Fraudulent Misrepresentation

Restatement (Second) of Contracts § 162(1) supplies the first of two ways a misrepresentation can support avoidance under § 164(1). A misrepresentation is fraudulent if the maker intends the assertion to induce a party to manifest assent and has one of three listed states of mind.¹ The definition works in two layers. The first asks about purpose: did the maker want the assertion to produce assent? The second asks about culpability: what did the maker know, or lack, about the truth of the assertion at the moment of speaking? The other route, materiality under § 162(2), asks instead whether the misstated fact would likely move a reasonable person, and it demands no wrongful state of mind.² This overview covers what the three states of mind share. The subsections that follow take them one at a time.

All three share one purpose requirement: intent to induce. A maker whose false remark was idle, offered with no thought that anyone would act on it, fails the requirement. A maker who offers the statement to bring about the deal satisfies it. The requirement is sometimes called an intent to deceive, but the label can mislead. A maker who knows a statement is false and intends the listener to rely on it necessarily intends to deceive. A maker who speaks with reckless disregard for the truth may intend reliance without forming any separate purpose about what the listener will think of the maker's honesty.³ The Restatement avoids the ambiguity by tying the intent to what the contract defense cares about: the other party's assent.

The second layer, the maker's state of mind, tracks the common-law test for deceit. Fraud is shown when a false representation was made knowingly, without belief in its truth, or recklessly, careless whether it was true or false.⁴ The Restatement (Third) of Torts states a parallel three-part test for scienter, the culpable mental state that fraud requires.⁵ In every formulation the maker's own mind is the issue, and a maker who honestly believes the statement has not committed fraud, even if the belief was careless. In Derry v. Peek, directors of a tramway company told prospective shareholders that the company had the right to use steam power, when that right depended on the Board of Trade's consent. The directors testified that they knew consent was required but believed it had been obtained or would follow as a matter of course. The House of Lords restored the trial court's judgment for them because they honestly held that belief.⁶ A maker in that position falls into the negligent or innocent categories described earlier in this chapter, and the contract defense then depends on materiality.

Fraud needs no showing of materiality because of what the maker did. A maker who sets out to induce assent with a known falsehood has already treated the statement as one that would matter to the listener, and the lie has done the job for which it was told. An honest maker who misstates an unimportant fact has no reason to expect that the statement will lead anyone to act. That misstatement must therefore clear the objective test of materiality before it supports avoidance.⁷ Some courts nonetheless say that the misstated fact must be material even in a fraud case, so an answer should state the Restatement position and note the habit.⁸ Fraud does not excuse the remaining elements of § 164(1). The lie must still have substantially contributed to the decision to assent, and the recipient must still have been justified in relying on it.⁹

Fraud in contract shares its vocabulary with the tort of intentional misrepresentation, so tort decisions often supply examples of each state of mind. The contract claim demands far less than the tort. Deceit requires representation, falsity, scienter, deception, and injury. Avoidance only restores the parties to where they stood before the transaction, so the deceived party need not prove damages.¹⁰ The first state of mind, actual knowledge that the assertion is false, comes next.

Knowledge of Falsity

Restatement (Second) of Contracts § 162(1)(a) names the first and most familiar route: the maker intends the assertion to induce assent and knows or believes that the assertion is not in accord with the facts.¹¹ This is the deliberate lie. The maker holds the truth in mind and says something else to bring the other party to agreement. The word believes sits beside knows for a reason. A maker who is unsure of the facts but thinks the assertion untrue, and makes it anyway, speaks against the maker's own view of the facts, which is the same wrong a maker with certainty commits.

This prong is the easy one because of what a knowing lie reveals. A maker who says something known to be false in order to produce assent has chosen the words for their effect on the listener, since an untrue statement serves no honest purpose in a bargain. The harm to the recipient is then the intended result, not an accident of carelessness, and the law asks the victim to prove little beyond the lie itself. The recipient need not show that the misstated fact would have mattered to a reasonable person, the burden the objective test of materiality imposes on the other route to avoidance.¹² The maker's own decision to lie about the fact shows that the maker expected it to matter. The defense still does not shrink to a showing of dishonesty, because § 164(1) continues to require that the lie substantially contributed to the recipient's assent and that the recipient was justified in relying on it.¹³

