This is “Misrepresentation”, section 6.2 from the book The Legal Environment and Business Law: Master of Accountancy Edition (v. 1.0). For details on it (including licensing), click here.
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The two types of misrepresentation are fraudulent and nonfraudulent. Within the former are fraud in the execution and fraud in the inducement. Within the latter are negligent misrepresentation and innocent misrepresentation.
MisrepresentationA false or misleading statement or impression given that induces a party to contract. is a statement of fact that is not consistent with the truth. If misrepresentation is intentional, it is fraudulent misrepresentation; if it is not intentional, it is nonfraudulent misrepresentation, which can be either negligent or innocent.
In further taxonomy, courts distinguish between fraud in the execution and fraud in the inducement. Fraud in the executionCausing a person to sign a legal document while that person believes he or she is signing some other type of document. is defined by the Restatement as follows: “If a misrepresentation as to the character or essential terms of a proposed contract induces conduct that appears to be a manifestation of assent by one who neither knows nor has reasonable opportunity to know of the character or essential terms of the proposed contract, his conduct is not effective as a manifestation of assent.”Restatement (Second) of Contracts, Section 163. For example, Alphonse and Gaston decide to sign a written contract incorporating terms to which they have agreed. It is properly drawn up, and Gaston reads it and approves it. Before he can sign it, however, Alphonse shrewdly substitutes a different version to which Gaston has not agreed. Gaston signs the substitute version. There is no contract. There has been fraud in the execution.
Fraud in the inducementDeceit or trick to cause someone to contract to his or her disadvantage. is more common. It involves some misrepresentation about the subject of the contract that induces assent. Alphonse tells Gaston that the car Gaston is buying from Alphonse has just been overhauled—which pleases Gaston—but it has not been. This renders the contract voidable.
Necessary to proving fraudulent misrepresentationMisrepresentation with the intention to deceive. (usually just “fraud,” though technically “fraud” is the crime and “fraudulent misrepresentation” is the civil wrong) is a misstatement of fact that is intentionally made and justifiably relied upon.
Again, generally, any statement not in accord with the facts (a fact is something amenable to testing as true) is a misrepresentation. Falsity does not depend on intent. A typist’s unnoticed error in a letter (inadvertently omitting the word “not,” for example, or transposing numbers) can amount to a misrepresentation on which the recipient may rely (it is not fraudulent misrepresentation). A half-truth can amount to a misrepresentation, as, for example, when the seller of a hotel says that the income is from both permanent and transient guests but fails to disclose that the bulk of the income is from single-night stopovers by seamen using the hotel as a brothel.Ikeda v. Curtis, 261 P.2d 684 (Wash. 1951).
Another type of misrepresentation is concealment. It is an act that is equivalent to a statement that the facts are to the contrary and that serves to prevent the other party from learning the true statement of affairs; it is hiding the truth. A common example is painting over defects in a building—by concealing the defects, the owner is misrepresenting the condition of the property. The act of concealment need not be direct; it may consist of sidetracking the other party from gaining necessary knowledge by, for example, convincing a third person who has knowledge of the defect not to speak. Concealment is always a misrepresentation.
A more passive type of concealment is nondisclosure. Although generally the law imposes no obligation on anyone to speak out, nondisclosure of a fact can operate as a misrepresentation under certain circumstances. This occurs, for example, whenever the other party has erroneous information, or, as Reed v. King (Section 6.5.2 "Misrepresentation by Concealment") shows, where the nondisclosure amounts to a failure to act in good faith, or where the party who conceals knows or should know that the other side cannot, with reasonable diligence, discover the truth.
