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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 isconcluded. In the course of negotiations, one party who is eager to contract may makestatements to induce the other party to enter into contract. A statement of fact which one partymakes 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 hemust have suffered material loss. Once a misrepresentation has been established, the representeehas two possible remedies: rescission and damages. The article discusses the elements ofmisrepresentation the representee must establish and the types of misrepresentation actionswhich may be available to him. It also looks at the common law and statutory remedies whichthe representor may be liable. Reference to court decisions both from England and Hong Kongwill 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 inducethe other party to enter into contract. A statement of fact which one party makes to induce the

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other to enter into the contract is a representation. If such statement is false, it is amisrepresentation. In order to be an actionable misrepresentation, the plaintiff must satisfy thefollowing 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 toanother before the contract is entered into. It must not be a term of the contract and it inducesthe 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 a1948 Morris. The court found that this was not a term of the contract. Since it was anunequivocal 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. ThePrivy Council had to decide whether the statement made by the seller of the house was astatement of fact or opinion inBisset v. Wilkinson [1927] AC 177. Bisset was a New Zealandowner of a farm that had never held any sheep. Bisset told Wilkinson that in his judgment theland had a carrying capacity of 2000 sheep. Wilkinson purchased the farm and found it couldnot carry 2000 sheep. Wilkinson sought rescission on the ground of misrepresentation. ThePrivy 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 commentwas one of honest opinion, not of fact. Erroneous opinion, though it might have been relied uponand 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 theplaintiff relies on the misrepresentation in deciding to enter into the contract. Therefore, if theplaintiff knew the statement was false but went ahead with the contract any way no action can bebrought. Likewise, a misrepresentation action would not lie if the representee was unaware ofthe misrepresentation and contracted in ignorance of it. Thus, inLee Wei Man v. Hong KongForexInvestment Ltd. [2001] HKC 1011, the plaintiff entered into a contract with the defendantto open an account to trade in foreign exchange. The plaintiff traded with a Ms Muk, thedefendants employee. The plaintiff incurred substantial loss in the course of six months. Shethen discovered that Ms. Muk did not hold the appropriate licence issued by the Securities andFutures Commission to enable her to trade for the defendant. She alleged that the defendant hadmade a misrepresentation by allowing Ms Muk to hold out as its licensed representative. The

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court held that the plaintiff was not induced into the contract by the defendantsmisrepresentation. The plaintiff had no idea whether Ms. Muk was holding a licence or notwhen she entered into the contract with the defendant. In fact, she did not know Ms. Mukneeded 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 detrimentunless it acquires a positive character. This happens when the defendant fails to disclosematerial facts and his failure to disclose the facts, the defendant knew the failure would create afalse impression. The plaintiff relied on the false impression and suffered loss as a result. In thiscase, 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) negligentmisrepresentation; (3) innocent misrepresentation. Remedies available to the plaintiff depend onthe type of misrepresentation he sues the representor.

Fraudulent Misrepresentation

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The definition of fraudulent misrepresentation was laid down in the House of Lords decision inDerry v. Peek(1889) 14 App Cas 337 as an untrue statement made (i) knowingly, or (ii) withoutbelief in its truth, or (iii) recklessly, careless whether it be true or false. If it is made with theintention that it should be acted upon by another and is so acted upon, there are grounds for anaction. Thus, fraudulent misrepresentation was established in Smith New Court Securities Ltd. v.

Scrimegeour Vickers (Asset Management) Ltd. [1992] BCLC 1104. The defendant persuaded theplaintiff to buy the shares in a company. The plaintiff bought the shares under the belief thatthey were in demand. Having bought the shares, the plaintiff suffered heavy financial loss anddiscovered that the defendants statement was made fraudulently as there were no buyers for theshares 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 suednot on the contract but on the tort of deceit. Both the breaking of a contract and the commissionof a tort give rise to liability in damages. Contract damages are to put the injured party in theposition 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 theinjured party in the position he would have been if the tort had never been committed. Theplaintiff may recover aggravated damages from the defendant, i.e. where the defendants conductis such that the plaintiff requires more than the usual amount of damages to compensate him forthe tort against him.

