Fraud

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by Sebastian A E Martens

1. Object

All European legal systems grant a right of avoidance to someone who has been induced into entering a contract by a fraud (dol, dolo, bedrog, Täuschung) perpetrated by his contractual partner. This is generally justified by two different lines of reasoning: (a) On the one hand, intentional (illegitimate) fraud is regarded as unacceptable conduct in the course of business. Thus, someone who defrauds his business partner shall not be able to rely on the validity of the transaction concluded as a result of his fraud. In German law, the moral reprobation of fraud is indicated by the attribute arglistig (maliciously) describing the fraudulent act. (b) On the other hand, fraud impairs the defrauded person’s process of forming consent. By the right of avoidance that is granted to him, the defrauded person shall be enabled to correct the consequences of his fraudulently induced mistakes.

While the first consideration focuses on the tortious act of the fraudulent person, the second concentrates on the effects of the fraud on the defrauded person. The provisions of the European legal systems dealing with fraud and their interpretation are considerably influenced by this dual understanding that underlies the concept of ‘fraud’ and that can, to a large degree, only be historically explained.

2. Historical background

In the continental European legal systems, the contract law remedy of a right of avoidance in cases of fraud has its origins in the Roman concept of dolus. In classical Roman law, a so-called actio de dolo was granted as a delictual (punitive) action in almost any case of a wrongfully caused loss, and with the help of an exceptio doli every violation of the principle of good faith could be raised as a defence in an action on the claim which had been obtained by the fraud. A conviction for fraud, apart from establishing a duty to pay damages, made the accused infamus, ie he lost his honour as a Roman citizen. This moral element is still sometimes part of the concept of ‘fraud’.

One fragment of the Digest which stated that dolus was contrary to a contractual consensus was of special importance for the later legal development. For, during the time of reception of Roman law, this consensus more and more became the justification for the binding force of a contract. Based on the Roman texts, the main obstacles to such a consensus became the three vices of consent: error (mistake), metus (duress) and dolus, which was then narrowly understood as only covering cases of intentional fraud. Unlike in Roman law, the term ‘consensus’ no longer described the mutual agreement of both contracting parties, but instead signified the individual declarations of consent of each contracting party which became the new founding concept of private autonomy. Because of this, fraud is categorized as a vice of consent (vice du consentement, Willensmangel) today and not as a (direct) obstacle to a valid agreement as it was in Roman times. Yet, it is regularly stressed that fraud is in fact not really a vice of consent but rather the cause of one, ie it is the cause of a mistake.

Another legal discovery of the Middle Ages survives only in French law today: the distinction between a dolus causam dans which caused the conclusion of a contract and thus is held to nullify it, and a dolus incidens which merely made the defrauded person accept disadvantageous contractual conditions and therefore only gives rise to a claim for damages. However, even in France this distinction is today more of theoretical than practical significance because the judges may also hold that a dol incident actually caused the conclusion of a contract. Thus, nullité rélative, ie a nullity of the contract that may only be invoked by the defrauded person, can now also be the legal consequence of a mere dol incident (Cour de Cassation, Cass. civ. 3ème, 22 June 2005).

3. Trends of international legal development

While it has long been uncontroversial that a legal system may not enforce a contractual obligation obtained by fraud against the will of the defrauded person, the exact definition of a legally relevant fraud (dolus) and its distinction from legitimate salesmanship (sollertia) have at all times proven to be difficult and have always had to be determined anew because of ever-changing circumstances. Thus, attempts have repeatedly been made to bring the business interests of vendors and the information expectations of customers into fair balance. However, for a long time an extension or a more flexible interpretation of the concept of dolus in the continental European systems was hindered by the punitive character of the remedies in cases of dolus. A gradual widening of the concept of fraud can only be observed since the 19th century after this inherited obstacle had finally been overcome in theory (long after it had lost any real practical significance).

Although the common law in England developed to a large extent independent of Roman law, the protection granted by it in cases of fraud was similarly quite narrow for a long time. Specifically, it initially offered nothing but an action in deceit as a help to a defrauded party. It was only in the 19th century when the equitable doctrine of misrepresentation was invented that misleading information in the contractual negotiations could be taken account of to a greater extent. Thus, the ancient rule of caveat emptor was gradually relaxed, the informational responsibility slowly shifted to the suppliers, and liability for fraud was expanded everywhere in Europe. This can be exemplified by the changing interpretation of Art 1116 Code civil: although the wording of this norm comprises only fraudulent acts (manœuvres pratiquées), it was initially held that a mere lie would suffice as well. Yet, it was only in the middle of the 20th century that malicious concealment (réticence) was also recognized as a case of fraud provided there was a duty of disclosure.