In a remarkable 1991 case out of New York, a New York City stockbroker bought an old house upstate (basically anyplace north of New York City) in the village of Nyack, north of New York City, and then wanted out of the deal when he discovered—the defendant seller had not told him—that it was “haunted.” The court summarized the facts: “Plaintiff, to his horror, discovered that the house he had recently contracted to purchase was widely reputed to be possessed by poltergeists [ghosts], reportedly seen by defendant seller and members of her family on numerous occasions over the last nine years. Plaintiff promptly commenced this action seeking rescission of the contract of sale. Supreme Court reluctantly dismissed the complaint, holding that plaintiff has no remedy at law in this jurisdiction.”
The high court of New York ruled he could rescind the contract because the house was “haunted as a matter of law”: the defendant had promoted it as such on village tours and in Reader’s Digest. She had concealed it, and no reasonable buyer’s inspection would have revealed the “fact.” The dissent basically hooted, saying, “The existence of a poltergeist is no more binding upon the defendants than it is upon this court.”Stambovsky v. Ackley, 169 A.D.2d 254 (N.Y. 1991).
If a statement of fact is made false by later events, it must be disclosed as false. For example, in idle chatter one day, Alphonse tells Gaston that he owns thirty acres of land. In fact, Alphonse owns only twenty-seven, but he decided to exaggerate a little. He meant no harm by it, since the conversation had no import. A year later, Gaston offers to buy the “thirty acres” from Alphonse, who does not correct the impression that Gaston has. The failure to speak is a nondisclosure—presumably intentional, in this situation—that would allow Gaston to rescind a contract induced by his belief that he was purchasing thirty acres.
An opinion, of course, is not a fact; neither is sales puffery. For example, the statements “In my opinion this apple is very tasty” and “These apples are the best in the county” are not facts; they are not expected to be taken as true. Reliance on opinion is hazardous and generally not considered justifiable.
If Jack asks what condition the car is in that he wishes to buy, Mr. Olson’s response of “Great!” is not ordinarily a misrepresentation. As the Restatement puts it: “The propensity of sellers and buyers to exaggerate the advantages to the other party of the bargains they promise is well recognized, and to some extent their assertions must be discounted.”Restatement (Second) of Contracts, Section 168(d). Vague statements of quality, such as that a product is “good,” ought to suggest nothing other than that such is the personal judgment of the opinion holder.
Despite this general rule, there are certain exceptions that justify reliance on opinions and effectively make them into facts. Merely because someone is less astute than the one with whom she is bargaining does not give rise to a claim of justifiable reliance on an unwarranted opinion. But if the person is inexperienced and susceptible or gullible to blandishments, the contract can be voided, as illustrated in Vokes v. Arthur Murray, Inc. in Section 6.5.3 "Misrepresentation by Assertions of Opinion".
Incorrect assertions of law usually do not give rise to any relief, but sometimes they do. An assertion that “the city has repealed the sales tax” or that a court has cleared title to a parcel of land is a statement of fact; if such assertions are false, they are governed by the same rules that govern misrepresentations of fact generally. An assertion of the legal consequences of a given set of facts is generally an opinion on which the recipient relies at his or her peril, especially if both parties know or assume the same facts. Thus, if there is a lien on a house, the seller’s statement that “the courts will throw it out, you won’t be bothered by it” is an opinion. A statement that “you can build a five-unit apartment on this property” is not actionable because, at common law, people are supposed to know what the local and state laws are, and nobody should rely on a layperson’s statement about the law. However, if the statement of law is made by a lawyer or real estate broker, or some other person on whom a layperson may justifiably rely, then it may be taken as a fact and, if untrue, as the basis for a claim of misrepresentation. (Assertions about foreign laws are generally held to be statements of fact, not opinion.)
