Claims in deceit: Some points to note

6th June 2016

Following our earlier article, Pleading fraud – some reminders from the courts, the High Court has recently considered claims in deceit for fraudulent misrepresentation and provided some useful guidance to parties attempting to plead and prove such a claim.

Nature of Claim

There are three types of misrepresentation: fraudulent, negligent and innocent.  Fraudulent misrepresentation is the most serious and requires the false representation to have been made knowingly, or without belief in its truth, or recklessly as to its truth [1].

A claim for fraudulent misrepresentation is founded in the tort of deceit.  The four elements are:

• the defendant makes a false representation to the claimant;
• the defendant knows that the representation is false, or alternatively is reckless as to whether it is true or false;
• the defendant intends that the claimant should act in reliance on it; and
• the claimant does act in reliance on the representation and, in consequence, suffers loss [2].

Recent Case Law

In Rizwan Hussain v Saleem Mukhtar [3], the claimant claimed damages for losses after investing in a company established by the defendant.  He claimed that he was induced to invest as a result of fraudulent misrepresentations, made by the defendant, as to the financial position of the company.  The Deputy Judge made various observations regarding the claimant’s pleaded cause of action:

First, the claimant pleaded that the representations “were false and were made by the Defendant fraudulently or recklessly, the Defendant not caring whether they were true or false…”  The Deputy Judge remarked that misrepresentations made recklessly, “not caring whether they were true or false”, are fraudulent, so that the claimant’s pleading identified one cause of action only – fraudulent misrepresentation (i.e. deceit) [4].

Secondly, the claimant’s counsel suggested that, although the claim was primarily one of fraudulent misrepresentation, it would be sufficient for the claimant to show that the representations had been made “negligently”, relying on section 2(1) of the Misrepresentation Act 1967 (the 1967 Act).  Where parties have entered into a contract, a claim for negligent misrepresentation under section 2(1) of the 1967 Act is available (in addition to any possible breach of contract claim) where the misrepresentation was made carelessly or without having reasonable grounds for believing its truth.

The 1967 Act provides that the same remedies (having the contract set aside and seeking unlimited damages) are available where the misrepresentation was made negligently as if it were made fraudulently, unless the person making the misrepresentation proves that they had reasonable ground to believe and did believe up to the time the contract was made that the facts represented were true.

There was nothing in the pleading pointing to any claims based on the 1967 Act.  The Deputy Judge indicated that the claimant’s counsel would need to consider whether to put forward an alternative case, then either apply to the court to plead it, or explain why no such application was necessary.  The claimant’s counsel submitted that (1) the section 2(1) alternative case was open to him without amending the pleading, (2) if the representations were found to be false, that alternative case would succeed unless the defendant could prove that he had reasonable grounds to believe, and did believe, that the representations were true, and (3) there was no need expressly to plead a claim under section 2(1) if the facts pleaded could support such a claim.

The Deputy Judge disagreed and made the following points:

• a claim in the tort of deceit is very different from a claim under section 2(1) of the 1967 Act: In a deceit claim, the claimant bears the burden of proving the defendant’s mental state (knowledge of or recklessness as to falsity); in a claim under section 2(1) it is for the defendant to prove that he had reasonable grounds for believing, and did believe, that the representation was true;
• the ingredients of the two “species” of misrepresentation are not identical: Claims under section 2(1) can only be brought where the claimant has entered into a contract after the misrepresentation and only against a party to the contract; claims in deceit are not subject to either of those restrictions;
• the limitation defences available may differ: A claim under section 2(1) is not “an action based upon the fraud of the defendant” so section 32 of the Limitation Act 1980 would not apply (under this provision the usual limitation period for bringing a claim may be postponed, with time starting to run instead from the date of discovery of the fraud or from when the claimant could, with reasonable diligence, have discovered it); and
• a defendant is entitled to understand whether a claim under section 2(1) is being advanced or not – a claimant wishing to advance such a claim as an alternative to a claim in deceit should plead it.

In Sears and another v Minco plc and others [5], the claimant claimed that he was induced to purchase and/or retain shares in Minco plc (Minco) by fraudulent misrepresentations made on the part of Minco itself and two individuals, the CEO and CFO of Minco.

Minco had a joint venture (JV) interest in a mining exploration project. The claimant submitted that the nature of Minco’s interest had been materially misrepresented to him, i.e. that the terms of the JV agreement (JVA) provided that the interest could not be diluted below 10 per cent. In fact, the CEO’s recollection of the JVA terms turned out to be wrong – the level below which Minco’s interest in the JV could not be diluted was misstated and the JVA actually provided that if the interest was diluted to less than 5 per cent then Minco would be deemed to have withdrawn from the JV. The claimant claimed to have suffered significant loss and damage as a result (in particular, by way of loss of profits on alternative investments that would otherwise have been made).The claim failed and was dismissed by the Judge, who made a number of notable findings, including the following:

The claimant’s case rested on certain words which were said to have been spoken in two informal lunch meetings with the CEO and CFO five to six years earlier. The claimant argued that the defendants (1) had actual knowledge of the relevant JVA terms, and had wilfully misstated them, alternatively (2) had made the representation either without any honest belief in its truth or recklessly, without caring whether it was true or false. The defendants asserted that any misrepresentation was simply an honest error made by the CEO, which matched his understanding of what the JVA terms provided (the CEO did not appreciate that the claimant might not have shared his understanding of the terms).

