MISREPRESENTATION IN BUSINESS TRANSACTIONS

Susan Leung School of Accounting & Finance, Hong Kong Polytechnic University Yuk Choi Road, Hunghom, Hong Kong SAR afsleung@polyu.edu.hk

ABTRACT It is often the case that business parties carry out negotiations before a formal contract is concluded. In the course of negotiations, one party who is eager to contract may make statements to induce the other party to enter into contract. A statement of fact which one party makes to induce the other to enter into the contract is a representation. If such statement is false, it is a misrepresentation. In order to be an actionable misrepresentation, the plaintiff-representee, i.e. the person induced by the false statement, must prove positive affirmations of fact and he must have suffered material loss. Once a misrepresentation has been established, the representee has two possible remedies: rescission and damages. The article discusses the elements of misrepresentation the representee must establish and the types of misrepresentation actions which may be available to him. It also looks at the common law and statutory remedies which the representor may be liable. Reference to court decisions both from England and Hong Kong will be made to carry out the analysis.

Key words: misrepresentation, representor, representee, damages, rescission.

ACTIONABLE MISREPRESENTATION It is often the case that business parties carry out negations before a formal contract is concluded. In the course of negotiations, one party who is eager to contract may make statements to induce the other party to enter into contract. A statement of fact which one party makes to induce the

other to enter into the contract is a representation. If such statement is false, it is a misrepresentation. In order to be an actionable misrepresentation, the plaintiff must satisfy the following elements:

It must be a Statement of Fact To constitute an action for misrepresentation, it must be a statement of fact made by one party to another before the contract is entered into. It must not be a term of the contract and it induces the other party to enter into the contract. The leading case in this area is Oscar Chess v. Williams [1957] 1 ALL ER 325, where the purchaser was told that the car to be purchased was a 1948 Morris. The court found that this was not a term of the contract. Since it was an unequivocal statement and was inaccurate it was a misrepresentation.

A Statement of Opinion does not amount to Misrepresentation What is being misrepresented must be a fact. A statement of opinion is not actionable. The Privy Council had to decide whether the statement made by the seller of the house was a statement of fact or opinion in Bisset v. Wilkinson [1927] AC 177. Bisset was a New Zealand owner of a farm that had never held any sheep. Bisset told Wilkinson that in his judgment the land had a carrying capacity of 2000 sheep. Wilkinson purchased the farm and found it could not carry 2000 sheep. Wilkinson sought rescission on the ground of misrepresentation. The Privy Council held that the material fact was clearly that Wilkinson knew that Bisset had never raised sheep on the farm. Accordingly, Wilkinson must have been aware that Bissets comment was one of honest opinion, not of fact. Erroneous opinion, though it might have been relied upon and induced the contract, gave no title to relief unless fraud was established.

Reliance and Loss Suffered as a Result Even if a misrepresentation is found to have been made, an action can be brought only where the plaintiff relies on the misrepresentation in deciding to enter into the contract. Therefore, if the plaintiff knew the statement was false but went ahead with the contract any way no action can be brought. Likewise, a misrepresentation action would not lie if the representee was unaware of the misrepresentation and contracted in ignorance of it. Thus, in Lee Wei Man v. Hong Kong Forex Investment Ltd. [2001] HKC 1011, the plaintiff entered into a contract with the defendant to open an account to trade in foreign exchange. The plaintiff traded with a Ms Muk, the defendants employee. The plaintiff incurred substantial loss in the course of six months. She then discovered that Ms. Muk did not hold the appropriate licence issued by the Securities and Futures Commission to enable her to trade for the defendant. She alleged that the defendant had made a misrepresentation by allowing Ms Muk to hold out as its licensed representative. The

court held that the plaintiff was not induced into the contract by the defendants misrepresentation. The plaintiff had no idea whether Ms. Muk was holding a licence or not when she entered into the contract with the defendant. In fact, she did not know Ms. Muk needed a licence. Her claim for misrepresentation, therefore, failed.