If the defendant did not have the stated intention when he made the representation, it might wellbe fraudulent. In a Hong Kong Court of Appeal case, Glory Gold Ltd. v. Star Play DevelopmentLtd. [2008] 2 HKLRD, the plaintiff successfully sued the defendant for fraudulentmisrepresentation. The plaintiff entered into a lease with the defendant to rent the 2nd floor of ashopping arcade to operate a restaurant. The 3rd floor of the same arcade was also vacant. As the2nd and 3rd floors of the building shared the same entrance and lifts on the ground floor, theplaintiff was particularly concerned about the intended use of the 3 rd floor. The estate agent onbehalf of the defendant showed to the plaintiff the design plans for the 3 rd floor which revealedthat the 3rd floor would be occupied by four small food stalls to form a food court and assured theplaintiff that the landlord would not let the 3 rd floor to a tenant who ran the same business of aChinese restaurant. Relying on the representation that the plaintiff would be the only Chineserestaurant operating in the building, it decided to lease the 2rd floor. Contrary to therepresentation made to the plaintiff, the defendant leased the 3rd floor of the building to anotherChinese restaurant.

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

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

Negligent Misrepresentation

As can be seen from above, to establish fraudulent misrepresentation, there must be fraud ordishonesty. In negligent misrepresentation, there is a careless or negligent statement, though notdishonest. In the important case,Hedley Byrne v. Heller[1964] AC 465, the House of Lordsruled that a careless statement which caused loss, even only financial loss, where a duty of carewas owed to the person to whom the representation was made, could lead to an action in tort formisrepresentation. 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 madehonestly 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 negligentmisrepresentation, all that the representee has to prove is that there was a misrepresentation. Theburden is on the representor to prove that he had reasonable grounds to believe, and that he didbelieve up to the time the contract was made that the facts represented were true. If therepresentor can not prove this, the representees claim for negligent misrepresentation willsucceed. Unlike the tort of negligence, the burden of proof of duty of care and breach of duty isplaced on the plaintiff, s.3(1) of the Misrepresentation Ordinance does away with the need toestablish any duty of care between the representor and the representee for a claim of negligentmisrepresentation to succeed.

The High Court of Hong Kong held in Yili Concepts (HKG) Ltd v. Lee WaiChuen & AnotherHCA 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 hisagent (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 1,200square 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 tobelieve 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 theMisrepresentation Ordinance against the defendants. Therefore, the plaintiff was entitled torescind the contract and claim $200,000 damages, being the amount of the initial deposit paid tothe defendants. D1 should also indemnify the plaintiff against any liability for stamp duty on theprovisional agreement.

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Negligent misrepresentation was also established in a UK case,Peekay Intermark Ltd. andAnother v.Australia and New Zealand Banking Group Ltd. [2005] EWHC 830 (Comm). Theplaintiffs contended that the investment was made by relying on the representations made byANZs representatives and that the representations were false and made negligently. Theplaintiffs claimed damages under s.2(1) of the Misrepresentation Act 1967. (Hong Kongsequivalent is s.3(1) Misrepresentation Ordinance.) The English High Court held that ANZ hadmisrepresented the nature and characteristics of the product in a fundamental respect as it wasvery different from what the plaintiffs had been told. Its true nature was a derivative producttaking 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 inthe event of sovereign default. The plaintiffs were therefore entitled to recover the differencebetween the sum invested and the amount recovered in accordance to s.2(1) of theMisrepresentation Act 1967.

