Fraud in law of contracts

FRAUD

INTRODUCTION

During this lecture you will learn the meaning, forms and the effects of fraud in a contract.  In fact its a continuation of the previous lecture on misrepresentation as it is very much related to fraud.

1. MEANING OF FRAUD

Intentional misrepresentation of facts is of the essence of "fraud".  In English law "fraud" was defined by the House of Lords in Derry vs Peek (1889) 14 App. case. 337 as a false representation which has been made:

(i) knowingly; or

(ii) without belief in its truth; or

(iii) recklessly careless whether it be true or false.

According to section 17 of the Ordinance, fraud means and includes:

"any of the following acts committed by a party to a contract, or with his connivance, or by his agent, with intent to deceive another party thereto or his agent, or to induce him to enter into the contract:-

(a) the suggestion, as to a fact, of that which is not true by one who does not believe it to be true;

(b) the active concealment of a fact by one having knowledge or belief of the fact;

(c) a promise made without any intention of performing it;

(d) any other act fitted to deceive;

(e) any such act or omission as the law specially declares to be fraudulent".

The first three clauses in section 17 above deal with fraud by intentional misrepresentation.  Perhaps, what need to be especially understood are the phrases "active concealment" in clause (b), and "any other act fitted to deceive" in clause (d).

"Active concealment" is something different from "passive concealment".   Passive concealment means mere silence as to material facts.  For example, A sells by auction, to B, a horse which A knows to be unsound.  A says nothing to B about the horse's unsoundness.  This is not fraud in A.  Mere silence, except some few cases which  shall be discussed subsequently, does not amount to fraud.

An active concealment of a material fact is a fraud.  Take the previous example of sale of a horse.  Suppose B says to A "If you do not deny it, I shall assume that the horse is sound".  A says nothing.  Here A's silence is equivalent to speech.  A is actively concealing the fact that the horse is unsound.

The phrase "any other act fitted to deceive" means any act which is done with the obvious intention of committing fraud.  For example, in the Indian case of Ningawa vs Byrappa S. Hirekuraba (1968) 2 SCR 797; AIR 1968 SC 956, a husband persuaded his illiterate wife to sign certain documents telling her that by them he was going to mortgage her two lands to secure his indebtedness and in fact mortgaged four lands belonging to her.  This was an act done with the intention of deceiving her.

2. SILENCE

2.1 The General Rule

 Mere silence is no fraud even if its result is to conceal facts likely to affect the willingness of a person to enter into a contract.  This is the general rule.

The rationale for this general rule dwells on the fact that a contracting party is under no obligation to disclose the whole truth to the other party or to give him the whole information in his possession affecting the subject  matter of the contract.  Hence, a trader may keep silent about a change in prices; or in our previous example of sale of an unsound horse, the seller omits to say anything about its quality.  No fraud is committed.  It is upon the other party to call for verification or information in cases of doubt.

However, the general rule is subject to some exceptions.  In certain instances, as observed earlier, silence may become deceptive.

2.2 When is Silence Fraud?

The instances when silence is fraud are as follows:

(a) Duty to Speak

The first instance is where a person is under a duty to speak.  This duty arises where one contracting party reposes trust and confidence in the other; or where one of the parties is utterly without any means of discovering the truth and has to depend on the good sense of the other party.  For example, cases of uberima fides i.e. utmost good faith.

The case of Haji Ahmad Yarkhan vs Abdul Gani Khan AIR 1937 Nag 270 is illustrative of cases of uberima fides.

In this case the plaintiff spent a sum of money to mark the engagement of his son.  He then discovered that the girl suffered from epiloptic fits and so broke off the engagement.  He sued the other party to recover from them compensation for the loss which he had suffered on account of their deliberate suppression of a vital fact which amounted to fraud.

The court in deciding the case referred to the holding of the House of lords in Nocton vs Ashburton [1914] AC 932 where it was pointed out that a more passive non-disclosure of the truth, however deceptive in fact, does not amount to fraud, unless there is a duty to speak.

One of the issues before the court was therefore whether in that case there was a duty to speak.  Referring to the facts of the case, the court said that the law imposes no general duty on any one to broadcast the blemishes of his female relations, not even to those who are contemplating matrimony with them. There was no fiduciary relation between the parties.  It therefore found no fraud, but the engagement was held to be avoidable by reason of the misrepresentation.

(b) Where Silence is Deceptive

As pointed earlier, sometimes silence is equivalent to speech.  A party to a contract who keeps silent whilst knowing that such silence will be deceptive is guilty of fraud.

For example, a buyer who knows more about the value of the property which is the subject of sale but prefers to keep the information from the seller.  The latter may avoid the sale.

