Misrepresentation

An untrue statement made to induce another party’s decision related to a contract

What is Misrepresentation?

A misrepresentation is a false statement made intentionally by one party to influence the other party to abide by the contract’s terms and conditions. A justified misrepresentation in the execution renders the contract void, and depending on the situation, the deceived party may seek legal redress and be awarded damages for any loss incurred or rescind the contract.

 

Misrepresentation

 

Such a dispute occurs when a person does not know or lacks a reasonable opportunity to know the character or the essence of a proposed contract because the other party misrepresents its essential terms or character. The party responsible for falsely leading the other party to consent the subject of the contract is the defendant, while the aggrieved party becomes the plaintiff.

 

Summary

  • A misrepresentation is an untrue statement made to induce another party’s decision related to a contract. 
  • A defendant accused of misrepresentation may be charged with failure to act in good faith and according to the reasonable standards of fair contract negotiations.
  • Misrepresentation can be categorized as fraudulent, innocent, or negligent misrepresentation.

 

How Misrepresentation Happens

Misrepresentation can only be justified by a statement of fact. Expressly making a misleading statement that a party knows is untruthful is a misrepresentation if it leads the other party to agree to a contract.

Assume, for example, that a car salesperson in a private transaction misrepresents the car’s number of miles. The value, which appears to a prospective buyer to be an important aspect of the vehicle, is actually untrue and is cleverly misrepresented. The customer accepts the offer and pays a high price on the car, but later finds that it includes much more wear and tear than represented. The customer can file a complaint against the dealer.

In high stake situations, an event of default by a lender amounts to misrepresentation, such as in a credit agreement. Termination of merger and acquisition deals can also be initiated on the grounds of misrepresentation, and the party responsible may be required to pay a breakup fee to the aggrieved party.

 

Types of Misrepresentations

The following are the main types of misrepresentation that can interfere with contractual relations:

 

1. Fraudulent misrepresentation

Fraudulent misrepresentation is a reckless statement made by one party to induce another party to enter into a contract. For example, a party may provide a statement that they know is untrue to another party that a parcel of land in Texas is located in an area where oil drilling recently started. The party becomes liable for fraudulent misrepresentation if the land is purchased based on the false information.

 

2. Negligent misrepresentation

Negligent misrepresentation is a form of non-fraudulent misrepresentation, where a defendant makes a false statement without due care in ascertaining its truthfulness. For example, if an audit firm is aware that a client will use one of its reports to get a bank loan, the firm will be liable for wrongful misrepresentation if the report contains false information about the client’s business.

The injured party may rescind the contract or file for damages incurred. Thus, negligent misrepresentation renders a contract voidable.

 

3. Innocent misrepresentation

Innocent misrepresentation is a statement of a material fact made by one party to induce a contract with another party, without the knowledge of its falsity, but with due care. The remedy is usually termination or rescission of the contract.

For example, consider a party who is contracted to sell a parcel of land to another party with a mutual understanding that the buyer will build an apartment on it. Both parties believe that it is lawful to use the parcel for the intended purpose. However, several days before completing the contract, the municipality in which the property is located had enacted an ordinance precluding land use for such purpose.

 

Misrepresentations - Types

 

Misrepresentation in an Arm’s Length Contract

Generally, non-disclosure and silence do not amount to misrepresentation when the parties engage in an arm’s length contract. In such a case, each party acts based on self-interest, and they do not owe each other duty of care. Thus, it is not a misrepresentation when a buyer is in possession of helpful information about the seller’s property, which he knows the seller is unaware of and does not divulge such information to the seller.

Similarly, a buyer is under no obligation to inform the seller about the increased value of the property. However, there are exemptions in certain situations. One of the exemptions is that the disclosure of fact would correct the mistake in the assumption that the other party is making the contract.

The second exemption is that if the disclosure of fact amounts to contravening the act of good faith and reasonable standards of transactions. The final exemption is that if one party fails to reveal a fact known to the other party.

 

Special Considerations

In situations involving a fiduciary relationship, misrepresentation can suffice by omission. In such a case, the fiduciary fails to disclose what they know about the subject of a contract. There is an obligation to correct any statement of fact that may later turn out to be false, failure to which misrepresentation occurs.

 

Additional Resources

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

  • Fiduciary Duty
  • Ponzi Scheme
  • Financial Statement Manipulation
  • Voodoo Accounting

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