Defenses to enforceability - Fraud, misrepresentation, and n...

Learning Outcomes

This article examines contract defenses based on misrepresentation and nondisclosure, including:

• Distinguishing fraudulent misrepresentation from material (non-fraudulent) misrepresentation and recognizing how each is tested on the MBE.
• Identifying the required elements of fraudulent misrepresentation: false assertion, scienter, intent to induce assent, causation, and justifiable reliance.
• Identifying the elements of material (innocent or negligent) misrepresentation and contrasting them with fraud for purposes of remedies and damages.
• Evaluating when a party’s reliance on oral or written statements is considered justifiable despite opportunities to investigate or contractual disclaimer clauses.
• Determining when silence, half-truths, or active concealment convert nondisclosure into an actionable assertion creating a duty to speak.
• Distinguishing fraud in the inducement from fraud in the execution and predicting whether a resulting agreement is void or merely voidable.
• Applying misrepresentation and nondisclosure doctrines to classic bar-exam fact patterns involving real estate sales, used-goods transactions, and agency relationships.
• Assessing the availability of rescission, restitution, expectation, reliance, and punitive damages when misrepresentation or nondisclosure is established.

MBE Syllabus

For the MBE, you are required to understand contract doctrines that can render an otherwise validly formed contract unenforceable, with a focus on the following syllabus points:

• Distinguishing fraudulent misrepresentation (scienter) from material misrepresentation.
• Identifying the elements of misrepresentation: false assertion of fact, materiality or scienter, intent to induce assent, and justifiable reliance.
• Applying the requirement of justifiable reliance, including when a party is allowed to rely on another’s statement despite the ability to investigate.
• Determining when nondisclosure is equivalent to an assertion (fiduciary relationships, half‑truths, basic mistaken assumptions, and active concealment).
• Recognizing when misrepresentation or nondisclosure makes a contract void versus voidable.
• Understanding available remedies: rescission, restitution, damages, and the possibility of punitive damages in fraud.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. For a contract to be voidable due to fraudulent misrepresentation, the plaintiff must prove all the following EXCEPT:
   1. A misrepresentation by the defendant.
   2. Scienter by the defendant.
   3. Pecuniary damages.
   4. Justifiable reliance by the plaintiff.
2. A misrepresentation is considered “material” if:
   1. The defendant knew the statement was false.
   2. It would likely induce a reasonable person to assent to the contract.
   3. The plaintiff actually relied on the statement.
   4. It relates to an opinion rather than a fact.
3. Generally, nondisclosure of a fact renders a contract voidable only when:
   1. The fact is easily discoverable by reasonable inspection.
   2. The nondisclosing party has a duty to disclose the fact.
   3. The fact relates to the value of the subject matter.
   4. Both parties are mistaken about the fact.
4. A concert promoter tells a musician: “I have already secured a major sponsor, so you will definitely be playing to a sold‑out crowd,” knowing that no sponsor has committed. The musician signs the contract and later learns no sponsor was ever lined up. Which statement is most accurate?
   1. This is mere “puffing,” so no misrepresentation occurred.
   2. This is a fraudulent misrepresentation that can make the contract voidable.
   3. This is an immaterial misrepresentation, so no defense is available.
   4. The musician’s duty to investigate bars any misrepresentation defense.

Introduction

Even when offer, acceptance, and consideration are present, a contract may be unenforceable if a party’s assent was obtained improperly. Misrepresentation and nondisclosure are defenses that attack the reality of assent and may allow the adversely affected party to avoid the contract.

On the MBE, these doctrines commonly appear as defenses to enforcement in fact patterns that otherwise show a facially valid contract. The key is to identify:

• Whether a false assertion of fact (or its equivalent) was made,
• Whether it was fraudulent or merely material,
• Whether the other party justifiably relied on it, and
• Whether silence should be treated as an assertion because a duty to speak arose.

Key Term: Misrepresentation
An assertion that is not in accord with the facts, made before or at the time of contracting.