Usually, assertions of intention are not considered facts. The law allows considerable leeway in the honesty of assertions of intention. The Restatement talks in terms of “a misrepresentation of intention…consistent with reasonable standards of fair dealing.”Restatement (Second) of Contracts, Section 171(1). The right to misstate intentions is useful chiefly in the acquisition of land; the cases permit buyers to misrepresent the purpose of the acquisition so as not to arouse the suspicion of the seller that the land is worth considerably more than his asking price. To be a misrepresentation that will permit rescission, an assertion of intention must be false at the time made; that is, the person asserting an intention must not then have intended it. That later he or she does not carry out the stated intention is not proof that there was no intention at the time asserted. Moreover, to render a contract voidable, the false assertion of intention must be harmful in some way to other interests of the recipient. Thus, in the common example, the buyer of land tells the seller that he intends to build a residence on the lot, but he actually intends to put up a factory and has lied because he knows that otherwise the seller will not part with it because her own home is on an adjacent lot. The contract is voidable by the seller. So a developer says, as regards the picturesque old barn on the property, “I’ll sure try to save it,” but after he buys the land he realizes it would be very expensive (and in the way), so he does not try to save it. No misrepresentation.
The second element necessary to prove fraud is that the misrepresentation was intentionally made. A misrepresentation is intentionally made “if the maker intends his assertion to induce a party to manifest his assent and the maker (a) knows or believes that the assertion is not in accord with the facts, or (b) does not have the confidence that he states or implies in the truth of the assertion, or (c) knows that he does not have the basis that he states or implies for the assertion.”Restatement (Second) of Contracts, Section 162(1).
The question of intent often has practical consequences in terms of the remedy available to the plaintiff. If the misrepresentation is fraudulent, the plaintiff may, as an alternative to avoiding the contract, recover damages. Some of this is discussed in Section 6.2.4 "Remedies" and more fully in Chapter 12 "Remedies", where we see that some states would force the plaintiff to elect one of these two remedies, whereas other states would allow the plaintiff to pursue both remedies (although only one type of recovery would eventually be allowed). If the misrepresentation is not intentional, then the common law allowed the plaintiff only the remedy of rescission. But the Uniform Commercial Code (UCC), Section 2-721, allows both remedies in contracts for the sale of goods, whether the misrepresentation is fraudulent or not, and does not require election of remedies.
The final element necessary to prove fraud is reliance by the victim. He or she must show that the misrepresentation induced assent—that is, he or she relied on it. The reliance need not be solely on the false assertion; the defendant cannot win the case by demonstrating that the plaintiff would have assented to the contract even without the misrepresentation. It is sufficient to avoid the contract if the plaintiff weighed the assertion as one of the important factors leading him to make the contract, and he believed it to be true. The person who asserts reliance to avoid a contract must have acted in good faith and reasonably in relying on the false assertion. Thus if the victim failed to read documents given him that truly stated the facts, he cannot later complain that he relied on a contrary statement, as, for example, when the purchaser of a car dealership was told the inventory consisted of new cars, but the supporting papers, receipt of which he acknowledged, clearly stated how many miles each car had been driven. If Mr. Olson tells Jack that the car Jack is interested in is “a recognized classic,” and if Jack doesn’t care a whit about that but buys the car because he likes its tail fins, he will have no case against Mr. Olson when he finds out the car is not a classic: it didn’t matter to him, and he didn’t rely on it.
Ordinarily, the person relying on a statement need not verify it independently. However, if verification is relatively easy, or if the statement is one that concerns matters peculiarly within the person’s purview, he or she may not be held to have justifiably relied on the other party’s false assertion. Moreover, usually the rule of reliance applies to statements about past events or existing facts, not about the occurrence of events in the future.
Nonfraudulent misrepresentation may also be grounds for some relief. There are two types: negligent misrepresentation and innocent misrepresentation.
Where representation is caused by carelessness, it is negligent misrepresentationA false or misleading statement or impression made because of carelessness.. To prove it, a plaintiff must show a negligent misstatement of fact that is material and justifiably relied upon.
As an element of misrepresentation, “negligent” here means the party who makes the representation was careless. A potential buyer of rural real estate asks the broker if the neighborhood is quiet. The broker assures her it is. In fact, the neighbors down the road have a whole kennel of hunting hounds that bark a lot. The broker didn’t know that; she just assumed the neighborhood was quiet. That is negligence: failure to use appropriate care.
