Contracts Induced By Misrepresentation

Contracts Induced by Misrepresentation

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Misrepresentation During Contracting

Contracts induced by misrepresentation occur often and it is important to know your legal rights. Misrepresentation is a statement that is not in accord with facts. [Rest. 2d § 159] In order to find liability for unlawful conduct when contracting, the misrepresentation can take many forms. At its essence, the assertions or omissions must be “material” to the deal.  This means that the information must be critical to the other party making its decision to contract.  

Contracts Induced by Misrepresentation Through Fraudulent Conduct

Contracts induced by misrepresentation through fraudulent means is common. In the law, a misrepresentation is fraudulent if the misrepresenting party intends an assertion to induce another party to enter an agreement and the misrepresenting party either:

  • knows or believes the assertion is untrue,
  • lacks confidence in the truth of the assertion but presents it as facts, or
  • says or implies that there is a basis for the assertion, such as personal knowledge or investigation, when in fact such a basis does not exist. [Rest. 2d 162]

If one party justifiably relies on a fraudulent misrepresentation, the contract is voidable by the innocent party. [Rest. 2d § 164] For example, if Buyer asks a Salesman if he sells any specific product and the Salesman actually does not know whether the product is of the specificity requested, and the product does not meet those specificities. In this case, the Buyer makes a purchase because he or she thinks the product meets certain and definite specifications. The sale is voidable by the Buyer.

Contracts Induced by Misrepresentation Must Be Material

Contracts induced by misrepresentation are legally voidable if the misrepresented fact is material to the deal. In contract law, in order for a a misrepresentation to be actionable, the misrepresentation must be material to the transaction. For example, the misrepresentations are material if:

  • the assertion probably will induce a reasonable person to agree or
  • the misrepresenting party knows the assertion probably will make a particular person agree [Rest. 2d § 162]

Contracts induced by misrepresentation of a material fact are voidable. A contract that results from a material misrepresentation (even if it is not fraudulent) is voidable by a party who justifiably relies on it and agrees to a contract as a result of it. [Rest. 2d § 164]. This is distinguishable from being unenforceable, rather it is voidable at the discretion of the wronged party. 

For example, if a contracting party truly believes a certain material fact to be true, then that party’s “misrepresentation” of that particular fact is not  considered “fraudulent” (which requires a specific intent to assert a known falsity). Nonetheless, if the false assertion is material to the transaction and would more likely than not induce a reasonable person to enter the contract, then the transaction will be voidable by the aggrieved party.

Contracts induced by misrepresentation of a material fact may also occur when there is an intentional omission of information that would have influenced the transaction. Misrepresentation of material fact is common in real estate transactions both commercial and residential. It can also take place in business transactions, such as in the buying or selling of a company.

Many agreements include clauses that protect the seller in the event that a material fact is unknown and discovered after the transaction so long as the seller was unaware of that fact until that time. However, intentionally hiding a material fact to motivate a transaction is illegal.

Nondisclosure Of Facts Are Considered To Be Contracts Induced by Misrepresentation

It is important to note, contracting parties do not have an obligation to disclose all facts concerning the subject matter of the contract to each other. [Rest. 2d § 161] Contracts are voidable if they result from fraudulent or material misrepresentation, or from an affirmative attempt to conceal material facts. [Rest. 2d 160]. It is often stated that one party to a contract has no general duty to disclose information or to take steps to correct the other party’s mistakes or misapprehension of fact.  An exception may apply when there is a form of special relationship between the parties, such as a fiduciary. 

Exceptions That Require Disclosure Of Known Facts When Contracting

If a special relationship or circumstance exist between the parties, then one party to a contract may have a duty to disclose facts to the other party. In these situations, the failure to disclose a fact may amount to a misrepresentation and render a contract voidable under the rule concerning fraudulent and material misrepresentations. [Rest. 2d 161]. 

Misleading Half-Truths Considered To Be Contracts Induced by Misrepresentation

If a party chooses to reveal some facts in a misleading way, then the “half-truths” can constitute misrepresentation even if the stated facts are not themselves untrue. [Rest. 2d § 159, comment b] A party might state half-truths – making a true statement but also strategically omitting qualifications or elaborations. This will render the statement to be an effective misrepresentation.

For example, the dean of law school states to applicant that law school is accredited by the American Bar Association. At the time the dean makes this statement, it is true. But the dean also knows that the American Bar Association is planning to revoke the school’s accreditation later that day. Failing to disclose this specific fact, given the dean’s assertion about accreditation, amounts to a material misrepresentation.

Failure To Correct A Previous Statement Considered To Be Contracts Induced by Misrepresentation

Nondisclosure may amount to contracts induced by misrepresentation if a party fails to correct a previous statement in light of new or newly discovered material information that would effect the other party’s decision. [Rest. 2d § 161 (a)].  If the party with scienter does not take new steps to correct the statement, then the contract is avoidable.

Relationships Of Trust Or Confidence

Nondisclosure of material facts is required if the prospective parties are in a fiduciary relationship or another relationship of trust or confidence. [Rest. 2d § 161 (d)].  These can be positions such as lawyer, doctor, and accountant.  

Disclosure To Correct Mistakes About Writings Considered To Be Contracts Induced By Misrepresentation

Disclosure is also required to correct the other party’s known mistake about the meaning or content of a writing. [Rest. 2d § 161 (c)]. This rule has a similar rationale to those of the doctrine of mistranscription.  The rule of interpretation governs situations in which one party knows that another party is assigning an unreasonable meaning to an expression.  Moreover, other legal doctrines can be applied to the interpretation of a document such as arguing that the written contract must be interpreted against the draftsman

General Possible Exception

Disclosure may also be required, even if none of the other exceptions apply. The duty to disclose exists if a material fact is known to one party by virtue of their special position and could not be readily determined by the other party in the exercise of normal diligence. This exception has commonly been applied to cases of the sale of residential homes.

