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International Business Machines Corp. v. Lufkin Industries, Inc.

Court of Appeals of Texas, Twelfth District, Tyler

July 12, 2017


         Appeal from the 159th District Court of Angelina County, Texas (Tr.Ct.No. CV-02073-13-02)

          Panel consisted of Worthen, C.J., Hoyle, J., and Neeley, J.


          James T. Worthen Chief Justice

         International Business Machines Corporation (IBM) appeals the trial court's judgment in favor of Lufkin Industries, Inc. (Lufkin). IBM raises five issues on appeal, and Lufkin raises a conditional cross-issue in its response brief and a separate cross-appeal. We affirm in part, reverse and render in part, and suggest a remittitur of a portion of the damages awarded in the trial court's judgment incorporating the jury verdict.


         Lufkin is a NASDAQ traded company that is an industry leader in manufacturing "engineered-to-order" power transmission gear boxes and "manufactured-to-order" oil field pumping units.[1] Its sales of both dropped in the Great Recession of 2007-2008. However, it expected a strong market recovery for both of these products, particularly due to the "fracking" and horizontal drilling revolution throughout Texas, North Dakota, and other states.

         To position itself for growth, Lufkin's leadership realized it needed to replace its highly configured but increasingly outdated Enterprise Resources Planning (ERP) System. An ERP system is a computer software business operating system that integrates all departments and functions across the company. Because of the high demand expected for Lufkin's two signature products, as the economy improved, time was of the essence to install a new ERP operating system. Lufkin's executive team had experienced the installation of new business operating systems, both at Lufkin and at other companies, that had taken more time than expected. These delays negatively impacted company earnings.

         IBM, through its hardware division, learned of Lufkin's concerns about a lengthy and delay-riddled implementation of a new ERP operating system. David Bisker, an IBM salesman, contacted Lufkin executives, and at his behest, representatives of the two companies began discussions about IBM's Express Solution.[2] IBM designed its Express Solution in 2006 and 2007 with a team of engineers under the direction of Juan Gonzalez, an IBM employee who implements SAP operating systems for small companies.

         On September 30, 2009, Gonzalez, on behalf of IBM but with the assistance of SAP, demonstrated software that IBM represented showed the functionality of IBM's Express Solution. Furthermore, IBM represented that its Express Solution was preconfigured in a way to manage both of Lufkin's vastly different product lines-its engineered-to-order transmission gear boxes and manufactured-to-order oil field pumping units. Additionally, IBM represented that its Express Solution would generate financial results for all of Lufkin's required reports, both for U.S. and international plants. After IBM represented that these vital functions required by Lufkin were already preconfigured in the Express Solution, Lufkin agreed to execute a contract, formally called the "Statement of Work" (SOW), with IBM on March 25, 2010.

         The SOW projected the implementation would be completed by March 1, 2011, when Lufkin would be able to "Go-Live" with its fully implemented IBM Express Solution. However, the first test of the system in November 2010 was a complete failure. The second test in February 2011 also failed. IBM requested a Project Change Request (PCR) extending the "Go-Live" date to June 1, 2011, along with an increase of its implementation fees by 2.6 million dollars. Lufkin's President, Jay Glick, became concerned "that the project was off the rails." IBM even fired its project manager, William Berry, in early 2011. Nevertheless, IBM continued to insist that it could complete the project if only given more time and money. IBM failed to inform Lufkin that it stopped marketing the Express Solution in the U.S. at the end of 2010.

         The June 1, 2011 "Go-Live" date passed without an operational system. Later in June, IBM requested another PCR which added over four million dollars to its fees. IBM assured Lufkin that this would allow it to properly complete the implementation for a January 1, 2012 "Go-Live" date. In September 2011, IBM's third test failed with many of the same problems from the previous two tests continuing to recur. A fourth test in November 2011 also went poorly. By the end of 2011, Lufkin had executed nine PCRs and paid $12, 983, 736 for IBM's Express Solution. As the January 1, 2012 "Go-Live" date approached, Lufkin sought assurances from IBM that the Express Solution would properly function. IBM promised Glick that although it would be a "Go-Live Ugly and that things might be a little rockier in a few places than a normal startup, " IBM had thoroughly tested the payroll system and that it would correctly function. Glick decided to deactivate Lufkin's operating system and to initiate IBM's Express Solution on January 1, 2012.