Whether a thing is a fact may be subject to the same general analysis used in discussing fraudulent misrepresentation. (A person could negligently conceal a fact, or negligently give an opinion, as in legal malpractice.)
A material misrepresentation is one that “would be likely to induce a reasonable person to manifest his assent” or that “the maker knows…would be likely to induce the recipient to do so.”Restatement (Second) of Contracts, Section 162(2). An honestly mistaken statement that the house for sale was built in 1922 rather than 1923 would not be the basis for avoiding the contract because it is not material unless the seller knew that the buyer had sentimental or other reasons for purchasing a house built in 1922.
We did not mention materiality as an element of fraud; if the misrepresentation is fraudulent, the victim can avoid the contract, no matter the significance of the misrepresentation. So although materiality is not technically required for fraudulent misrepresentation, it is usually a crucial factor in determining whether the plaintiff did rely. Obviously, the more immaterial the false assertion, the less likely it is that the victim relied on it to his detriment. This is especially the case when the defendant knows that he does not have the basis that he states for an assertion but believes that the particular point is unimportant and therefore immaterial. And of course it is usually not worth the plaintiff’s while to sue over an immaterial fraudulent misrepresentation. Consequently, for practical purposes, materiality is an important consideration in most cases. Reed v. King (Section 6.5.2 "Misrepresentation by Concealment") discusses materiality (as well as nondisclosure).
The issues here for negligent misrepresentation are the same as those set out for fraudulent misrepresentation.
Negligent misrepresentation implies culpability and is usually treated the same as fraudulent misrepresentation; if the representation is not fraudulent, however, it cannot be the basis for rescission unless it is also material.
The elements necessary to prove innocent misrepresentationA misrepresentation made by one who believes it is true. are, reasonably enough, based on what we’ve looked at so far, as follows: an innocent misstatement of fact that is material and justifiably relied upon.
It is not necessary here to go over the elements in detail. The issues are the same as previously discussed, except now the misrepresentation is innocent. The plaintiffs purchased the defendants’ eighteen-acre parcel on the defendants’ representation that the land came with certain water rights for irrigation, which they believed was true. It was not true. The plaintiffs were entitled to rescission on the basis of innocent misrepresentation.Lesher v. Strid, 996 P.2d 988 (Or. Ct. App. 2000).
Remedies will be taken up in Chapter 12 "Remedies", but it is worth noting the difference between remedies for fraudulent misrepresentation and remedies for nonfraudulent misrepresentation.
Fraudulent misrepresentation has traditionally given the victim the right to rescind the contract promptly (return the parties to the before-contract status) or affirm it and bring an action for damages caused by the fraud, but not both.Merritt v. Craig, 753 A.2d 2 (Md. Ct. App. 2000). The UCC (Section 2-721) has rejected the “election of remedies” doctrine; it allows cumulative damages, such that the victim can both return the goods and sue for damages. And this is the modern trend for fraudulent misrepresentation: victims may first seek damages, and if that does not make them whole, they may seek rescission.Ehrman v. Mann, 979 So.2d 1011 (Fla. Ct. App. 2008). In egregious cases of fraud where the defendant has undertaken a pattern of such deceit, the rare civil remedy of punitive damages may be awarded against the defendant.
One further note: the burden of proof for fraudulent misrepresentation is that it must be proved not just “by a preponderance of the evidence,” as in the typical civil case, but rather “by clear, cogent, and convincing evidence”; the fact finder must believe the claim of fraud is very probably true.Kirkham v. Smith, 23 P.3d 10 (Wash. Ct. App. 2001).
Misrepresentation may be of two types: fraudulent (in the execution or in the inducement) and nonfraudulent (negligent or innocent). Each type has different elements that must be proved, but in general there must be a misstatement of fact by some means that is intentionally made (for fraud), material (for nonfraudulent), and justifiably relied upon.