Few things get people's emotions riled as when they believe they have been defrauded. In many of the business cases we handle, one or the other party raises concerns about fraud. Finding the truth is a key objective of our entire legal system. Indeed, depending on the circumstances, fraud often supports criminal charges. Every lawyer knows however, that proving fraud is something completely more difficult than making the casual accusation. This blog discusses fraud, what it is in the legal sense, and the potential consequences.
What is Fraud?
It is important to know that there is a substantial difference between a simple ‘lie' and fraud. A ‘lie' is an intentionally false statement presented as being true. However, it is not generally wrongful, in the legal sense, to lie. For example, I would not be subject to liability or criminal prosecution for falsely claiming that I caught a 30-inch walleye yesterday, nor would my 5-year-old son for telling me he has eaten all of his beans, when in fact he dumped them down the disposal.
To successfully prove fraud (or fraudulent misrepresentation) in the legal sense however, a claimant must present admissible evidence that satisfies each element of the claim. The elements, according to the Minnesota Supreme Court, are as follows:
1. A false representation by a party of a past or existing fact that is susceptible of knowledge;
2. The person making the representation made it either: (a) knowing it was false; or (b) as if he knew, but without actually knowing whether it was true or false;
3. The representation was made with the intention to induce another party to act in reliance on the representation;
4. The representation caused the other party to act in reliance; and
5. The other party suffered pecuniary damages as a result of that reliance.
Hoyt Properties, Inc. v. Production Resource Group, L.L.C., 736 N.W.2d 313, 318 (Minn. 2007). A claim for fraud does not exist if any one of these elements cannot be proven. Moreover, each element ends up being more complex in application than it seems on paper.
For example, the seemingly simple question of whether a party has made a false representation is often the subject of significant debate. What if a statement is half true? Can there be a false statement where the claim is premised on an omission rather than an overt statement? What about silence or nondisclosure of facts? In general, a party may be liable for fraud in all of these scenarios, but only in certain circumstances that depend on the facts of each case.
The concept of ‘past or present fact' is also important. Courts have generally held that predictions, statements of expectation and/or statements of intention are not ordinarily actionable as fraud. For example, the statement, “I am going to catch a 30-inch walleye tomorrow,” is not a representation of past or present fact but a prediction, which would not qualify as fraudulent. Such statements will only be actionable as fraud if they were known to be untrue at the time they were made. Additionally, statements of opinion are not considered a statement of past or existing fact. Consequently, statements such as ‘high quality' are not typically actionable as fraud.
Subjective knowledge and intent are also important factors. To be liable for fraud, the party must have both known the statement was false (generally) and intended that their audience would rely on the false statement. It seems self-evident that parties would debate these issues vigorously in cases alleging fraud. What if the representation was a good faith mistake? What if the false statement was made on the assumption that the listener was going to independently research the issue? Essentially, courts will require proof of bad faith to support these requirements.
The concept of ‘reliance' is also very important. No claim of fraud will succeed unless the aggrieved party proves that they actually relied on the representation. For example, a claim will fail if it is shown that the aggrieved party had already acted, or had verified the statement to be unreliable and undertook his own investigation. Furthermore, reliance must be justified. Reliance is not justified, for example, if the aggrieved party had a readily available and more reliable source for the information and chose not to access that information, or if the representation was so obviously false as to put them on inquiry notice.
Finally, a claim will not exist unless the claimant proves that they suffered actual damages as a result of the fraud. Minnesota differs from other states and has adopted the ‘out-of- pocket' rule as a measure of damages. Out-of-pocket damages, according to the Minnesota Supreme Court, is “the difference between the actual value of the property received and the price paid for the property, along with any special damages naturally and proximately caused by the fraud prior to its discovery, including expenses incurred in mitigating the damages.” B.F. Goodrich Co. v. Mesabi Tire Co., 430 N.W.2d 180, 182 (Minn. 1988). (The majority of states have adopted the benefit-of-the-bargain rule under which a plaintiff can recover the benefit of what he was promised. Yost v. Millhouse, 373 N.W.2d 826, 831 (Minn. Ct. App. 1985).). So for example, if I thought I was getting an incredible deal on a counterfeit coin for which I paid $10,000.00 but believed it to be worth $1 million dollars, in an action against the fraudster, I could only recover my $10,000.00, not the $990,000.00 in equity I thought I was going to get from the deal. In states other than Minnesota, I might be able to recover the $990,000.00 under the so called ‘benefit-of-the-bargain' rule.