Key Term: Fraudulent Misrepresentation
A misrepresentation made with scienter (knowledge of falsity or reckless disregard for the truth) and with the intent to induce the other party’s assent, on which the other party justifiably relies.

Key Term: Material Misrepresentation
A misrepresentation that would likely induce a reasonable person to assent to the contract, or that the maker knows would likely induce this particular recipient to assent.

Key Term: Scienter
The state of mind in which the person making the statement either knows it is false or acts with reckless disregard as to its truth or falsity.

Key Term: Justifiable Reliance
Reliance that is reasonable under the circumstances, given the parties’ relationship, the nature of the statement, and the obviousness (or not) of the truth.

Misrepresentation may be fraudulent (intentional) or non‑fraudulent (innocent but material). In either case, the resulting contract is typically voidable at the option of the misled party. In contrast, certain extreme forms of fraud (fraud in the execution) can make a purported contract void.

Key Term: Fraud in the Inducement
Fraud that induces a party to assent to a contract by misrepresenting facts about the subject matter or terms, while the party knows that a contract is being entered into.

Key Term: Fraud in the Execution
Fraud that misleads a party about the very nature of the document being signed, so that the party does not realize it is a contract at all; such an agreement is typically void.

Misrepresentation

A misrepresentation is an assertion that is not in accord with the facts. It can be made by words or conduct and can be intentional or unintentional.

Common forms of misrepresentation include:

• False statements about existing facts (e.g., the mileage of a car, current zoning of land).
• Misleading partial disclosures (half‑truths).
• Active concealment, such as covering water damage so it cannot be seen on inspection.
• Occasionally, statements of opinion or law, if made by someone with superior knowledge or in a fiduciary relationship, or if they imply specific facts.

Key Term: Active Concealment
Affirmative acts intended, or known to be likely, to prevent the other party from learning a fact (for example, painting over structural cracks to hide them).

Fraudulent Misrepresentation (Fraud in the Inducement)

A contract is voidable by the innocent party if that party’s assent is induced by the other party’s fraudulent misrepresentation. The elements are:

• False assertion of fact
  There must be an assertion about an existing fact (or past fact). This can be:

  • An express false statement;
  • Conduct intended to mislead (e.g., rolling back an odometer);
  • A half‑truth or failure to correct an earlier statement that has become false.

  Mere “puffing” or sales talk (e.g., “This is the best car on the market”) generally does not qualify, unless the speaker has specialized knowledge or the statements imply verifiable facts.

• Scienter
  The misrepresenting party knows the assertion is false or acts with reckless disregard as to its truth or falsity.

• Intent to induce assent
  The misrepresentation must be made with the purpose of causing the other party to enter the contract, or in circumstances where that result is substantially certain.

• Justifiable reliance
  The innocent party actually relies on the assertion, and such reliance is justifiable in context (discussed in more detail below).

When these elements are met, the contract is voidable by the defrauded party, who may elect to rescind or affirm the contract and seek damages.

Key Term: Nondisclosure
Remaining silent about a fact; ordinarily not an assertion, but in specified circumstances the law treats nondisclosure as equivalent to an assertion that the fact does not exist.

Material Misrepresentation

A contract is also voidable by the innocent party if assent is induced by a material misrepresentation, even without scienter. This is sometimes called innocent or negligent misrepresentation.

Key points:

• The assertion must still be false and relate to a fact.
• The misrepresentation must be material:
  • It would likely induce a reasonable person to assent; or
  • The maker knows it would likely induce this particular person to assent.

The maker need not know the statement is false; it may be an honest but mistaken belief. As long as the misrepresentation is material and the other elements (inducement and justifiable reliance) are satisfied, the contract is voidable.

Justifiable Reliance

For both fraudulent and material misrepresentation, the innocent party’s reliance must be actual and justifiable.