Silence may amount to Misrepresentation Silence, as opposed to a positive representation, cannot influence a person to act to his detriment unless it acquires a positive character. This happens when the defendant fails to disclose material facts and his failure to disclose the facts, the defendant knew the failure would create a false impression. The plaintiff relied on the false impression and suffered loss as a result. In this case, the maker of the statement has a duty to inform the other person to correct the statement. Failure to do so may render the defendant liable for misrepresentation.

In the Hong Kong Court of Appeal case, Shum Kong & Others v Chui Ting Lin & Others, unreported, HCA No 16227 of 1999, [2001] HKEC 651, Mr and Mrs Shum (the vendors) owned a 700 square foot, three storey village house. Attached to the house were a garden and a garage which they leased from the government. The lease would expire on the sale of the house. The Shums advertised their house for sale and Mrs Shum showed would-be purchasers around the house, garden and garage with the estate agent. The purchasers thought they were purchasing the house, garden and garage and were unaware that the garden and garage belonged to the government. The purchasers paid a deposit of $350,000. They later realised that the purchase was only for the house. They sought to rescind the contract on the ground of misrepresentation. The Court of Appeal held that by showing purchasers the property without informing them that the sale only comprised the house, Mrs Shum and the estate agent made a misrepresentation by conduct. From the tour of the property it was reasonable for the purchasers to conclude that the purchase included the garden and garage. The misrepresentation was material and the purchasers entered into the contract relying on the misrepresentation. The purchasers could therefore rescind the provisional sale and purchase agreement in respect of the property.

TYPES OF MISREPRENTATION There are three types of misrepresentation: (1) fraudulent misrepresentation; (2) negligent misrepresentation; (3) innocent misrepresentation. Remedies available to the plaintiff depend on the type of misrepresentation he sues the representor.

Fraudulent Misrepresentation

The definition of fraudulent misrepresentation was laid down in the House of Lords decision in Derry v. Peek (1889) 14 App Cas 337 as an untrue statement made (i) knowingly, or (ii) without belief in its truth, or (iii) recklessly, careless whether it be true or false. If it is made with the intention that it should be acted upon by another and is so acted upon, there are grounds for an action. Thus, fraudulent misrepresentation was established in Smith New Court Securities Ltd. v. Scrimegeour Vickers (Asset Management) Ltd. [1992] BCLC 1104. The defendant persuaded the plaintiff to buy the shares in a company. The plaintiff bought the shares under the belief that they were in demand. Having bought the shares, the plaintiff suffered heavy financial loss and discovered that the defendants statement was made fraudulently as there were no buyers for the shares at all. The plaintiff was awarded damages.

The plaintiff can bring an action for damages in the case of fraud. In this case, the plaintiff sued not on the contract but on the tort of deceit. Both the breaking of a contract and the commission of a tort give rise to liability in damages. Contract damages are to put the injured party in the position he would have been in if the contract had been performed. This means that in the case of contract damages, only damage which was in the contemplation of the parties is recoverable. This is not necessarily all of the plaintiffs loss. Tort damages, on the other hand, are to put the injured party in the position he would have been if the tort had never been committed. The plaintiff may recover aggravated damages from the defendant, i.e. where the defendants conduct is such that the plaintiff requires more than the usual amount of damages to compensate him for the tort against him.

If the defendant did not have the stated intention when he made the representation, it might well be fraudulent. In a Hong Kong Court of Appeal case, Glory Gold Ltd. v. Star Play Development Ltd. [2008] 2 HKLRD, the plaintiff successfully sued the defendant for fraudulent misrepresentation. The plaintiff entered into a lease with the defendant to rent the 2nd floor of a shopping arcade to operate a restaurant. The 3rd floor of the same arcade was also vacant. As the 2nd and 3rd floors of the building shared the same entrance and lifts on the ground floor, the plaintiff was particularly concerned about the intended use of the 3rd floor. The estate agent on behalf of the defendant showed to the plaintiff the design plans for the 3rd floor which revealed that the 3rd floor would be occupied by four small food stalls to form a food court and assured the plaintiff that the landlord would not let the 3rd floor to a tenant who ran the same business of a Chinese restaurant. Relying on the representation that the plaintiff would be the only Chinese restaurant operating in the building, it decided to lease the 2rd floor. Contrary to the representation made to the plaintiff, the defendant leased the 3rd floor of the building to another Chinese restaurant.

