When does a breach of contract constitute fraud?

When does a breach of contract constitute fraud? In strict legal terms, the answer is ‘never’. We explain why below.

But the sentiment behind the question is usually that a party to a contract feels as though an obligation under the contract has been avoided or broken, and there was an element of dishonesty in the breach.

Let’s take for example the sale and purchase of a business. The buyer and the seller sign a Share Purchase Agreement (SPA). The SPA contains certain warranties about the business that persuaded the buyer to buy the business. Those warranties act as a guarantee about how much the business is worth, and the key facts about the business that make it an attractive prospect.

If, having bought the company, the buyer then finds out that those warranties were untrue, the buyer starts to think that the seller was dishonest. In that scenario, the buyer may feel that there has been a breach of contract, which constitutes a fraud.

Why Breach of Contract is Distinct from Fraud

But an action in fraud is distinct from a breach of contract claim.

There are five elements to a breach of contract claim:

1. Obligation: There was a clause in the contract that set out an obligation on one of the parties.
2. Breach: That clause has been breached. The obligation has not been performed.
3. Causation: But for that breach, the claimant would not have suffered loss.
4. Remoteness: The type of loss was in the contemplation of the parties.
5. Loss: The claimant actually suffered a loss.

Fraud, on the other hand, comes in many different forms. In the example of alleged ‘lies’ in an SPA, the most suitable cause of action to explore would be fraudulent misrepresentation.

The six elements of a fraudulent misrepresentation claim are:

1. One party made a representation either orally or in writing.
2. That representation was false.
3. The defendant knew that the representation was false or had no belief in its truth.
4. The defendant intended that the representation would induce the claimant to act or refrain from acting.
5. The claimant was in fact induced by the representation to act or refrain from acting.
6. The claimant thereby suffered loss.

It is clear from element (4) that an action in fraudulent misrepresentation is based on actions before the contract was entered into. Breach of contract on the other hand is only available as an action when the contract is already in existence.

Can you plead ‘breach of contract’ and ‘fraudulent misrepresentation’ together?

In the example of the SPA in which the buyer considers warranties were untrue, the buyer will have grounds to sue in breach of contract.

The buyer may also seek to pursue a claim in fraudulent misrepresentation. It is possible to plead both claims together.

Fraudulent misrepresentation is a more difficult claim to prove, because the claimant has to prove the state of mind of the defendant. For the claimant to prove elements (3) and (4) above, it must find a way to show that a defendant knew its representation was false, and that the defendant intended that the representation would induce the claimant to enter into the SPA. Proving somebody else’s state of mind is no easy task.

But a claim in fraudulent misrepresentation may be a better way to achieve the claimant’s objectives. For example, the buyer may want to freeze the seller’s bank account, if they are concerned about the integrity of the seller, who may dissipate the sales proceeds so there is nothing to enforce against after a trial.

Or, the buyer may only discover the inaccuracies after strict limitation periods have expired. There are usually carve-outs in an SPA for fraud, so the buyer may be able to bring a fraudulent misrepresentation claim if the breach of contract claim is time-barred.

Other Actions in Civil Fraud that Overlap with Breach of Contract

While a breach of contract claim cannot technically constitute fraud, the tort of inducing a breach of contract is a recognised action in fraud.

Inducing another person to commit a wrong, or break their contract with another party, can incur liability as an accessory (OBG Ltd v Allan [2007] UKHL 21). As Grant & Mumford point out “the chief practical relevance of the tort of inducing breach of contract in a fraud case is its potential to cast the net of liability beyond the immediate wrongdoer in any given situation” (Civil Fraud First Edition (2018), 3-003). The reason why a claimant may choose to ‘cast a wider net’ is to give them more options when it comes to enforcement.

If you’d like any advice on a breach of contract claim, or a potential fraud claim, please get in touch with our experienced solicitors.