Innocent Misrepresentation

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

It is a standard pleading practice that a lawyer acting for the plaintiff to plead more than oneground of liability against the defendant. As it is often difficult to prove fraud unless with thedefendants confession, innocent misrepresentation can prove a good alternative of thedefendants liability. In so doing, the defendants denial of knowledge in order to defeat thefraud 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 personclaimed he entered into a contract as a result of an innocent misrepresentation the party misledhad no right to damages but he could take action in court for rescission. As discussed below, abar 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 Act1967, now governs the remedies available for innocent misrepresentation. S.3(2) of theMisrepresentation Ordinance allows the court to award damages instead of rescission where thecourt considers it equitable to do so. This sub-section seems to give the court discretion to treat

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a contract as subsisting and award damages to the injured party in those cases where themisrepresentation is of a minor nature and rescission would be too drastic a remedy. The samesub-section allows the court to exercise discretion to award damages in a situation whererescission 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 regardshimself as bound by the contract. However, if the other party refuses to return what he gainedunder the contract, the party misled may have to go to court to enforce the rescission. Althoughrescission releases the other party from future obligations to perform the contract, it does notexcuse the representor from liability in damages if his failure to perform was due to hismisrepresentation. For example, inBuckland v. Farmer & Moody [1973] 3 All ER 929, theplaintiff sold land to the defendants who failed to complete. The plaintiff rescinded the contractand awarded damages in respect of his loss on the resale of the property to another buyer. Thedecision was upheld by the Court of Appeal.

Rescission is a discretionary remedy and in any legal action on the contract, it is granted subjectto certain important principles. In particular, the right to rescind can be lost in the followingways:(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 ofLagunas Nitrate Co. v. Lagunas Syndicate[1899] 2 Ch 392. Lagunas Syndicate sold nitrate works to the Lagunas Nitrate Co. under acontract which contained misleading particulars. The company sued for rescission of thecontract. The court held that owing to the alteration of the property consequent on its beingworked by the company, the position of the parties had been so changed that they could not berestored 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, withfull knowledge of the misrepresentation, he expressly affirms it by stating that he intends to goon with it, or does some act from which an implied intention may properly be deduced. TheCourt of Appeal held inLong v. Lloyd[1958] 2 All ER 402 that the plaintiff had affirmed thecontract and therefore could not rescind. In this case, the plaintiff bought a lorry from thedefendant and during a journey, the dynamo ceased to function. The plaintiff told the defendant

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of the defects and the defendant offered to pay half the cost of the reconstructed dynamo. Theplaintiff accepted the offer and the lorry was driven to Middlesborough and it broke downeventually. The plaintiff sued for rescission. The Court of Appeal held that acceptance by theplaintiff of the defendants offer to pay half the cost of the reconstructed dynamo and thesubsequent 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 preventownership of goods sold under the contract from passing to the representor who does own thegoods unless and until the injured party rescinds the contract. If the representor sells the goodsto a third party before the contract is rescinded by the injured party, a good contract existsbetween the injured party and the third party. This was held to be the case inPhilips v. brooksLtd. [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 jewelersold a ring to him. North gave a cheque on which he forged the signature of Sir GeorgeBullough. The ring was then pawned to Brooks. North was subsequently convicted of obtainingthe ring by false pretences and Philips took action to recover the ring from Brooks. The courtheld that a good title had passed to the pawnbroker, Philips, because the contract between thejeweler 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. InLeaf v.

International Galleries [1950] 1 All ER 693 (CA), the plaintiff bought a painting from thedefendants who said that it was painted by Constable. Five years later the plaintiff discoveredthat the painting was not painted by Constable and he applied for rescission of the contract. TheCourt of Appeal held that the plaintiff was too late to rescind. He had affirmed the contract bydoing nothing for five years. (The plaintiff may now have had a successful action for damagesfor negligent misrepresentation under the Misrepresentation Act 1967/MisrepresentationOrdinance 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 advisersmaking untrue statements to clients n the course of selling investment products, owners ofbusinesses selling their businesses to prospective buyers or owners of property or estate agentswho are eager to sell or earn a commission by making untrue statements concerning the propertyin question.

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

Businessmen and investors are therefore advised that before a transaction is concluded, care mustbe taken to ensure that they fully understand the facts represented to them by the other parties. Ifin 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 isdiscovered, buyers of businesses or investors must resist such representors attempts and shouldallow themselves a cooling-off period before proceeding further and to find out the trueposition 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, PearsonLongman, Harrow.

Larson, A. 2010.Fraud, Silent Fraud, and Innocent Misrepresentation, athttp: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 PteLtd. Singapore.

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