(c) Change of Circumstances

We saw earlier how change in circumstances can render a representation a misstatement.  Similarly, if a representation is true when made, but on account of a change of circumstances, becomes false when it is actually acted upon by the other party, then it is the duty of the person who made the representation to communicate the change of circumstances.  

For example in the case of With vs O'Flanagan [1936] 1All ER 727; [1936] Ch 575 (CA) - In the negotiations for the sale of his medical practice, the defendant represented that his practice had brought in £ 2000 per annum during the preceeding three years and that he had a specified number of patients on his panel.  Negotiations resulted in a contract in about five months.  During this time the defendant became ill and could not

]attend to his practice.  This resulted in a serious loss of practice, but the purchaser could learn about it only after the completion of the sale.  It was held that the change of circumstances should have been brought to the notice of the purchaser.  The plaintiff was thus allowed to rescind the contract.

(d) Half Truths

These are instances where a person, although under no duty to disclose a fact, voluntarily discloses something and then stops half the way.

The rule is that a person may be under no duty to disclose a fact, but if he speaks, a duty arises to disclose the whole truth.  Lord MacNaughten in the case of Gluckscin vs Barnes [1900] AC 240, 250 pointed out thus:

"Everybody knows that sometimes half truth is no better than a down-right falsehood."

In the U.S. case of Junius Construction Corpn. vs Cohen (1931) 257 NY 393 the plaintiff purchased a tract of land.  The contract of sale stated that the land was subject to a right of the Borough to open two streets within the area.  But as a matter of fact the borough had the right to open three streets.

The court held that the plaintiff had the right of rescission.   Cordozo C.J. said:

"We do not say that the seller was under a duty to mention the projected streets at all.  That question is not here.  What we say is merely this, that having undertaken or professed to mention them, he could not fairly step halfway".

Just as it had already been observed in respect of the effect of silence in cases of misrepresentation, in fraud by silence, if the plaintiff just means to discover the truth by ordinary diligence, he cannot obtain rescission.  But in any other case, the fraudulent party cannot say that the other could have discovered the truth.

3. LIMITS OF RESCISSION

We have seen in the foregoing that where consent to a contract is caused by coercion, undue influence, misrepresentation or fraud, the victim has a right of rescission.  That is, he can avoid the contract.  Section 19 (1) of the Ordinance provides that:

"when consent to an agreement is caused by coercion, undue influence, fraud or misrepresentation, the agreement is a contract avoidable at the option of the party whose consent was so caused".

However, the right to rescind the contract is subject to certain infirmities or exceptions which may defeat it as follows:

3.1 Where Truth could be discovered by Ordinary Diligence

The proviso to subsection (1) of section 19 provides that if consent was caused by misrepresentation, or by silence whi Fch amounts to fraud within the meaning of section 17, the contract is not avoidable if the party whose consent was so caused had the means of discovering the truth with ordinary diligence.

You will note from the scope of the proviso that this exception only applies to cases of misrepresentation or fraudulent silence.  It does not cover cases of coercion and undue influence.

3.2 Affirmation

Under subsection (3) of section 19, where a party whose consent was cause by fraud or misrepresentation, after becoming aware of his right of rescission, affirms the contract, the right to rescission is lost.  Such a party may affirm the contract by insisting on its performance. Affirmation may be express or implied.  It is implied when the party who is entitled to rescind the contract does something which is inconsistent with his right of rescission.

For example, where he appropriates to his use the defective goods received under a avoidable contract.

3.3 Lapse of Time

The right of rescission has to be exercised within reasonable time after discovering the misrepresentation.  Unexplained delay may preclude its exercise.

3.4 Rights of Third Parties

The right of rescission is lost as soon as a third party, acting in good faith, acquires rights in the subject matter of the contract.  This was the case in Phillips vs Brooks Ltd [1919] 2 KB 243 which shall be discussed in extenso in the subsequent topic on mistake.  That is, where a person obtains goods by fraud and, before the seller is able to avoid the contract, disposes them off to a bona fide party, the seller cannot then rescind.

3.5 Restitution

The basic condition for allowing rescission is that, the party seeking rescission must be in a position to restore the benefits he may have obtained under the contract.  This condition is contained in section 64 of the Ordinance, which reads:

"When a person at whose option a contract is avoidable rescinds it, the other party thereto need not perform any promise therein contained in which he is promissory.  The party rescinding a avoidable contract shall, if he has received any benefit thereunder from another party to such contract, restore such benefit, so far as may be, to the person from whom it was received".

If the party seeking to rescind the contract cannot effect restitution as required by section 64 he thenceforth losses the right of rescission.