred by statute of limitations because “[plaintiffs] could have discovered the alleged misrepresentations simply by reading the[] documents” and therefore plaintiffs had “notice despite the fact that they both testified that they did not read any of the documents that [defendant] gave them. It was [plaintiffs’] responsibility to read these documents, and, had they done so, they could have discovered the alleged misrepresentations.”).

Because plaintiffs must be diligent in discovering claims, refusing to read a prospectus will likely not be considered adequate diligence and may cause the statute of limitations to begin to run when plaintiffs receive a prospectus or other similar document.

A plaintiff may overcome the prospectus defense by showing: (1) the terms of the prospectus fall outside the “reasonable expectations” of the parties; and/or (2) the defendant owed a duty to the plaintiff, which excused the plaintiff from reading the document. See Darner Motor Sales, Inc. v. Universal Underwriters Ins. Co., 140 Ariz. 383, 394, 398 (1984)).

Reasonable Expectations

In Darner, the Arizona Supreme Court set forth “doctrine of reasonable expectations,” which “relieves a party from ‘certain clauses of an agreement which he did not negotiate, probably did not read, and probably would not have understood had he read them.’” Philadelphia Indem. Ins. Co. v. Barerra, 200 Ariz. 9, 14, ¶ 12 (2001) (quoting Darner, 140 Ariz. at 394). The doctrine of “reasonable expectations” applies when the contract is a “contract of adhesion” and the language the plaintiff seeks to avoid goes against the “reasonable expectations” of the parties. Darner, 140 Ariz. at 398-99. 

“An adhesion contract is typically a standardized form offered to consumers of goods and services on essentially a ‘take it or leave it’ basis without affording the consumer a realistic opportunity to bargain ...” Broemmer v. Abortion Services of Phoenix, Ltd., 173 Ariz. 148, 150 (1992) (citations omitted). In Darner, the court determined the contract was one of adhesion because its boilerplate language was not bargained for, read or understood by the buyer. Darner, 140 Ariz. at 390. Courts have also held that parts of standardized form contracts typically used by brokers can be adhesive because investors either must accept or reject them and cannot truly negotiate them. See, e.g., Finkle & Ross v. A.G. Becker Paribas, Inc., 622 F. Supp. 1505, 1511 (S.D.N.Y. 1985) (“Here, the investor is faced with an industry wide practice of including Arbitration Clauses in standardized brokerage contracts. As the investor faces the possibility of being excluded from the securities market unless he accepts a contract with such an agreement to arbitrate, such clauses come within the adhesion doctrine.”).

In determining whether terms in a contract are at odds with a buyer’s “reasonable expectations,” courts should consider whether the seller had reason to believe that the buyer “would not have accepted the agreement if he had known that the agreement contained the particular term.” Darner, 140 Ariz. at 392 (quoting Restatement (Second) of Contracts § 211 cmt. (c)). This may be shown by:

prior negotiations or inferred from the circumstances. Reason to believe may be inferred from the fact that the term is bizarre or oppressive, from the fact that it eviscerates the non-standard terms explicitly agreed to, or from the fact that it eliminates the dominant purpose of the transaction. The inference is reinforced if the adhering party never had an opportunity to read the term, or if it is illegible or otherwise hidden from view.

Id. In Darner, the court determined that a certain provision in the contract limiting coverage was contrary to the “reasonable expectations” of the parties because the provision was “standard boilerplate” and “was not bargained for, not written by and not read by the parties” and, importantly, it “undercut” the negotiated deal. Id. at 395. 

A plaintiff may be able to show that disclosures in a prospectus are beyond the “reasonable expectations” of the plaintiff by presenting evidence of prior discussions between the plaintiff and the broker/adviser, wherein the broker/adviser made promises and or statements that created expectations different than those contained in the prospectus. 