Fabricated credentials show the prong in its plainest form. In Rozen v. Greenberg, Rozen wrote to Greenberg, a tax preparer he did not know, and claimed that he had headed a tax preparation service for the last few years. He pointed her to a website describing his team of professionals, repeated the claims by telephone, and showed her an impressive office.¹⁴ She sold him her client list in exchange for a share of the income he earned from preparing her clients' returns. In truth he had no business, no clients, and no completed returns; he had been a CPA for only a few weeks, and the office belonged to the firm that employed him.¹⁵ The court of appeals affirmed the finding of fraud. Every claim concerned Rozen's own history, which he could not have misremembered, so the facts left no room for an honest mistake. The same lesson appears when the lie hides a personal history. In Sarvis v. Vermont State Colleges, a college could rescind an employment agreement because the employee put false information on a resume to hide a record of criminal incarceration.¹⁶

A lie can also arrive as a false answer to a direct question. In Willen v. Hewson, the seller of a large house on an estate advertised it as peaceful and serene. The buyers then heard from the seller's niece that teenagers came onto the property after football games. When they telephoned the seller, she assured them that such incidents were rare and that her niece was prone to exaggeration.¹⁷ After closing, the buyers found constant trespass and vandalism that a security system and fence could not stop. The court upheld the finding that the seller knew of the problem and committed fraud through both the advertisement and the dishonest answer.¹⁸ Johnson v. Davis follows the same pattern in a Florida house sale. After the contract was signed, the sellers affirmatively repeated to the buyers that the roof had no problems. The buyers then paid an additional $26,000 deposit, and the court held that the statement was a false representation of a material fact, made with knowledge of its falsity, which entitled the buyers to the deposit back.¹⁹ Rozen built a false identity to open a deal, while the Willen and Johnson sellers answered or repeated a statement about the property. The maker's state of mind is the same in all three.

Because the prong turns on what the maker knew, proof is usually indirect. Makers seldom admit that they knew a statement was false, so the trier of fact looks to the circumstances. If it would have been unlikely or unreasonable for the maker to believe the statement true, the trier may infer that the maker knew it was false. If the maker persuades the trier that the statement was actually believed, however unreasonably, the misrepresentation is at most negligent and knowledge of falsity is not established.²⁰ The maker's motive for lying carries no weight. In Edgington v. Fitzmaurice, an English action for deceit, Bowen L.J. said that it is wholly immaterial with what object the lie is told, so long as the maker meant the person addressed to rely on it.²¹ A maker who lies out of kindness, to soothe a worried buyer, therefore has the same culpable state of mind as one who lies for profit.

An exam stem that reports only that a statement turned out to be untrue has therefore not shown that the maker knew it. Knowledge must have existed when the statement was made, and the facts that establish it are records the maker had read, a personal history the maker could not have forgotten, an earlier warning, or a direct question answered falsely. When the stem supplies none of them, the statement can still be a misrepresentation that supports avoidance if it is material, but it is not fraudulent under clause (a).²² The next two clauses of § 162(1) reach the maker who does not know the assertion is false but states or implies more confidence or more basis than the maker has.

Lack of Confidence

Restatement (Second) of Contracts § 162(1)(b) makes a misrepresentation fraudulent when the maker intends the assertion to induce assent and does not have the confidence in the truth of the assertion that the maker states or implies.²⁴ It is the second of three alternative culpable states of mind under § 162(1), and it reaches a speaker whom the first clause leaves alone.²⁵ Clause (a) requires that the maker know or believe the assertion untrue, and a maker who is merely doubtful holds neither state of mind.²⁶ Clause (b) turns the inquiry from what the maker thinks about the facts to how sure the maker is, measured against how sure the assertion sounds. Two quantities are compared: the confidence the words state or imply, and the confidence the maker actually has. Fraud lies in the gap.

