When a Breach of Contract Becomes Fraud

The difference between a contract breach and fraud is a fine line. A breach of contract deals more with disappointed expectations, whereas fraud deals with the intent to inflict financial harm. Traditionally, breach of contract is based on misunderstandings (bad contract formation), non-performance or non-conforming performance. Usually when a contract has gone bad it is because a party has made a promise he/she cannot keep and/or there is no meeting of the minds. Breach of contract is opinion driven where the remedy is non-punitive and a party is generally limited recovery based on economic loss. Fraud, on the other hand, is fact driven and involves dishonest conduct where a wronged party may recover not only for actual loss, but the law also provides for a punitive remedy as well.

A breach of contract becomes fraud when one party makes a false representation of a material fact (whether spoken or by conduct) by providing false or misleading information or concealing information that should have been disclosed wherein the other party relies on such information. Fraudulent conduct could also exist when there are “known” misunderstandings. For example, when one realizes another party misunderstands a material term of a contract that party must correct that misunderstanding upon discovering that one party fails to completely understand all terms of the agreement. If this does not happen, the party with knowledge of the misunderstanding has engaged in fraudulent behavior. The motive behind fraudulent conduct usually is for financial or economic gain. A contract entered into based on fraudulent conduct is voidable. In other words, a court can cancel a contract that has been formed on the basis of misrepresentation of information relied on. However, courts are obligated to respect the boundary between contract law and tort law.

One way courts have preserved this distinction is with the “Economic Loss” rule, which bars recovery in tort for injuries other than those sustained by a person or other property. This rule was designed to prevent contract law from drowning in an ocean of torts. The difference is: bargain protection v. safety of individuals. Failure to maintain this distinction creates interference with the freedom to contract. Therefore, when pursuing a fraud claim that stems from contract formation, the fraud must be based on some additional conduct that amounts to an independent tort (“Independent Duty” rule). However, since the economic loss rule is not designed to destroy tort law, courts have carved out exceptions on a case-by-case basis, especially when there is suspicion of fraud. The courts will impose consequences to those acting in bad faith and engaging in tricks while negotiating and/or performing obligations under a contract.

Someone who believes they have been deceived and tricked after engaging in a contractual relationship with another party must act immediately upon discovering they have been a victim of fraud. The longer a person is the object of dishonest conduct the more severe the damages. If you believe you have been a victim of fraud it is important to speak with experienced attorneys who understand how to present a case beyond breach of contract. The law firm of Stoner Grannis LLP houses experienced attorneys who are willing to assist you and answer any questions if you believe you have been a victim of fraud.