Whether a Plaintiff’s Duty to Read is Excused

When a defendant owes a plaintiff a duty to give proper advice about a document, then the plaintiff may be justified in relying on that advice without reading the document, such as a prospectus. See Darner, 140 Ariz. at 398 (“We are a nation which also prides itself on a tradition of allowing a person to rely upon the words of another who, because of a special knowledge, undertakes to act as an advisor. If an agent has an economic self-interest in imparting information, sound policy does require that the agent's duty to speak without negligence be reinforced by basic tort principles inherent in the common law.”). Sellers of securities cannot hide behind murky or complicated contract provisions to avoid the consequences of their misrepresentations, regardless of whether those representations were made fraudulently or negligently. See Formento v. Encanto Bus. Park, 154 Ariz. 495, 499 (Ct. App. 1987), supplemented (Aug. 4, 1987); Hill v. Jones, 151 Ariz. 81, 84 (Ct. App. 1986).

In Darner, the court determined the insurance agent did not owe a fiduciary duty to the plaintiff, but instead owed a lesser duty “to act with the care and expertise of one licensed to sell insurance in this state.” Id. at 397, 399. Despite no fiduciary duty, the court still found that the plaintiff was justified in relying on the defendant’s oral representations because the defendant was an insurance agent with a duty to act with care and expertise. Id. Although Darner involved insurance agents, it is no less applicable in the securities context. See Gordinier v. Aetna Cas. & Sur. Co., 154 Ariz. 266, 272 (1987) (holding “Darner methodology was not intended to be limited to the precise facts presented in that case”). 

Indeed, in contrast to the lesser duties owed by insurance agents in Darner, it is well-settled that investment advisers and brokers owe a fiduciary duty to their clients. See, e.g., Sec. & Exch. Comm'n v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191 (1963); Conway v. Icahn & Co., 16 F.3d 504, 510 (2nd Cir. 1994); Davis v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 906 F.2d 1206, 1217 (8th Cir. 1990); Gochnauer v. A. G. Edwards & Sons, Inc., 810 F.2d 1042, 1049 (11th Cir. 1987); SEC v. Rauscher Pierce Refsnes, Inc., 17 F. Supp. 2d 985, 992-95 (D. Ariz. 1998); Baker v. Wheat First Sec., 643 F. Supp. 1420, 1429 (S.D. W. Va. 1986); Stewart v. Phoenix Nat’l Bank, 49 Ariz. 34, 44-46 (1937); Duffy v. King Cavalier, 264 Cal. Rptr. 740, 749-50 (Ct. App. 1989).

Fiduciary duties include acting with the utmost good faith, integrity, honesty and loyalty in the agent’s transactions with the principal. See Hassenpflug v. Jones, 84 Ariz. 33, 36 (1958); Musselman v. Southwinds Realty, Inc., 146 Ariz. 173, 175 (Ct. App. 1985).

Further, as the Arizona Supreme Court stated: “A broker is under a [fiduciary] duty to disclose to his client information which he possesses pertaining to the transaction in question.” Jennings v. Lee, 105 Ariz. 167, 173 (1969). See also Caravan Mobile Home Sales, Inc. v. Lehman Bros. Kuhn Loeb, Inc., 769 F.2d 561, 567 (9th Cir. 1985) (“As an agent [a broker] has a duty to give any information relevant to the affairs entrusted to him of which he has notice.”); Walston & Co. v. Miller, 100 Ariz. 48, 52 (1966) (“There is no quarrel with the proposition of law that when a broker serves as a customer’s agent, he is a fiduciary and owes his principal a duty to communicate certain information to him . . . Unless otherwise agreed, an agent is subject to a duty to use reasonable efforts to give his principal information which is relevant to affairs entrusted to him and which, as the agent has notice, the principal would desire to have and which can be communicated without violating a superior duty to a third person.’”).

In sum, Plaintiffs may defeat the prospectus defense by asserting claims under A.R.S. § 44-1991, showing the terms of the prospectus fall outside the parties’ reasonable expectations, or establishing the defendant owed the plaintiffs a duty that excused the plaintiffs’ failure to read, such as a fiduciary duty owed by an adviser or broker to a client.