For example, a seller of a house, who has experience as an owner, is aware of a non-apparent termite infestation. In many states the seller may be obliged to disclose the infestation to a prospective buyer, especially if the parties reside in an area in which buyers normally do not commission termite inspections before purchasing homes. See, Hill v. Jones, 725 P.2d 1115 (Ariz. Ct. App. 1986.

Broad Possibilities For Exception

Restatement Second states an even broader possible general exception, requiring disclosure necessary to “correct a mistake of the other party as to a basic assumption on which that party is making the contract… if nondisclosure of the fact amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing.” [Rest. 2d § 161 (b)].

Duress And Threats During Contracting

Contracts induced by misrepresentation are voidable on the ground of duress where consent was induced by wrongful or improper threats. [Rest. 1st § § 492-495; Rest. 2d §§ 175-176] A contract is also commonly said to be “void” in the event that apparent assent results from physical compulsion. [Rest. 2d § 174]

Wrongful Or Improper Threat

Threats are clearly wrongful when they amount to criminal conduct, civil violations, tortious conduct, or bad-faith frivilous civil threats ( threatening to “tie someone up with lawsuits forever” with no basis). [Rest. 2d § 176(1)]. In addition, economic threats of financial harm may be improper if:

  • made in bad faith; and
  • used to extract unfair terms. [Rest. 2d 176 (2)].

Economic Duress

A threat to withhold something that another party needs or wants is not in itself duress. It is not wrongful to refuse to contract or to agree to contract only on very favorable terms. But economic duress is a defense to the enforcement of a contract when:

  • One party commits or threatens to commit a wrongful act, potentially including a breach of contract, that would place the other party in a position that would seriously threaten their property or finances unless the other party enters into a contract; and
  • No adequate means are available to avoid or prevent the threatened loss, other than entering into the contract.

The issue of economic duress often comes up in cases of contract modification. For instance, one party may be explicitly or implicitly threatening breach if the modification is not made.

However, threatening breach of contract does not itself amount to economic duress because:

  • the threatened party may have reasonable alternatives to contract modification (such as suing for breach of the original contract); and 
  • it is not always wrongful to threaten breach of contract.  

The law recognizes a concept known as “efficient breach.”  The breaching party may make a cost benefit analysis in order to forgo the current contract to enter into a more profitable deal.  Nonetheless, the breaching party will be liable and still may pay contract damages.  The decision is still beneficial as the cost of damages is outweighed by the profit to be made by the other deal.  

Undue Influence

Undue influence is unfair persuasion of a party.  A party to the contract must be considered to be under the domination of the person exercising the persuasion. Or, who by virtue of the relation between them, is justified in assuming that the person will not act in manner inconsistent with the party’s welfare.

If a party’s assent is induced by the other party’s undue influence, the contract is voidable by the victim.

For example, an elderly aunt is cared for by her nephew. The nephew pressures the aunt to sell him some of her personal property at an unfairly low price. An undue influence defense will likely succeed here. Due to the relationship, the aunt was justified in assuming that the nephew would not act in a manner inconsistent with her welfare.

What Constitutes Undue Influence Under California Law?

In California, there are certain behaviors that can be used to establish undue influence. These include:

  • The vulnerability of the victim: The victim is susceptible to undue influence because of mental or physical impairment, emotional distress, isolation, or dependence.
  • The Influencer’s Apparent Authority: The influencer has assumed a position of power or trust and uses it to exert undue influence over the victim.
  • The Suspect’s Actions: The suspect isolates the victim from friends and family, controls their finances, initiates changes in personal or property rights, or makes demands on them.
  • The Result of the Suspect’s Actions: The victim’s actions are not in their best interests and result in an unfair advantage to the influencer. This may be seen in economic consequences, divergence from a prior pattern or course of conduct, or the terms of a testamentary

California Civil Code Section 1689

California law provides essentially that if a defendant proves that he or she entered into a contract as a consequence of Undue Influence, the Court may exercise rescission over the contract. 

California Civil Code Section 1689 provides, in relevant part:

(b) A party to a contract may rescind the contract … (1) If the consent of the party rescinding, or of any party jointly contracting with him, was given by mistake, or obtained through duress, menace, fraud, or undue influence, exercised by or with the connivance of the party as to whom he rescinds, or of any other party to the contract jointly interested with such party. [Cal. Civil Code Section 1689].

Undue Influence essentially is an affirmative defense to a breach of contract claim in these circumstances and a defendant should plead it as such in his or her Answer to Complaint, when filed with the Court.

California Welfare & Institutions Code Section 15610.70

In California, there are laws to protect elder abuse in the form of taking advantage of the elderly when contracting. California Welfare & Institutions Code Section 15610.70 provides that undue influence is the excessive persuasion that causes another person to act or refrain from acting by overcoming that person’s free will and results in inequity. A typical Undue Influence case might involve someone pressuring an elderly person into entering into a contract which is very unfair to the elderly person. Once the victim understands that he or she has been taken advantage of, they generally need legal representation to nullify the contract.

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TOP RATED LAWYER

Justin Sterling, Esq. is a leading attorney.  Mr. Sterling is the founder of The Sterling Firm, a top-rated law firm with its original headquarters in Los Angeles, California. The Sterling Firm has a client base that stretches not only across the nation but also around the globe. We offer experienced and driven legal counsel for your matter.

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