The Court of Appeal held that in order to ground a case on misrepresentation, the plaintiff had to rely on misrepresentation of facts and not promises. However, a representation as to present intention for future conduct, as in this case, came within the ambit of an existing fact. Here, the plaintiff not only pleaded that the obligation was not fulfilled, it also specifically pleaded that at the time the defendant made the representation, he had the contrary intention to let the 3rd floor as

a Chinese restaurant to another tenant. The defendant was therefore liable for fraudulent misrepresentation.

Negligent Misrepresentation As can be seen from above, to establish fraudulent misrepresentation, there must be fraud or dishonesty. In negligent misrepresentation, there is a careless or negligent statement, though not dishonest. In the important case, Hedley Byrne v. Heller [1964] AC 465, the House of Lords ruled that a careless statement which caused loss, even only financial loss, where a duty of care was owed to the person to whom the representation was made, could lead to an action in tort for misrepresentation. Before this case, the tort of negligence was confined to acts, not words.

S.3(1) of the Misrepresentation Ordinance defines negligent misrepresentation as one made honestly believing that it was true, but without reasonable grounds for such a belief. Neither negligence nor duty of care is mentioned in this sub-section. To establish negligent misrepresentation, all that the representee has to prove is that there was a misrepresentation. The burden is on the representor to prove that he had reasonable grounds to believe, and that he did believe up to the time the contract was made that the facts represented were true. If the representor can not prove this, the representees claim for negligent misrepresentation will succeed. Unlike the tort of negligence, the burden of proof of duty of care and breach of duty is placed on the plaintiff, s.3(1) of the Misrepresentation Ordinance does away with the need to establish any duty of care between the representor and the representee for a claim of negligent misrepresentation to succeed.

The High Court of Hong Kong held in Yili Concepts (HKG) Ltd v. Lee Wai Chuen & Another HCA 12911/1997 (unreported) that the defendants were liable for negligent misrepresentation. In this case, the plaintiff wanted to buy a property from the first defendant (D1). D1 and his agent (D2) stated that the enclosed floor area of the property was 1,200 square feet. The plaintiff, relying on the statement, signed a provisional sale and purchase agreement and paid a deposit of $200,000. The plaintiff thereafter came to know that the area of the property was less than 1,200 square feet. The plaintiff applied to the court to rescind the contract.

The High Court held that there was no evidence to support a case of fraudulent misrepresentation. However, the defendants could not prove that they had reasonable grounds to believe and did believe up to the time the contract was made that the facts represented were true. The plaintiff had established a case of negligent misrepresentation under s.3(1) of the Misrepresentation Ordinance against the defendants. Therefore, the plaintiff was entitled to rescind the contract and claim $200,000 damages, being the amount of the initial deposit paid to the defendants. D1 should also indemnify the plaintiff against any liability for stamp duty on the provisional agreement.

Negligent misrepresentation was also established in a UK case, Peekay Intermark Ltd. and Another v. Australia and New Zealand Banking Group Ltd. [2005] EWHC 830 (Comm). The plaintiffs contended that the investment was made by relying on the representations made by ANZs representatives and that the representations were false and made negligently. The plaintiffs claimed damages under s.2(1) of the Misrepresentation Act 1967. (Hong Kongs equivalent is s.3(1) Misrepresentation Ordinance.) The English High Court held that ANZ had misrepresented the nature and characteristics of the product in a fundamental respect as it was very different from what the plaintiffs had been told. Its true nature was a derivative product taking the form of a structured deposit, which gave investors no interest in any underlying GKO, a bond issued by the Russian Treasury, and no say in how the investment was to be liquidated in the event of sovereign default. The plaintiffs were therefore entitled to recover the difference between the sum invested and the amount recovered in accordance to s.2(1) of the Misrepresentation Act 1967.