The claim failed and was dismissed by the Judge, who made a number of notable findings, including the following:

• Neither of the two individual defendants knew that they did not have a perfect recall of the JVA terms relating to Minco’s interest and would have needed to see the JVA to refresh their memory of the precise terms. Both of them genuinely believed that the CEO sufficiently knew the relevant terms. He was genuinely mistaken as to what those terms were. That was not sufficient to justify a finding of fraud or deceit.
• While the representation was false, misleading and ambiguous, and the claimant understood it in the sense which was false (i.e. that the JVA gave Minco a safe 10 per cent interest), the CEO intended the representation to be understood in the alternative sense (i.e. based on his own understanding of the JVA), not in the sense which was false. This was a further obstacle to the claimant’s case, because a person who makes a statement honestly believing it to be true in the sense which he understands it to bear is not guilty of fraud merely because the other person understands it in a different sense which is false.
• It was both foreseeable and reasonable for the claimant to rely on what the CEO said about the terms at the two lunch meetings. He was Minco’s CEO and a professionally qualified, and practically experienced, geologist who had been involved in the project from the outset. He could be expected to be familiar with the JVA. It was not a publicly available or accessible document and so actual or potential investors in Minco would inevitably have to look to Minco’s management for information as to its terms. Investors could be expected to rely on anything that was said to them about the JVA by the executive members of Minco’s board. The CEO had previously (and exceptionally) arranged for the claimant to visit the project site in his capacity as an investor in Minco, and the purpose of the two lunch meetings was to enable the claimant (again exceptionally) to receive further information from, and to pose questions to, two of Minco’s executive directors. The representation was “material” – it was capable of influencing a reasonable person in deciding whether to purchase/retain shares in Minco.
• Neither individual consciously intended the claimant to rely on anything that was said in order to induce him to purchase/retain shares in Minco. However, the requirement that a representation must be made with the intention that the claimant should act on it is satisfied not only where the person making the representation actually desires the claimant to rely on what he says, but also where he appreciates that he will actually do so. Here, it must have been readily appreciated that the claimant was likely to purchase shares in Minco as a result of anything that was said to him; and it was a natural consequence of what was said that he would want to continue to hold his shares in Minco for the time being.
• As to what amounts to reliance, the test is whether the person on the receiving end of the representation would have entered into the contract had the representation not been made, rather than what he would have done had he known the truth. The “presumption of inducement” is challenged by the person who made the representation showing that it did not play a real and substantial part in the other party’s decision to enter into the transaction; he does not have to go so far as to show that the representation played no part at all in that decision.

As an aside, it is worth noting that the CEO’s representation was made in his capacity as Minco’s CEO and on Minco’s behalf.  The Judge found that, when the representation was made, Minco assumed a duty to the claimant to take reasonable care to ensure that the information conveyed to him was correct.  There was a sufficient relationship of proximity between Minco and the claimant.  This was a face-to-face meeting with identified investors who were clearly seeking information relevant to the company’s business and position which was not freely available publicly.  Although the CFO considered them to be “off-the-record”, the Judge could not regard the two lunch meetings as purely informal, social occasions.  The CEO accepted that the meetings were the only times he could recall ever having had a private lunch with investors in Minco; he appreciated that they would be interested to hear what he had to say about the company, and that in all likelihood they would rely on what he had to say about it.  He accepted that it was always possible that if he, as CEO, had any discussion with shareholders, they might well rely on what he was saying, particularly if they were unable to verify what he was saying from other sources themselves.  Since the CEO had not consulted the precise terms of the JVA, and was relying entirely upon his recollection of those terms dating back to 2002 (when the JVA was signed), Minco (through its CEO) was in breach of its duty of care to the claimant (this was relevant to the claimant’s claim against Minco for damages for negligent misstatement, separate to the claim in deceit).

Practical Tips

The first case emphasises the importance for a claimant of pleading all causes of action they are seeking to rely on and the second provides guidance on the approach that a court will take in relation to the different elements to be proved in a claim in deceit.

Extra care should be taken to ensure that company representatives are alive to the dangers of misrepresenting facts, particularly in less formal meeting environments.  In the context of contractual negotiations, parties should ensure that marketing material and all forms of pre-contract communications are accurate, and that they are kept accurate and up-to-date on an ongoing basis.  Prior to conclusion of any contract, parties should check whether any circumstances or key terms have changed since communications and negotiations began and, if they have, ensure that all involved are aware and remain happy to proceed.

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[1] Derry v Peek [1889] UKHL 1
[2] Eco 3 Capital Ltd and others v Ludsin Overseas Ltd [2013] EWCA Civ 413
[3] [2016] EWHC 424 QB
[4] Derry v Peek and AIC Ltd v ITS Testing Services (UK) Ltd (The Kriti Palm) [2006] EWCA Civ 1601
[5] [2016] EWHC 433 (Ch)