How is Negligent Misrepresentation Different?
Negligent misrepresentation is different from fraud primarily because wrongful intent is not required. Basically, a person can be liable for negligent misrepresentation if they made a false statement, knowing that others would rely upon it, without exercising reasonable care in obtaining or communicating the information. See Bonhiver v. Graff, 248 N.W.2d 291 (Minn. 1976). The person making the statement need not intend to mislead the recipient. So for example, an auditing firm hired to review the condition of a company may be held liable if they make a statement about a company that is untrue and the auditing firm should have known it was untrue based on the records they reviewed. As with fraud, an aggrieved party must prove that they reasonably relied on the information and that they suffered damages. In the counterfeit collector coin example above, a dealer may be liable for negligent misrepresentation if he falsely advertised the coin as a rare collector because he misread the information provided to him when he bought the coin.
Other limitations come into play with negligent misrepresentation, particularly as to who is entitled to rely on a statement.
Other Laws that Relate to Fraud.
The ‘common laws' are the laws that apply by virtue of judicial precedent applied through the history of court cases. For fraud, in addition to the common law, there are a number of statutes in Minnesota that might apply, depending on the circumstances. Ones that come to mind are the ‘Consumer Fraud Act' the ‘False Statement in Advertising Act,' and the ‘Uniform Deceptive Trade Practices Act,' among others.
Without going into the details of these laws, they generally allow aggrieved parties to pursue claims against wrongdoers on a lower burden of proof and with more significant consequences where the conduct fits within the scope of the applicable statute.
So for the Consumer Fraud Act, an aggrieved party may hold a wrongdoer for fraud or misrepresentation liable in connection with the sale of ‘merchandise' whether or not the aggrieved party suffers actual damages. ‘Merchandise' is defined broadly and could even encompass the sale of real estate or services. As with the other statutes, the aggrieved party may also potentially recover their attorney's fees in bringing the action.
For the False Statement in Advertising Act, it is wrongful to make a false statement in a public advertisement with the intent of increasing business.
For the Uniform Deceptive Trade Practices Act, it lists 12 specific types of conduct, mostly in connection with the sale of ‘goods or services' that are prohibited. The prohibited conduct generally encompasses false advertising type claims such as selling phony goods, misrepresenting the condition or origin, or misrepresenting the terms of sale.
Fraud in Business Cases.
In addition to the above, fraud in the business context often gives rise to other claims or causes of action. For example, co-shareholders in a small business owe each other and their company fiduciary duties to be open, honest, and loyal. Therefore, in some cases, fraud may give rise to a claim among shareholders of breach of fiduciary duty. One example would be where a co-shareholder falsely tells his other co-shareholder that a potentially large customer decided not to do business with the company when in fact the co-shareholder lured the customer to do business with him outside of the company.
Another example of fraud impacting a business case is in the context of tortious interference with contractual relations. Tortious interference with contractual relations is a claim where a claimant sues a wrongdoer for wrongfully causing a third party to break a contract. Without going into the specific elements of this claim, the use of fraud by the wrongdoer would help to prove the claim.
In sum, proving fraud in the legal sense is more complex than it would seem, but if fraud or negligent misrepresentation has occurred, the conduct may also give rise to other statutory and common law claims, particularly in the business context. In light of this complexity, if you have suffered serious damages from what you believe is fraud, it is always a good idea to talk to a lawyer. At Hance Law Firm, we are always interested in evaluating a potential case of business fraud, and our initial consultation is always free of charge.