The law reads confidence into an assertion because of what listeners do with it. A listener deciding whether to rely on a statement must also decide how much checking it needs, and the cheapest guide is how sure the speaker sounds. A flat statement with no qualifier tells the listener that the fact is so and that the speaker is sure it is so, and the listener scales back the checking accordingly. A speaker who has doubts and speaks flatly has therefore misled the listener about reliability, the very thing the listener is relying on. Correcting the signal costs the speaker a phrase such as “as far as I know,” while the listener cannot see private doubts. That asymmetry puts the loss on the speaker who chose the flat form. It also explains why recklessness is treated like a lie: a speaker indifferent to whether a statement is true has no confidence in it. Judge Cardozo put the wrong this way: “Fraud includes the pretense of knowledge when knowledge there is none.”²⁷

The clause has older roots. The classic common-law test for deceit, from Derry v. Peek, asks whether a false representation was made knowingly, without belief in its truth, or recklessly, careless whether it be true or false, and the later alternatives in that formulation are the ancestors of clause (b).²⁸ The Restatement (Third) of Torts: Liability for Economic Harm § 10(b) uses nearly the same words, making a misrepresentation fraudulent when the maker knows that he does not have the confidence in the accuracy of his representation that he states or implies.²⁹ Courts have also treated a statement made as of the speaker's own knowledge, by one who does not know whether it is true, as falsely implying a reason to believe it. Some courts label that state of mind intent and others call it recklessness, and either suffices for fraud.³⁰

The facts of Jordan v. Knafel show the gap at work. Karla Knafel became pregnant after a sexual relationship with the basketball star Michael Jordan, and she told him categorically that he was the father. On the strength of that assertion the two signed a settlement under which Jordan promised to pay her $5 million and she promised not to start paternity proceedings against him.³¹ Later tests showed that the child was not his, and the Illinois appellate court affirmed summary judgment for Jordan in his action to avoid the settlement.³² When she spoke, Jordan could have been the father, and Knafel did not know otherwise. The court still found a fraudulent misrepresentation, because a categorical statement of paternity implied that Jordan was her only sexual partner during the period of conception, and she knew that he might not have been.³³ Clause (a) would have required Jordan to prove that she knew the statement was false, which he could not do. Clause (b) required only that she spoke with a certainty she lacked. The same facts could also support a claim of fraudulent nondisclosure for her silence about the other partner, but affirmative fraud is the stronger theory, because it rests on what she said and not on what she left out.³⁴

Because the clause measures the speaker's actual confidence, an honest hedge brings the stated confidence down to the real level, and no gap remains. The same measuring explains why the clause leaves out a speaker who is sure and wrong. A maker who persuades the trier of fact that the statement was actually believed, however unreasonably, has made at most a negligent misrepresentation, and scienter, the guilty state of mind that fraud requires, is not established.³⁵ Proof runs the other way as well. A maker seldom admits to private doubt, so if it would have been unlikely or unreasonable for the maker to believe the statement, the trier may infer that the maker lacked the confidence the statement conveyed.³⁶ Carelessness therefore works as evidence of doubt, though it is not itself the wrong. The line between fraud and negligence is narrow here, since reckless disregard for the truth, or an extreme degree of negligence in ascertaining the facts, may qualify as fraud.³⁷

The third step does the real work, and the fourth keeps the clause from becoming a shortcut around the rest of the defense. A maker who lacked the confidence conveyed has satisfied only the state-of-mind element of fraud. The next clause, § 162(1)(c), addresses a related situation in which the maker knows the assertion rests on less than the maker states or implies, as when a speaker claims to have checked a fact and has not.⁴⁰

Lack of Basis

Restatement (Second) of Contracts § 162(1)(c) supplies the third state of mind: the maker intends the assertion to induce assent and knows that the maker does not have the basis that the assertion states or implies.⁴² The Restatement (Third) of Torts: Liability for Economic Harm § 10(c) uses nearly the same words.⁴³ Clause (b) compares how sure the maker was with how sure the assertion sounded. This clause compares what the maker had to go on with what the assertion suggested the maker had.⁴⁴ The two can come apart. A seller who feels certain on a hunch that the soil is clean leaves clause (b) with no shortfall of confidence to find, yet a flat statement about soil conditions implies that someone has tested or inspected, and that implied foundation is missing. Clause (c) reaches that maker.