Legal writers all over Europe have in recent years been occupied with explaining and justifying such duties of disclosure. An apparently deep channel divides the English common law, which is generally opposed to duties of disclosure, from the continental European legal systems that are more willing to acknowledge such duties. However, there is a great congruence of the practical results. Thus, a distinction is generally made between, on the one hand, contracts which are aimed at cooperation and which require special trustfulness and, therefore, justify rigorous duties of disclosure (so-called contracts uberrimae fidei in the common law, particularly insurance contracts, information obligations (insurance contracts), and fiduciary relationships), and, on the other hand, contracts which aim to balance contrary interests with each party being principally responsible for its own information. In the negotiating process of these latter contracts, the continental legal systems also only exceptionally recognize duties of disclosure. The discussion of the scope of and the reasons for duties of disclosure has not yet led to a clear and uniform definition. Rather, general principles have been formulated which are to be taken into consideration and have to be balanced against each other in every individual case. Increasingly, ‘information responsibility in contractual negotiations’ is understood as a single comprehensive problem transgressing the boundaries of traditional doctrinal categories. In solving it, the economic importance of information and the conflicting interests of the contracting parties have to be taken into consideration. Traditional truths are radically questioned, and even a ‘right to lie’ that would have been inconceivable to the legislators of the 19th and early 20th centuries is proposed under specific circumstances.

To satisfactorily analyse duties of disclosure that have only recently been recognized within the traditional doctrinal system has proven to be very difficult. The continental European legal systems, in particular, traditionally limit the liability for wrong or insufficient information to cases of intentional fraud, still adhering to an ‘intention dogma’ that has its roots in the Roman concept of dolus. However, it is widely accepted today that there also has to be liability for a negligent breach of a duty of disclosure. Some writers justify this on the ground of a general duty to negotiate in good faith and a general concept of culpa in contrahendo. Other writers argue that duties of disclosure should be integrated within the traditional system of vices of consent by explaining the concept of (a relevant) mistake with the help of these duties. Thus, a relevant mistake should no longer be determined using different categories of mistakes. Rather, a relevant mistake should only be held to exist if a balancing of the conflicting interests so demands. According to this analysis a right of avoidance for mistake is only justified if the contractual partner of the mistaken party can be held responsible for the mistake, eg because he caused it by a (negligent) misrepresentation or because he did not correct it in breach of a duty of disclosure. Finally, some authors want to interpret the provisions concerning fraud more widely and want to apply them also to cases of negligent breaches of information duties. Thus, the concept of fraud would become the nucleus of an ever-growing information law (information obligations (consumer contracts), information obligations (insurance contracts), information duties (employment contracts)).

4. The provisions concerning fraud in PECL and UNIDROIT PICC

Both Art 4:107 PECL (which has been substantially adopted in Art II-7:205 DCFR) and Art 3.8 UNIDROIT PICC treat fraud as a special case of mistake and therefore understand fraud as a vice of consent. This is in agreement with the prevalent tendencies of modern legal development. Differing from the general rules concerning mistake, a mistake caused by fraud is held to justify a right of avoidance even if it does not objectively concern material circumstances. The systematic categorization of fraud as a special case of mistake causes problems in cases of fraud by a third party. For if it is the fraudulently induced mistake which justifies the right of avoidance, this right of avoidance should not principally depend on whether the fraud was committed by the contractual partner or a third party. However, Art 4:111(2) PECL and Art 3.11(2) UNIDROIT PICC only grant a right of avoidance in case of a fraud by a third party for whom the contractual partner is not responsible if the contractual partner knew or should reasonably have known about the fraud or if he has not yet made any disposition in reliance on the validity of the contract.

The definition of fraud in Art 4:107(1) PECL and Art 3.8 UNIDROIT PICC is almost identical and is based on widely concurring provisions of all European legal systems. Thus, a right of avoidance is, first, granted in case of a fraudulent act. It is irrelevant whether the fraud is committed by words or by conduct. Different from some legal systems, it is also irrelevant whether the fraud is about questions of fact or questions of law. It must only be about circumstances which already exist at the time of the conclusion of the contract.

Secondly, a fraud can also be committed by the omission of information when good faith and fair dealing require the disclosure of such information. Article 4:107(3) PECL gives some guidelines for the interpretation of this general clause. On the one hand, the interests of the person facing a potential disclosure obligation are to be taken into consideration: special expertise points to a duty of disclosure, high costs of acquiring the information in question argue against it. On the other hand, a duty of disclosure is also dependent on the need for protection of the person entitled to be informed. Thus, it is of relevance whether that person could reasonably be expected to acquire the information himself and how important the information was for his decision to enter into the contract.