         The "Go-Live Ugly" was likewise unsuccessful. Lufkin was forced to manually calculate payroll amounts because the Express Solution did not function properly. Lufkin's employees were upset and company morale sank. Moreover, the vendor payment system failed, requiring Lufkin to manually make payments to vendors. Likewise, project materials were not delivered to the appropriate machine on a timely basis, and Lufkin's products were not able to be shipped as scheduled and promised. The company had to mostly operate manually during most of the first half of 2012.

         The problems extended to financial reporting. As a publicly traded stock on the NASDAQ stock exchange, Lufkin released quarterly reports every three months. With the IBM Express Solution unable to run its business operation system, Lufkin was unable to close its books for January, February, and March of 2012. Lufkin, as a publicly-traded company, was required to report the failed IBM Express Solution implementation and the resultant problems to the public. Lufkin's stock price suffered. Glick reported that the financial situation for the second quarter of 2012 was "similarly bad." Lufkin's stock price continued to be adversely affected.

         In the summer of 2012, after six months of a virtually nonfunctioning Express Solution, Lufkin invited IBM and SAP to assess what needed to be done to implement an effective operating system for Lufkin. IBM sent one person who did not have authority to take any action. SAP, on the other hand, began analyzing what could be done to reconfigure the Express Solution so that its software would become operable for Lufkin. With SAP's help, along with other third party consultants, Lufkin was eventually able to develop an operating system after a year and a half of effort. Lufkin continues using this system today. After the disastrous "Go-Live Ugly" Express Solution implementation on January 1, 2012, Lufkin paid third-party consultants an additional $7, 544, 545.

         After implementing an effective business operating system, with the assistance of SAP and third-party contractors, Lufkin sued IBM for, among numerous causes of action, fraudulent inducement of a contract, fraud, and breach of contract. IBM filed a motion for summary judgment, claiming that Lufkin agreed to disclaim its reliance on IBM's representations made prior to signing the SOW, and consequently, Lufkin could not establish the reliance element of the fraudulent inducement and fraud claims as a matter of law.

         The trial court denied IBM's motion, and the case proceeded to a jury trial. The jury first determined that IBM fraudulently induced Lufkin to execute the SOW, as modified by the PCRs. It further determined that IBM committed fraud against Lufkin and made a negligent misrepresentation on which Lufkin justifiably relied. The jury also found Lufkin had not waived or ratified IBM's fraudulent acts and it was not estopped from asserting its fraud claims. Furthermore, the jury determined that IBM breached the contract by failing to comply with the SOW, as modified by the nine PCRs.

         The jury found that Lufkin had suffered ten million dollars in out-of-pocket damages, which represented the difference in the value of IBM's Express Solution and the amount Lufkin paid for it. The jury also found Lufkin incurred eleven million dollars in "reasonable and necessary expenses incurred in attempting to restore operation of Lufkin's software." On Lufkin's fraud claim, the jury awarded six million dollars. Although the jury determined IBM made negligent misrepresentations and breached the SOW, it found no damages for Lufkin on either cause of action. The jury also declined to award exemplary damages against IBM.

         The trial court entered a judgment in favor of Lufkin against IBM for $23, 776, 025.10, which was based on twenty-one million dollars in out-of-pocket and mitigation damages for Lufkin's fraudulent inducement claim, and $2, 776, 025.10 in prejudgment interest.[3] IBM timely appealed.

         Fraudulent Inducement

         In its first issue, IBM challenges the jury's finding of fraudulent inducement, and argues that a provision in the SOW disclaiming reliance on representations it made to Lufkin conclusively negates fraudulent inducement's reliance element.