A statement carries an implied basis because of how listeners use assertions. A listener who hears a flat claim about a hidden or technical matter, such as what a laboratory found in the ground, usually cannot see the underlying records and cannot cheaply repeat the work. The listener can infer that the speaker, or someone the speaker trusts, has already done the checking, and so spends less on verification than would otherwise be sensible. A speaker who knows that no checking has happened, and who speaks flatly anyway, has taken the benefit of that inference without earning it. Correction costs the speaker almost nothing, because a sentence saying the claim is a guess or that the results have not been reviewed would restore the listener's caution. The listener cannot learn the truth short of doing the very checking the statement was meant to make unnecessary, so the loss falls on the speaker who chose the unqualified form. Judge Cardozo's formula for this wrong, the pretense of knowledge when there is none, fits the clause directly.⁴⁵

The leading illustration involves a sale of land. In Waste Management of Massachusetts, Inc. v. Carver, the seller made a representation about the extent of contamination on the land without first obtaining current information from the consultants hired to test it. The Massachusetts Appeals Court granted rescission, holding that the seller could not avoid liability by ignoring available information.⁴⁶ A statement about how far contamination extends implies that the speaker knows what the testing shows. The seller had the means of learning that, left them unused, and spoke as if it had used them, so the assertion rested on less than it conveyed. Rescission then returned the parties to the positions they held before the contract was made.⁴⁷

The clause speaks of what the maker knows, which invites the objection that a seller who never looks never learns that a basis is missing. Waste Management refuses that escape, and Ultramares Corp. v. Touche, Niven & Co. supplies the reasoning in a different setting. Accountants there certified that a balance sheet agreed with the company's books. The New York Court of Appeals, through Judge Cardozo, held that negligence or blindness, even when it falls short of fraud, is evidence from which fraud may be inferred if the negligence is gross.⁴⁸ A jury could find that accountants who were put on guard by suspicious circumstances had closed their eyes to the obvious and then certified as true to their own knowledge a matter on which they had no knowledge.⁴⁹ Other courts reach the same place by treating a statement made as of the speaker's own knowledge, by someone who does not know whether it is true, as a false implication that the speaker has reason to believe it.⁵⁰ Letting the maker ignore a source and then claim ignorance would reward the very conduct the clause condemns, since the more information a seller could get, the stronger the seller's motive for declining to look.

Because makers rarely admit that they knew a basis was missing, proof usually runs through circumstances. If it would have been unlikely or unreasonable for the maker to believe the statement, the trier of fact may infer that the maker knew the statement was false, or at least that the maker knew he lacked the knowledge the statement asserted or implied.⁵¹ A maker who persuades the trier that the statement was actually believed, however unreasonably, has made at most a negligent misrepresentation, and the guilty state of mind that fraud requires is not established.⁵²

The statement in that scene is still an assertion not in accord with the facts, so a misrepresentation exists, and the buyer's route to avoidance runs through materiality. A misrepresentation is material if it would be likely to induce a reasonable person to manifest assent, and a statement about soil contamination plainly meets that test.⁵³ What separates this seller from the one in Waste Management is the seller's relationship to the information. One seller obtained the consultant's findings and relied on them. The other had access to current findings and spoke without consulting them. The first seller's statement rested on everything it implied, and the second seller's rested on less. A seller who says openly that he has not seen the results and is only guessing states no basis and implies none, so clause (c) leaves that seller alone too. An exam stem reporting only that a seller never checked has therefore not finished the analysis. The clause applies when the seller spoke as if the checking had been done and knew it had not.

The three clauses of § 162(1) can now be set side by side, since each names a different message that an assertion sends about the speaker's mind.⁵⁴

Knowledge of falsity. The maker knows or believes that the assertion is not in accord with the facts.⁵⁵
Lack of confidence. The maker is less sure of the assertion than the words state or imply.⁵⁶
Lack of basis. The maker knows that the assertion rests on less than the maker states or implies.⁵⁷

What the three share is that each lets a court find fraud without proof of an outright known lie. Each starts from the observation that an assertion tells the listener about the speaker's belief, certainty, and grounds as well as about the world, and each treats a misstatement of any of those messages as deception. The effect is to blur the line between fraud and negligence, because reckless disregard for the truth, or an extreme degree of negligence in ascertaining information before speaking, may qualify as fraud.⁵⁸ The English law of deceit reached the same judgment on moral grounds, since a statement made recklessly for the purpose of influencing another person is dishonest.⁵⁹ A claimant who proves any one clause has proved only the culpable state of mind. The contract is voidable only if the maker also intended to induce assent, the misrepresentation substantially contributed to that assent, and the recipient was justified in relying on it.⁶⁰ A claimant who proves none of the clauses keeps one more route, which is to show that the misrepresentation was material.⁶¹