Reliance is generally justifiable when:

• The assertion concerns a fact that is not obviously false.
• The recipient does not possess substantially superior knowledge on the subject.
• The parties are not in a setting where blind reliance would be unreasonable (for example, when the contract expressly disclaims reliance on prior statements and both parties are sophisticated).

Important MBE points about justifiable reliance:

• A party is usually permitted to rely on the other side’s factual representation even if the truth could have been discovered by reasonable investigation. Failure to investigate does not, by itself, defeat reliance.
• However, reliance is not justified when:
  • The falsity is obvious (e.g., the written contract directly contradicts the alleged representation in a way clear on its face).
  • The statement is clearly opinion, sales talk, or prediction, and there is no special relationship or superior knowledge.
  • The party knows or strongly suspects the statement is false but proceeds anyway.

Key Term: Rescission
An equitable remedy that cancels the contract and seeks to return the parties, as nearly as possible, to their pre‑contract positions.

Key Term: Restitution
Restoration of benefits conferred under a contract (or quasi‑contract), usually measured by the value of the benefit unjustly retained.

Fraud in the Execution

Fraud in the execution occurs when a party is misled about the very nature of the document being signed (for example, told it is a receipt when it is in fact a guaranty). In such cases:

• The party does not realize they are assenting to a contract at all.
• The apparent “contract” is typically void, not merely voidable.

This is distinct from fraud in the inducement, where the party knows a contract is being signed, but is misled about important facts relating to the bargain. Fraud in the inducement makes the contract voidable, not void.

Misrepresentation and Third Parties

On the MBE, misrepresentation can come from:

• The other contracting party; or
• A third party.

If a third party makes the misrepresentation, the contract is voidable by the misled party only if:

• The other contracting party knew or had reason to know of the misrepresentation; or
• The other contracting party is in such a relationship with the misrepresenter (e.g., agent, co‑conspirator) that the misrepresentation is attributable to them.

Worked Example 1.1

Seller, knowing a car’s engine has serious internal damage, tells Buyer, “This car’s engine is in perfect condition, just rebuilt.” Buyer, relying on this statement, purchases the car. Soon after, the engine fails completely. Can Buyer rescind the contract?

Answer:
Yes. Seller made a false assertion of fact about the engine’s condition, knew it was false (scienter), and clearly intended Buyer to rely on it to buy the car. Buyer did in fact rely, and the hidden engine defect was not obvious. This is fraudulent misrepresentation, and the contract is voidable at Buyer’s option. Buyer may seek rescission plus restitution, and possibly damages.

Worked Example 1.2

Realtor is selling a house. Based on outdated city plans, Realtor tells Buyer the property is zoned for commercial use, honestly believing this to be true. Buyer, intending to open a shop, relies on this statement and buys the house. Buyer later discovers the zoning is strictly residential. Can Buyer rescind?

Answer:
Yes. Realtor’s statement about zoning was a false assertion of fact that was material to Buyer’s decision. Although Realtor lacked scienter (she honestly believed the statement), zoning suitability for Buyer’s intended use would clearly induce a reasonable person to assent. Buyer’s reliance was justifiable, so this is a material misrepresentation making the contract voidable.

Worked Example 1.3

Dealer tells Consumer, “In my opinion, this used car is excellent,” without inspecting it. The car has serious defects that inspection would have revealed. Consumer buys and later discovers the problems. Is there a misrepresentation defense?

Answer:
Possibly. Standing alone, “excellent” looks like mere opinion or puffing. But an opinion can carry implied factual assertions where the speaker has (or appears to have) superior knowledge or has not made any reasonable investigation. On these facts, Dealer’s statement, coupled with failure to inspect, may be treated as an implied assertion that there are no serious undisclosed defects, supporting a misrepresentation defense if Consumer justifiably relied.

Worked Example 1.4

Seller tells Buyer, “The basement has never had water problems,” knowing this is false. The purchase contract states, “Property sold as is; buyer has inspected and is not relying on prior statements.” Buyer did only a cursory inspection, saw no water, and buys. Later, Buyer discovers chronic flooding. Seller argues Buyer cannot claim reliance because of the “as is” clause. Result?