Innocent Misrepresentation An innocent misrepresentation is one made honestly believing that it was true, with reasonable grounds for such a belief. In the case where the plaintiff cannot prove the defendant acted with the intent to defraud but can nonetheless establish a cause of action for innocent misrepresentation. For example, the plaintiff may be unable to establish that the defendant knew or ought to have known that a particular material fact represented was false at the time it was made.

It is a standard pleading practice that a lawyer acting for the plaintiff to plead more than one ground of liability against the defendant. As it is often difficult to prove fraud unless with the defendants confession, innocent misrepresentation can prove a good alternative of the defendants liability. In so doing, the defendants denial of knowledge in order to defeat the fraud claim may actually support the plaintiffs alternative claim for innocent misrepresentation.

At common law, before the passing of the Misrepresentation Ordinance in 1969, when a person claimed he entered into a contract as a result of an innocent misrepresentation the party misled had no right to damages but he could take action in court for rescission. As discussed below, a bar to rescission may exist in any one of the grounds set out and the injured person would be left without any remedy.

The Misrepresentation Ordinance, which was modeled on the English Misrepresentation Act 1967, now governs the remedies available for innocent misrepresentation. S.3(2) of the Misrepresentation Ordinance allows the court to award damages instead of rescission where the court considers it equitable to do so. This sub-section seems to give the court discretion to treat

a contract as subsisting and award damages to the injured party in those cases where the misrepresentation is of a minor nature and rescission would be too drastic a remedy. The same sub-section allows the court to exercise discretion to award damages in a situation where rescission is not available, for example, on grounds of delay.

THE REMEDY OF RESCISSION This remedy is available to a party misled by innocent, negligent or fraudulent misrepresentation. A party can merely rescind the contract by letting the other party know that he no longer regards himself as bound by the contract. However, if the other party refuses to return what he gained under the contract, the party misled may have to go to court to enforce the rescission. Although rescission releases the other party from future obligations to perform the contract, it does not excuse the representor from liability in damages if his failure to perform was due to his misrepresentation. For example, in Buckland v. Farmer & Moody [1973] 3 All ER 929, the plaintiff sold land to the defendants who failed to complete. The plaintiff rescinded the contract and awarded damages in respect of his loss on the resale of the property to another buyer. The decision was upheld by the Court of Appeal. Rescission is a discretionary remedy and in any legal action on the contract, it is granted subject to certain important principles. In particular, the right to rescind can be lost in the following ways: (i) The parties cannot be restored to their original positions; (ii) If the contract is affirmed; (iii) Third parties have acquired rights under the contract; (iv) There has been long delay in asking for the remedy. (i) The Parties cannot be Restored to Their Original Positions Rescission was no longer possible in the case of Lagunas Nitrate Co. v. Lagunas Syndicate [1899] 2 Ch 392. Lagunas Syndicate sold nitrate works to the Lagunas Nitrate Co. under a contract which contained misleading particulars. The company sued for rescission of the contract. The court held that owing to the alteration of the property consequent on its being worked by the company, the position of the parties had been so changed that they could not be restored to their original positions, and therefore the contract could not be rescinded. (ii) If the Contract is Affirmed

If the injured party affirms the contract, he cannot rescind. He will affirm the contract if, with full knowledge of the misrepresentation, he expressly affirms it by stating that he intends to go on with it, or does some act from which an implied intention may properly be deduced. The Court of Appeal held in Long v. Lloyd [1958] 2 All ER 402 that the plaintiff had affirmed the contract and therefore could not rescind. In this case, the plaintiff bought a lorry from the defendant and during a journey, the dynamo ceased to function. The plaintiff told the defendant

of the defects and the defendant offered to pay half the cost of the reconstructed dynamo. The plaintiff accepted the offer and the lorry was driven to Middlesborough and it broke down eventually. The plaintiff sued for rescission. The Court of Appeal held that acceptance by the plaintiff of the defendants offer to pay half the cost of the reconstructed dynamo and the subsequent journey to Middlesborough did amount to affirmation and rescission could not be granted to the plaintiff.