         Standard of Review

         In considering a legal sufficiency challenge, we review all the evidence in the light most favorable to the trial court's judgment and indulge every reasonable inference in its favor. City of Keller v. Wilson, 168 S.W.3d 802, 822 (Tex. 2005). We credit any favorable evidence if a reasonable factfinder could and disregard any contrary evidence unless a reasonable factfinder could not. Id. at 821-22, 827. We may only sustain a legal sufficiency challenge when (1) the record discloses a complete absence of a vital fact, (2) the court is barred by rules of law or evidence from giving weight to the sole evidence offered to prove a vital fact, (3) the sole evidence offered to prove a vital fact is no more than a mere scintilla, or (4) the evidence conclusively establishes the opposite of a vital fact. Id. at 810. More than a scintilla of evidence exists when the evidence rises to a level that would enable reasonable and fair minded jurors to differ in their conclusions. Wal-Mart Stores, Inc. v. Spates, 186 S.W.3d 566, 568 (Tex. 2006) (per curiam); Forbes Inc. v. Granada Biosciences, Inc., 124 S.W.3d 167, 172 (Tex. 2003).

         In reviewing a factual sufficiency challenge, we consider all of the evidence and uphold the finding unless it is so against the overwhelming weight of the evidence as to be clearly wrong and unjust. Cain v. Bain, 709 S.W.2d 175, 176 (Tex. 1986) (per curiam). But factfinders are the sole judges of the credibility of the witnesses and the weight to give their testimony. Wilson, 168 S.W.3d at 819. They may choose to believe one witness and disbelieve another. Id. If the evidence at trial would enable reasonable minds to differ in their conclusions, we will not substitute our judgment, so long as the evidence falls within the zone of reasonable disagreement. Id. at 822.

          Applicable Law

         Fraudulent inducement is a particular species of fraud that arises only in the context of a contract. Nat'l Prop. Holdings v. Westergren, 453 S.W.3d 419, 423 (Tex. 2015). A party asserting that it was fraudulently induced into entering into a contract must show that (1) the other party made a material representation, (2) the representation was false and was either known to be false when made or made without knowledge of the truth, (3) the representation was intended to be and was relied upon by the injured party, and (4) the injury complained of was caused by the reliance. In re Int'l Profit Assocs., Inc., 274 S.W.3d 672, 678 (Tex. 2009).

         The enforceability of a reliance disclaimer is a question of law. Italian Cowboy Partners, Ltd. v. Prudential Ins. Co. of Am., 341 S.W.3d 323, 333 (Tex. 2011) (citing Schlumberger Tech. Corp. v. Swanson, 959 S.W.2d 171, 181 (Tex. 1997)). The Texas Supreme Court has declined to adopt a per se rule that a disclaimer automatically precludes a fraudulent inducement claim. See Forest Oil Corp. v. McAllen, 268 S.W.3d 51, 61 (Tex. 2008).

         Our analysis of the parties' intent begins with the contract's express language, and we consider the entire agreement. Italian Cowboy Partners, 341 S.W.3d at 333. To disclaim reliance, the parties must use clear and unequivocal language. Id. at 336 (citing Forest Oil Corp., 268 S.W.3d at 62; Swanson, 959 S.W.2d at 179-80). This elevated requirement of precise language helps ensure that parties to a contract-even sophisticated parties represented by able attorneys-understand that the contract's terms disclaim reliance such that the contract may be binding even if it was induced by fraud. Id.

         The Texas Supreme Court has further stated that it has a clear desire to protect parties from unintentionally waiving claims for fraud, but also identified "the competing concern - the ability of parties to fully and finally resolve disputes between them." Id. at 332 (quoting Swanson, 959 S.W.2d at 179). A disclaimer included in an agreement at the initiation of a business relationship should be all the more clear and unequivocal to effectively disclaim reliance and preclude a claim for fraudulent inducement, lest we "forgive intentional lies regardless of context." Id. at 335 (quoting Forest Oil Corp., 268 S.W.3d at 61). In such a case, "to refuse relief [by enforcing the disclaimer] would result in opening the door for a multitude of frauds and in thwarting the general policy of the law." Id. at 332 (quoting Dallas Farm Mach. Co. v. Reaves, 307 S.W.2d 233, 239 (Tex. 1957)).