Answer:
Buyer likely still has a misrepresentation defense. An “as is” or non‑reliance clause is relevant to justifiable reliance, especially between sophisticated parties, but it does not automatically shield intentional fraud. Many courts (and the Restatement view reflected on the MBE) hold that such clauses do not bar a fraudulent misrepresentation claim where the clause itself was part of the scheme to induce assent.

Nondisclosure

As a general rule, a party is not required to volunteer information to the other contracting party. Silence alone, even about material facts, is ordinarily not misrepresentation.

However, in certain situations, nondisclosure is treated as an assertion that the fact does not exist and can support a misrepresentation defense.

General Rule: No Duty to Disclose

Contracting parties are generally expected to exercise their own diligence in discovering facts relevant to the bargain. Absent special circumstances, one party’s failure to reveal information—even information that strongly favors that party—will not make the contract voidable.

Exceptions Creating a Duty to Disclose

Under modern doctrine, nondisclosure has the same effect as an assertion when a duty to disclose arises. Common MBE‑tested situations include:

• Fiduciary or confidential relationships
  In relationships of trust and confidence (e.g., trustee‑beneficiary, lawyer‑client, business partners), each party must disclose material facts relevant to the transaction.

• Correcting a previous assertion (half‑truths)
  If a party makes a statement that was true when made but later becomes false, or was misleadingly incomplete from the start, the party must disclose additional facts necessary to prevent the statement from being materially misleading.

• Correcting a basic mistaken assumption
  A duty to disclose arises when:

  • One party knows the other is operating under a mistake about a basic assumption of the contract; and
  • Disclosure is necessary to correct that mistake; and
  • The failure to disclose violates the duty of good faith and fair dealing.

  This is often tested where a seller knows of a latent defect that the buyer cannot reasonably discover and that goes to the heart of the bargain.

• Active concealment
  Affirmative acts taken to prevent the other party from discovering a material fact (for example, putting fresh paint over structural damage) are equivalent to an assertion that the defect does not exist and are treated as misrepresentation, not mere nondisclosure.

• Statutory duties
  Some jurisdictions impose specific disclosure obligations by statute (e.g., certain disclosures in residential real estate sales). Breach may support a misrepresentation‑based defense or separate statutory remedy.

Worked Example 1.5

Seller knows that a house’s structural support is shifting, causing serious structural problems, but the defects are not visible on a casual inspection. Seller says nothing. Buyer inspects superficially, sees nothing wrong, and buys. After closing, Buyer discovers the defect. Is Seller’s silence actionable?

Answer:
Likely yes. Structural stability is a basic assumption of the bargain, the defect is latent, and Seller knew Buyer was mistaken and could not reasonably discover the issue. In many jurisdictions, Seller’s failure to disclose under these circumstances violates the duty of good faith and is treated as a misrepresentation, making the contract voidable.

Worked Example 1.6

A celebrity is rushed through signing a stack of documents by an assistant who says, “These are just autograph pages for fans.” One of the documents is actually a guaranty of a large loan. The celebrity signs without reading. When sued on the guaranty, can the celebrity raise a fraud defense?

Answer:
Yes, this is classic fraud in the execution. The celebrity did not realize the document was a contract at all and was misled about its nature. The purported guaranty is likely void, not merely voidable.

Exam Warning

Be careful to distinguish:

• Mere nondisclosure (no duty) from
• Situations where a duty to disclose exists because of:
  • A fiduciary or confidential relationship;
  • A prior statement that has become inaccurate or misleading;
  • Knowledge of the other party’s basic mistaken assumption; or
  • Active concealment.

Also, distinguish fraud in the inducement (voidable) from fraud in the execution (often void).

