Health Source, Inc, offers to buy Medico Equipment & Supplies Corporation. On June 1, Medico gives Health Source copies of Medico's financial statements for the pre-vious year. The statements show an inventory of $10 million. On June 15, Medico

Question

discovers that the previous year's inventory is overstated by $500,000, but does not inform Health Source. On July 1, Health Source, relying on the fi-nancial statements, buys Medico. On July 10, Health Source discovers the inven-tory over-statement. Can Health Source succeed in a suit against Medico? On what basis?

Answer 1

Yes, Health Source can succeed in a suit against Medico. The basis for the suit could be fraud be-cause Medico had a duty to disclose that the inventory was overstated as soon as Medico learned of that fact.
The elements of an action for fraud are (1 ) the misrepresentation of a material fact, (2 ) the intent to deceive, and (3 ) the innocent party's justifiable reli-ance on the misrepresentation. Ordinarily, no party to a contract has a duty to come forward and disclose facts. Each party is responsible for the use of common sense and normal business sense in negotiating a con-tract. An action for fraud can be based on a failure to disclose material facts when there is a certain relationship between the parties such as be-tween part-ners in a partnership or when a party could not reasonably discover a fact known to the other party. An action may also be maintained if, as here, a party that misstates a material fact later learns of the misstate-ment but does not disclose it to the other party.This is misrepresentation by conduct.

Here, by providing finan-cial statements, Medico made certain representations. Those representa-tions were false, how-ever, as Medico learned. Medico's knowledge of the over-stated inventory and failure to disclose this to Health Source indicated intent to deceive. Health Source's reli-ance on Medico's statements was reasonable and justifiable.