Fraudulent misrepresentation claims - high risk and potentially high reward

When someone deliberately lies during a business transaction, they may be committing fraudulent misrepresentation. This is also sometimes described as fraud by false representation.

Fraudulent misrepresentation claims commonly arise in private company sales, typically involving founder-sellers who have built and run the business themselves.

The dynamics change significantly with public company cases. These typically revolve around false statements in market announcements, annual reports, or other public documents. Claims often involve multiple shareholders and proceed as group litigation. The regulatory framework adds another layer of complexity, with higher evidential standards required and potential parallel investigations by market authorities.

Legal test for fraudulent misrepresentation

The 4 essential elements required to prove fraudulent misrepresentation are :-

• A false statement of fact (not opinion or future intention)

• The person making it knew it was false, or was reckless as to whether it was true

• The statement was made with the intention of getting the other party to rely on it

• The other party did rely on it and suffered loss as a result

It's important to understand that all four elements must be proven. The key element that makes it 'fraudulent' rather than negligent is element 2 - proving the person knew they were lying or didn't care if what they said was true or false. This is often the hardest element to prove in practice.

Civil or criminal?

Claims for fraudulent misrepresentation can be both civil and/or criminal. In reality, most claims are in the civil courts because victims generally focus on recovering their losses and the criminal burden of proof is more difficult and the police/CPS may not pursue a criminal case.

Criminal prosecution is typically only appropriate when there's widespread fraud affecting multiple victims or when public protection is a primary concern. While criminal proceedings might be necessary for cases involving organised crime or systematic fraud, they generally take longer and offer less certainty of financial recovery.

Reasons to consider a civil claim

Potential legal and tactical advantages of alleging fraudulent misrepresentation (either on a stand alone basis or in addition to other claims such as breach of contract) include :-

• Right to rescind - If you can prove fraudulent misrepresentation, you have the technical right to rescind (cancel) the contract, a remedy which is otherwise difficult to obtain. However, in practice, you still may not be able to rescind (see below).

• Better option than breach of contract claim - fraudulent misrepresentation claims typically sit outside the usual contractual framework. This means you can bypass any contractual liability caps, limitation periods, and other restrictions that might limit contract claims such as warranty claims. Most contractual protections sellers put in place simply don't work against fraud.

• Director/seller defendant liability and tactical pressure - with fraud claims, you can pursue individual sellers or directors personally, even if they've sold through a company structure. This is crucial when dealing with corporate vehicles set up just for the sale, or where the seller company has been stripped of assets. Directors can't hide behind their company's limited liability if they personally made fraudulent statements.

Drawback and risks

• Difficult to prove - you need clear evidence that the defendant knew their statements were false - mere negligence isn't enough. This often requires internal documents or emails that defendants may have deleted or hidden. Key witnesses might be hostile or unavailable. Building a fraud case typically requires expensive forensic investigation and expert evidence. If you lose, you'll likely face significant adverse costs orders. There's also reputational risk in being seen to have made unfounded fraud allegations.

• Potential damage to alternative claims - once you allege fraud, it can be harder to succeed with alternative claims if the fraud allegation fails. You might appear opportunistic to the court, and your credibility on other issues might suffer. Insurance that might have covered warranty claims often excludes fraud allegations. It can also make settlement much harder as defendants are reluctant to admit fraud.

Alternative claims to consider

Proving fraudulent misrepresentation is often harder than it first appears. You need evidence that the seller knowingly lied - not just that they were careless or optimistic. Because of this, other alternative claims may be a wiser course of action, such as claims for :-

• Negligent misrepresentation - only need to prove the seller was careless in making statements, not deliberately dishonest. While you might not get rescission, you can still recover your losses and claims are often easier to prove and settle.

• Breach of warranty - often the most practical route, especially where you have warranty insurance. Claims are usually clearer to prove as they focus on objective facts rather than the seller's state of mind. Time limits and financial caps will apply, but this is balanced by greater certainty.

• Breach of contract - based on clear written terms, these claims are well-understood by courts and often easier to quantify. They can be particularly useful where specific promises were included in the sale agreement.

• Tort of deceit - the tort of deceit is effectively the same as fraudulent misrepresentation in terms of what you need to prove. The key difference is that deceit doesn't require a contract - you can sue anyone who knowingly made false statements to induce you to act, even if they weren't party to the final contract.

Most successful claims combine several of these options rather than focusing solely on fraud. It's often sensible to start with simpler claims and keep fraud allegations in reserve, particularly while exploring settlement options.

Problems with the right to rescind

Under English law, even if you prove fraudulent misrepresentation, you cannot always rescind the contract. While there is technically an automatic right to rescission for fraudulent misrepresentation (unlike negligent misrepresentation where it's discretionary), this right can be lost in several ways:

• If restitution is impossible (i.e., you cannot return what you received in substantially the same state)

• If you affirm the contract after discovering the fraud

• If there's been excessive delay in claiming rescission

• If third party rights have intervened

• If you've irreversibly integrated or changed what you received

So while the right itself is stronger than for other types of misrepresentation, practical barriers often prevent its exercise. This is particularly relevant in business sales where the target company has often been changed significantly by the time fraud is discovered.