Remedies

If a party’s assent is induced by fraudulent or material misrepresentation, or by actionable nondisclosure, the contract is generally voidable by that party. The primary remedies are rescission, restitution, and damages.

Rescission and Restitution

• Rescission
  The misled party elects to avoid the contract. The contract is treated as though it never existed.

• Restitution
  Upon rescission, each party must return any benefit received from the other. This can involve:

  • Returning property;
  • Repaying money; or
  • Awarding the value of benefits conferred.

Procedurally, the defrauded party must:

• Act promptly upon discovering the misrepresentation or nondisclosure; and
• Not affirm the contract (for example, by continuing to perform after learning the truth).

Affirmance may limit the party to a damages remedy instead of rescission.

Damages

In addition to, or sometimes instead of, rescission and restitution, the misled party may recover damages.

Key distinctions:

• Fraudulent misrepresentation (tort‑type damages)
  The victim may typically recover damages under a tort measure, which can include:

  • Benefit‑of‑the‑bargain damages (value as represented minus value received); or
  • Out‑of‑pocket losses (amount paid minus value received).

  Consequential and incidental damages reasonably arising from the fraud may also be recoverable. Some jurisdictions allow punitive damages for intentional fraud.

• Material (non‑fraudulent) misrepresentation
  Where the misrepresentation was innocent but material, remedies may be more limited:

  • Rescission with restitution is standard.
  • Damages may be limited to reliance or out‑of‑pocket losses.
  • Punitive damages are generally not available absent fraud.

On the MBE, you are not usually required to choose precisely between benefit‑of‑the‑bargain and out‑of‑pocket measures; focus instead on recognizing that:

• Fraud allows damages in addition to rescission, and possibly punitive damages;
• Innocent or negligent misrepresentation supports rescission and restitution, with more modest damage awards.

Worked Example 1.7

Investor buys a business based on Owner’s fraudulent books, which overstate annual profits by $200,000. Investor pays$1,000,000, believing profits are $300,000 per year; in reality, profits are$100,000 per year and the business is worth only $600,000. What damages are available?

Answer:
Investor can rescind and recover the purchase price in exchange for returning the business, plus consequential losses. Alternatively, Investor may keep the business and seek damages. Under a benefit‑of‑the‑bargain measure, damages could be the difference between the value as represented ($1,000,000) and the value received ($600,000), or under out‑of‑pocket, the difference between the price paid ($1,000,000) and the value received ($600,000). Because this is intentional fraud, punitive damages may also be available where state law permits.

Key Point Checklist

This article has covered the following key knowledge points:

• Misrepresentation is an assertion that is not in accord with the facts and may be fraudulent or material (innocent).
• Fraudulent misrepresentation requires a false assertion of fact, scienter, intent to induce assent, and justifiable reliance.
• Material misrepresentation does not require scienter but must be likely to induce a reasonable person (or this particular person) to assent.
• Justifiable reliance usually exists even if the truth could have been discovered by reasonable investigation, unless the falsity is obvious or the statement is clearly opinion without special circumstances.
• Fraud in the inducement makes the contract voidable; fraud in the execution can make a purported contract void.
• Generally, there is no duty to disclose during bargaining, but nondisclosure is actionable when:
  • There is a fiduciary or confidential relationship;
  • A prior statement has become inaccurate or misleading;
  • One party knows the other is mistaken about a basic assumption and silent nondisclosure violates good faith;
  • There is active concealment of a material fact.
• Active concealment is treated as a misrepresentation, not mere silence.
• Contracts induced by fraudulent or material misrepresentation, or actionable nondisclosure, are voidable by the innocent party.
• The main remedies are rescission with restitution, and damages; fraud supports broader damages and potentially punitive damages.

Key Terms and Concepts

• Misrepresentation
• Fraudulent Misrepresentation
• Material Misrepresentation
• Scienter
• Justifiable Reliance
• Fraud in the Inducement
• Fraud in the Execution
• Nondisclosure
• Active Concealment
• Rescission
• Restitution