Fraud is an important consideration in the area of legal contracts because of the fact that if fraud is present in the formation of a contract, the contract can, and mostly will, be invalidated. To establish contract fraud, it must be established that the party committing the fraud knowingly misrepresented a material fact with the intent to defraud and that the opposing party justifiably relied upon such misrepresentation (Blair, 2009). In order for the fraud to affect the contract the effected party must have suffered injury. Without injury the contract will not be affected.
In the legal sense, a misrepresentation of a material fact usually means that a party lied about a term of the contract that was essential in the decision making process that resulted in the contract being formed. It is important to distinguish between what constitutes a lie in the formation of a contract and what constitutes what is ordinarily considered mere “puffing.” In the negotiation of nearly every contract there are statements made that are opinions and not facts that are used to induce the contract (Shell, 1991). Such statements do not constitute fraud. In order to constitute fraud the statement must be clearly factual and rise to the level of being a discernible lie, however, silence can constitute a fraudulent act when a party fails to disclose a hidden defect of which he is aware. To be considered material a fact must be likely to play a significant role in inducing a reasonable person to enter a contract or if the person asserting the fact knows that the other person is likely to rely on the fact.
Any misrepresentation that is made must be done knowingly. Knowingly in the legal sense requires that the fraudulent party knew that the misrepresentation was false and that he or she had no basis for making the statement or made the statement without being confident that it was true.
The fact that a material representation exists and has been knowingly made is not sufficient to establish fraud, it must also be shown that such misrepresentation was justifiably relied upon. This means that the non-fraudulent party must have a reasonable basis for relying upon the misrepresentation. If a party has obvious reasons for doubting the validity of the statements made by fraudulent party or knows for a fact that the other party is lying then there is no justifiable reliance and there is no provable fraud.
Once a material misrepresentation is demonstrated and the reliance is shown to be justifiable the party alleging fraud must still demonstrate that he has suffered an injury as a result of the fraudulent party’s actions (Harris, 2005). Fraud may exist but unless there are provable damages there will be no finding of fraud. As in nearly every contract action, the typical damages are measured in terms of money.
In most situations, an actionable case of contract fraud provides a party with two available remedies: 1) rescind the contract and receive a refund of any consideration that has already been paid, or 2) affirm the contract and sue for any provable decrease in the value of the contract. The aggrieved party must elect between these two available remedies. In tort cases involving fraud the victimized party is entitled to seek punitive damages but in contract fraud cases punitive damages are generally not available nor are nominal damages.
In some jurisdictions there is also the possibility that a finding of contract fraud could result in criminal penalties be assessed against the fraudulent party. In the jurisdictions where this is applicable, this would only occur in the most significant or egregious of cases and the sanctions applied would be limited to the payment of civil damages. In a very limited number of cases, criminal fines or even jail time might be applied but this is likely only when the aggrieved party is a government agency. For the most part, the courts are reluctant to involve themselves in private contract matters.
Blair, A. (2009). A Matter of Trust: Should No-Reliance Clauses Bar Claims for Fraudulent Inducement of Contract. Marquette Law Review, 423-475.
Harris, D. (2005). Remedies in Contract and Tort. New York: Cambridge University Press.
Shell, G.R. (1991). When is it Legal to Lie in Negotiations. Sloan Management Review, 93-101.
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