The fraud must have caused a mistake, or, in case of a breach of a duty of disclosure, a mistake must not have been corrected, which in turn caused the mistaken person to enter into the contract in question. ‘But for’ causation suffices.

In the European legal systems the subjective elements which are required as to the fraudulent person have been relaxed over recent years. Intention is no longer strictly required and recklessness usually suffices. Thus, the fraudulent person must, firstly, have acted intentionally or at least recklessly with regard to the misrepresentation or non-disclosure. Secondly, he must have acted intentionally or recklessly with regard to the mistake caused or left uncorrected. While Art 3.8 UNIDROIT PICC seems to refer to these common subjective elements of fraud, Art 4:107 (2) PECL gives a more narrow definition of ‘fraudulent’ as ‘intended to deceive’. This narrow definition which excludes mere knowledge or recklessness is in conflict with modern legal developments.

The requirement of intention entails a certain tension within both the PECL and the UNIDROIT PICC vis-à-vis the general provisions concerning mistake. Under these general provisions a misrepresentor is held strictly liable, and a right of avoidance depends only on establishing a causal link between the misrepresentation and the conclusion of the contract. However, whereas the mistake—under the general provisions on mistake—also has to be material in order to give rise to a right of avoidance, the provisions for fraud have no such requirement of materiality, demanding instead intention by the misrepresentor.

The right of avoidance is exercised by a unilateral declaration. In contrast to many legal systems, neither PECL nor UNIDROIT PICC specify a fixed limitation period for the right of avoidance. Instead they only demand that the right is exercised by the defrauded person within a reasonable time after he has discovered his fraudulently induced mistake.

Apart from the right to avoid the fraudulently induced contract, Art 3.18 UNIDROIT PICC and Art 4:117 PECL also grant a claim for damages to the defrauded person against his contractual partner. Damages may be claimed alternatively to, or cumulatively with, the avoidance of the contract and comprise all loss caused by the fraud. If the fraudulent person has given a contractual guarantee as to a misrepresented circumstance, Art 4:119 PECL additionally gives a claim for contractual damages under which the defrauded person may claim his interest in the performance of the contract.

5. Uniform law

Although it does not yet contain a provision concerning fraud, EU law is strongly influencing the development of pre-contractual duties of disclosure in Europe. Consumers in particular are to be protected by the provision of comprehensive information during contractual negotiations. Thus, Art 169(1) TFEU/153(1) EC provide for a right of consumers to information (information obligations (consumer contracts)). This right is substantiated in many acts of secondary European legislation. These include the distance selling directive, the consumer credit directive, the package travel directive, the timeshare directive, diverse insurance directives and, not least, the markets in financial instruments directive which regulates extensive and detailed duties of disclosure in financial transactions. All these directives are based on the common idea that consumers should be enabled to make a rational decision by providing them with comprehensive information about the object and content of the respective contract. At the same time, the requirements are intended to improve the functioning of the market. The prominent position of information duties in EU law is also emphasized in the Acquis Principles. Published in 2007, they devote a whole section of the chapter on pre-contractual duties to information duties and extend them beyond the field of consumer contracts to transactions between businesses.

The secondary European legislation in force usually prolongs cooling-off periods as a consequence of a breach of an information duty and leaves it to the national legal systems to provide for further sanctions, eg a claim for damages.

Literature

Reinhard Zimmermann, The Law of Obligations, ch 21: ‘Metus and Dolus’ (1990); Muriel Fabre-Magnan, De l’obligation d’information dans les contrats (1992); Tony Weir (tr), Hein Kötz, European Contract Law, vol I (1997) 196 ff; Hans Christoph Grigoleit, Vorvertragliche Informationshaftung (1997); Holger Fleischer, Informationsasymmetrie im Vertragsrecht (2001); Reiner Schulze, Martin Ebers and Hans Christoph Grigoleit (eds), Informationspflichten und Vertragsschluss im Acquis communautaire (2003); Martin Josef Schermaier ‘§§ 116–124. Willensmängel’ in Historisch-kritischer Kommentar zum BGB, vol I (2003) nn 104 ff; Ruth Sefton-Green, Mistake, Fraud and Duties to Inform in European Contract Law (2005); Gerhard Wagner, Lügen im Vertragsrecht in Reinhard Zimmermann (ed), Störungen der Willensbildung bei Vertragsschluss (2007); John Cartwright, Misrepresentation, Mistake and Non-disclosure (2007).

Retrieved from Fraud – Max-EuP 2012 on 04 December 2022.

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