The Misrepresentation Defense

Fraud and Misrepresentation

A lie can free a party from a contract, but only a lie that did its work. Restatement (Second) of Contracts § 164(1) says when: if a party's manifestation of assent is induced by either a fraudulent or a material misrepresentation by the other party, and the recipient is justified in relying on it, the contract is voidable by the recipient.¹ Each clause of that sentence is a separate requirement, and each later section of this chapter develops one of them.

Exam Analysis Steps

A claimant must clear four questions, in this order:

Misrepresentation. Did the other party assert something that is not in accord with the facts? That is all the Restatement means by a misrepresentation.³
Fraudulent or material. Was the misrepresentation fraudulent? It is if the maker intended it to induce assent and either knew or believed it untrue, lacked the confidence in it that the maker stated or implied, or knew the maker lacked the basis the maker stated or implied.⁴ Failing that, was it material? It is if it would be likely to induce a reasonable person to assent, or if the maker knows it would be likely to induce this recipient to do so.⁵
Inducement. Did the misrepresentation substantially contribute to the recipient's decision to assent?⁶
Justified reliance. Was the recipient justified in relying on it?⁷

Step two offers two alternatives, and the pairing trades fault against importance. When the maker is at fault, because the maker lied outright or claimed a confidence or basis the maker lacked, the misstated fact need not be important. The defense arises irrespective of the importance of the fact, although some courts carelessly say that even here the fact must be material.⁸ When the maker was honest and merely wrong, the Restatement asks a different question: would a reasonable person have cared? That is why an innocent misrepresentation must be material.

The pairing also explains why avoidance can succeed where a fraud action fails. Rescission only restores the situation that existed before the transaction, so its requirements are far less demanding than those of a tort action.⁹ A party may rescind for a material misrepresentation even though the maker had no fraudulent intent (scienter), while the law may deny or limit a tort remedy for the same statement.¹⁰ The converse does not hold. A party who was fraudulently induced to contract may instead elect to avoid the transaction and claim restitution.¹¹

Voidable does not mean void. The contract binds both parties until the recipient chooses to undo it, and the choice belongs to the recipient alone. A transfer induced by fraud or misrepresentation may be invalidated because the transferor's consent is defective.¹² It is the victim's consent that is defective, so the victim decides what to do about it. A void contract would bind no one and would let the liar walk away. Voidability instead lets a victim keep a bargain the victim still wants. Take a homebuyer whose seller bribed a termite company for a clean report. If the buyer wants to keep the house, a tort action for money damages is a more attractive remedy than rescission.¹³ The last section of this chapter takes up how the victim elects among these routes.

Even so, neither law nor morality requires that all lies made in negotiations be redressed.¹⁴ Two sales of a painting show where the line falls.

The falsehood and the seller's knowledge are identical in the two sales. Only one thing differs: whether the lie moved the buyer. That is why inducement and justified reliance have their own sections below, alongside the rules on what counts as an assertion and when a misrepresentation is fraudulent or material.

Fraud and Misrepresentation

The Misrepresentation Defense

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