(iii)

Third Parties have Acquired Rights under the Contract

Although a misrepresentation gives the injured party the right to rescind, it does not prevent ownership of goods sold under the contract from passing to the representor who does own the goods unless and until the injured party rescinds the contract. If the representor sells the goods to a third party before the contract is rescinded by the injured party, a good contract exists between the injured party and the third party. This was held to be the case in Philips v. brooks Ltd. [1919] 2 KB 243. North, a fraudulent person, went into Philipss jewelry shop and represented himself to be Sir George Bullough, a person of status and credibility. The jeweler sold a ring to him. North gave a cheque on which he forged the signature of Sir George Bullough. The ring was then pawned to Brooks. North was subsequently convicted of obtaining the ring by false pretences and Philips took action to recover the ring from Brooks. The court held that a good title had passed to the pawnbroker, Philips, because the contract between the jeweler and North was good until it was disaffirmed by Philips.

(iv)

There has been Long Delay in asking for the Remedy

Lapse of time is evidence of affirmation and can defeat an action for rescission. In Leaf v. International Galleries [1950] 1 All ER 693 (CA), the plaintiff bought a painting from the defendants who said that it was painted by Constable. Five years later the plaintiff discovered that the painting was not painted by Constable and he applied for rescission of the contract. The Court of Appeal held that the plaintiff was too late to rescind. He had affirmed the contract by doing nothing for five years. (The plaintiff may now have had a successful action for damages for negligent misrepresentation under the Misrepresentation Act 1967/Misrepresentation Ordinance provided the action is brought within the six year limitation period.)

IMPLCATIONS FOR BUSINESSMEN AND INVESTORS Misrepresentation can occur in many business transactions, for example, financial advisers making untrue statements to clients n the course of selling investment products, owners of businesses selling their businesses to prospective buyers or owners of property or estate agents who are eager to sell or earn a commission by making untrue statements concerning the property in question.

If misrepresentation does occur in the transaction, the plaintiff not only has to suffer financial loss as a result of the defendants misrepresentation, but also has to undergo expensive, often painful and time-consuming legal procedures of taking his case to court should he decide to sue the defendant. On the plaintiffs part, if he wins the case, no doubt he would like to rescind the contract, i.e. to return the business or property to the defendant and to claim a refund of the purchase price. However, as discussed above, rescission may not be available in certain circumstances. If this is the case, the plaintiff will find himself stuck with the unfortunate position of having to keep the business or property although damages may be obtained from the defendant.

Businessmen and investors are therefore advised that before a transaction is concluded, care must be taken to ensure that they fully understand the facts represented to them by the other parties. If in doubt, professional or expert advice or assistance must be sought. Whilst the representor may be very eager to conclude the contract at an as early as possible time before misrepresentation is discovered, buyers of businesses or investors must resist such representors attempts and should allow themselves a cooling-off period before proceeding further and to find out the true position before a transaction is finally entered into.

REFERENCES Carver, A. 2004. Hong Kong Business Law, Longman, Hong Kong. Fisher, M.J. 2007. Contract Law in Hong Kong, Hong Kong University Press, Hong Kong. Gib, A. 2009. Contract law, Thomson Reuters, London. Keenan, D & Smith, K. 2007. Smith & Keenans English Law: Text and Cases, Pearson Longman, Harrow. Larson, A. 2010. Fraud, Silent Fraud, and Innocent Misrepresentation, at http:www.expertlaw.com/library/business/fraud.html. McKendrick, E. 2010. Contract law: Text, Cases, and Materials, Oxford University Press, Oxford. Srivastava, D.K. 2007. Business Law in Hong Kong, Sweet & Maxwell Asia. Stott, V. 2010. An Introduction to Hong Kong Business Law, Pearson Education South Asia Pte Ltd. Singapore.