January 2011: Legal Issues

Words: Dan Kamys ??Legal Issues From Bad to Worse: Keeping Fraud out of Breach of Contract

Fraud claims can carry potentially severe consequences not ordinarily associated with claims for simple breach of contract, and have increasingly found their way into situations traditionally associated with breach of contract. It is important for contractors to recognize the difference between these two distinct claims, in order to reduce risk and guard against potentially damaging claims.

Even with the best of intentions, a contractor has many opportunities to make mistakes, to become overextended, or make promises that, ultimately, go unfulfilled. As contractors and customers alike rightfully focus on the importance of “keeping one’s word,” broken promises and disappointed expectations can lead frustrated customers to confuse unintentionally defective work and bad results with dishonesty and even fraud.

What is fraud, legally? Fraud is more than simple failure to keep one’s word, and does not arise simply because a predicted result never materialized. Fraud is defined as a false representation of material fact that one party makes intentionally and knowingly, intending to mislead, and which causes the other party to rely on the false representation and suffer damages.1 A contractor with 10 years of landscaping experience may commit fraud by saying “I have 20 years of landscaping experience,” but probably does not commit fraud by saying “I am an experienced landscaper.”

Implications of fraud claims for corporations, individuals The practical difference between fraud and breach of contract is far beyond semantic. Fraud is predicated on dishonest conduct, and courts generally require that a party plead fraud with specificity. This often means that a complaint for fraud will name the individual who committed the fraud, and specifically accuse that individual of dishonest conduct. A complaint stating these claims is a matter of public record for all to see.

Beyond reputational concerns, a fraud claim carries liability risks not generally found in a typical breach of contract case. For example, if a limited-liability company fails to meet a construction deadline or make a payment to a supplier, owners and employees of the LLC generally are not liable for breach of contract, unless they signed a personal guaranty to the contract. If an owner or employee commits fraud, however, that individual can share personal liability with the company, even though he was acting as the company’s agent at the time. This liability also may include punitive damages.

Half-remembered conversations and misunderstandings often can blur the line between breach of contract and fraud, leading to serious but, ultimately, avoidable claims.?? A contractor can keep broken promises and disappointed expectations from turning into fraud claims by recognizing some key traps for the unwary.

Fact, opinion and the “fraudulent promise” Fraud depends on a misrepresentation of a fact, not opinion. For example, “The house is in good condition” and “My services are high quality” are opinions, while “The house was built in 1989” and “I have a Class A Virginia contractor’s license” are expression of facts. An opinion is subject to interpretation, while a statement of fact is either correct or incorrect.

Performance issues pose other opportunities for confusion. While a party’s simple failure to perform a contract is not fraud by itself, the equation changes where a party makes a promise with no intention to try to fulfill that promise in the future. While this type of claim is often difficult to prove, courts have looked to circumstantial evidence, such as failing to apply for a permit, lack of communication with the customer, and requesting advances for completion of work that the contractor never completes.

How to reduce risk A contractor can do much to reduce the risk of fraud claims by preventing misunderstandings and disappointed expectations. A few key points:

  • Avoid making unrealistic promises
  • Maintain regular communication, and confirm any “fact” before relaying it to the customer
  • Avoid opinions that may be misunderstood as “facts,” such as, “I am the top contractor in my area.” Even if such a phrase is an opinion about quality, a customer who understands it as an untrue representation about sales volume or years of experience can present a worrisome problem in a courtroom
  • Misunderstandings happen, so remember to document key conversations with the customer, and confirm the customer’s understanding and expectations in writing before the job moves forward.

While a failed contract is never a good thing, the right precautions can help prevent unfulfilled promises from morphing into something even worse.

William Groh is an associate with Bean, Kinney & Korman and can be reached at wgroh@beankinney.com. Return to Table of Contents
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