          It is only after we determine that the contract clearly and unequivocally disclaims the complaining party's reliance on representations that we proceed to examine the other circumstances surrounding the contract's formation and analyze the Forest Oil factors, such as whether the parties: (1) negotiated the terms of the contract rather than simply included boilerplate language, (2) specifically discussed the issue which became the topic of the subsequent dispute, and (3) were represented by counsel, experienced in business matters, and dealing with each other in an arm's length transaction. See id. at 337, n.8 (citing Forest Oil, 268 S.W.3d at 60).

         Fraudulent Inducement

         On September 30, 2009, IBM presented to Lufkin a version of SAP software that was already highly configured, representing that it was IBM's Express Solution. This was the only implementation system that IBM discussed with Lufkin before signing the SOW. IBM represented to Lufkin that its Express Solution was already eighty percent preconfigured and would need only about twenty percent customization. Thus, according to IBM, Lufkin would have a new business operating system without spending an inordinate amount of time implementing the software. However, Gonzalez, in a November 4, 2009 email to the IBM sales representatives negotiating the transaction, warned that the functionality Lufkin wanted would need significant configuration and customization. For example, Gonzalez knew that the Express Solution was created only for approximately thirty users. Lufkin had 650 users. Gonzalez also knew that the Express Solution was intended and designed for a company with one company code. Lufkin had nine company codes. He testified that the Express Solution was intended and designed for the operation of two plants. Lufkin had fifty-six plants.

         Berry testified that the Express Solution implementation for many companies, including Lufkin, was likely "doomed to fail from signature." He testified that IBM's strategy was to secure a contract and hope that its implementation team would figure out the details later.

         Soon after the parties signed the SOW, IBM implementation engineers told Lufkin that the Express Solution did not have the enhanced functionality and configuration that had been represented and that it would need much more extensive customization than twenty percent. When Lufkin management brought these concerns to IBM management, they were continually reassured to have patience and trust IBM's process because its personnel "were the experts." Even after each integration test cycle (ITC) failure and subsequent "Go-Live" extension date, IBM continued to ensure Lufkin that it would eventually deliver an Express Solution system that would be capable of operating the SAP software and conducting Lufkin's business functions. Lufkin determined that it had no choice but to go forward and trust IBM because to start over would have been both cost and time prohibitive. When the parties initiated the "Go-Live, " Lufkin switched from its existing business operating system to the Express Solution, but the new system could perform only ten percent of what IBM had promised. Unable to simply reinstitute its prior system, the Express Solution implementation failure required Lufkin to manually conduct its financial and manufacturing processes. In mid-2012, after Lufkin looked to begin an effective implementation of the SAP platform, IBM ceased to provide substantive support in correcting the system's problems. This forced Lufkin to work with SAP and third-party contractors to develop the business system, which it currently uses, over the next year and a half.

         IBM materially misrepresented the functionality of its Express Solution. Gonzalez's email to the IBM sales team and other executives established that IBM knew that the representations regarding the Express Solution that it made to Lufkin were false. IBM knew that the key to obtaining a contract with Lufkin, as explained by Berry, was that Express Solution would be installed quickly. Further, IBM knew they could make the sale to Lufkin with the representation that the Express Solution would be installed quickly because it was eighty percent preconfigured and did not require time consuming and expensive customization. The record shows that Lufkin relied upon these representations by IBM. Finally, the failed implementation of IBM's Express Solution following the January 1, 2012 "Go-Live Ugly" forced Lufkin to virtually operate without a business operating system for six months, and then up to another year and a half before a workable configuration for the SAP software could be implemented.

         Accordingly, viewing all the evidence in the light most favorable to the verdict, we hold that the evidence is legally sufficient to support the jury's finding that IBM fraudulently induced Lufkin to execute the SOW on March 25, 2010. See Wilson, 168 S.W.3d at 822. Such a finding is not so against the overwhelming weight of the evidence as to be clearly wrong and unjust. See Cain, 709 S.W.2d at 176.

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