Four Theories of Recovery for Misrepresentations Causing Pecuniary Harm

The Restatement (Second) of Torts identifies four causes of action that can be used to recover for misrepresentations causing monetary harm. The distinctions between the four theories are nuanced and are not uniformly applied by state courts. What follows is a simplified summary of some of the major differences between the four remedies. Both Fraud and Innocent Misrepresentation use scienter as an element of their causes of action. Restitution and Negligent Misrepresentation do not.

Breach of warranty is also available under contract law and is subject to contract law defenses. (E.g. Restatement (Second) of Contracts (St. Paul, MN: American Law Institute Publishers, 1981), §§ 304, 306). It is outside the scope article which deals with tort and near tort remedies. In cases involving the sale of goods under Article 2 of the Uniform Commercial Code, most fact patterns actionable under the tort of Innocent Misrepresentation would also be actionable under the Code on the theory of breach of warranty. Unlike Innocent Misrepresentation, the measure of damages for breach of warranty includes compensation for benefit of the bargain and for consequential losses. Innocent Misrepresentation has the advantage of not being subject to Code defenses such as the parol evidence rule.

1) Restitution: After the merger of courts of law and equity in most jurisdictions, some courts applied the equitable rescission remedy at law allowing a party to seek rescission of a transaction on the ground of misrepresentation, even an innocent misrepresentation.[1] The usual precondition for Restitution is the return of what was received although a “number of courts have permitted a tort action for damages without regard to the requirement that the transaction be completely rescinded, either by the plaintiff or by the court, and without limiting the action to the restitutionary concept of recovery of money paid”.[2]

2) Fraud: Fraud has developed into a complicated cause of action that requires proof, usually by clear and convincing evidence, of a number of elements.[3] One element is the speaker’s knowledge of the falsity. Derry v. Peek [4] held there was no liability for a misrepresentation if the speaker believed the statement to be true. The Derry definition of scienter as that term is defined was incorporated into the Restatement (Second) of Torts § 526.[5] The notes to the restatement justify following Lord Herschell’s opinion by identifying eleven cases where Derry was followed in the United States.[6] Studying these cases reveals that none of them contain detailed analysis. None of them seem to recognize the intellectual challenge faced by Lord Herschell. Only one mentions Derry by name. None mention Lord Herschell or his call for a legislative solution. One case uses circular reasoning by citing the Restatement as its authority. Some cases like Lamberton fear eliminating the good faith exception without explanation. Lamberton quotes with approval a Pennsylvania case, “It would introduce a new and very dangerous element into the case to say that the jury must decide whether the defendant had reasonable grounds for his belief”. We are not told why. Several cases do not seem to support the law as expressed by the Restatement which currently reads:

§ 526. Conditions Under Which Misrepresentation Is Fraudulent

A misrepresentation in a business transaction is fraudulent if the maker (a) knows or believes the matter to be otherwise than as represented, or (b) knows that he has not the confidence in its existence or non-existence asserted by his statement of knowledge or belief, or (c) knows that he has not the basis for his knowledge or belief professed by his assertion.

The plaintiff has the burden of proving through facts and circumstances the “guilty” knowledge of the maker of the representation. Item (a) describes an intentional misrepresentation because the maker knows the representation is not true. Items (b) and (c) describe what the courts refer to as recklessness. The maker is uncertain or merely guessing when he makes the representation. However, if the maker is wrong because he has not been careful in researching the facts before making the representation, or honestly believes a lie (e.g. there was no Holocaust), the maker is not liable for Deceit.

3) Negligent misrepresentation: No scienter is required to prove negligent misrepresentation. It is defined as:

§ 552. Information Negligently Supplied For The Guidance Of Others

(1) One who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information.

(2) Except as stated in Subsection (3), the liability stated in Subsection (1) is limited to loss suffered

(a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and

(b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction.

(3) The liability of one who is under a public duty to give the information extends to loss suffered by any of the class of persons for whose benefit the duty is created, in any of the transactions in which it is intended to protect them.[7]

Liability for Negligent Misrepresentation is more limited than liability for Deceit which extends to any of the class of persons who was intended or should have been expected to act in reliance upon the misrepresentation. The defendant is liable for any loss suffered by this class of persons in “any of the general type of transactions in which he intends or should expect their conduct to be influenced”.[8] On the other hand, the “maker of the negligent misrepresentation is subject to liability to only those persons for whose guidance he knows the information to be supplied, and to them only for loss incurred in the kind of transaction in which it is expected to influence them, or a transaction of a substantially similar kind”.[9] As stated in Subsection (3), if is a public duty to give the information, the negligent misrepresentation is actionable.[10]

Unlike a Fraud action, the defendant is subject to a contributory negligence defense:

§ 552A. Contributory Negligence

The recipient of a negligent misrepresentation is barred from recovery for pecuniary loss suffered in reliance upon it if he is negligent in so relying.[11]

Damages are limited to out of pocket[12] pecuniary loss in contrast to Deceit which includes benefit of the bargain damages.[13]

4) Innocent Misrepresentation: This remedy is very similar to Restitution except that the plaintiff is permitted to retain what he has received and recover damages. It is useful in cases in which the plaintiff “is unable to restore what he received in its original condition; when he has made improvements or for other reasons finds it desirable to keep what he has received rather than return it; when he is barred from rescission by delay or has so far committed himself that he has lost the remedy by an election; or when for some other reason, such as the defendant's change of position, restitution is not available to him”.[14] Damages are solely to restore the plaintiff to his pre-transaction status. Benefit of the bargain and consequential damages are unavailable.

Although this tort could be considered an example of strict liability, courts retain the requirement of scienter is a way foreign to Derry or Restatement (Second) of Torts § 526:

The courts that apply this rule have expressed it in differing ways. Some have imposed upon a party to a bargaining transaction a “duty” to know. Others have held that an unqualified statement of fact, which is susceptible of personal knowledge and which turns out to be false, is fraudulent insofar as there was no disclaimer of personal knowledge; and this view seems to have been taken without regard to whether the other party was actually deceived by the absence of the disclaimer. Although these courts use the language of scienter, their decisions actually constitute the imposition of liability for innocent misrepresentation. [15]

The Restatement rule applies to any sale, rental, or exchange of land, chattels, securities, or anything else of value including intangibles. A person who is not a party to the transaction is not covered even though he acts according to expectations in taking or refraining from action it in reliance upon the misrepresentation. Even if the plaintiff is a party to the misrepresentation, the rule does not cover damages in a transaction with a third person resulting from the misrepresentation.[16]

Footnotes

[1] Rescission is similarly granted for mutual mistake. See Restatement of Restitution, §§ 6, 8.

[2] Restatement (Second) of Torts, § 552C, “Comment on Subsection (1)”.

[3] E.g. Oregon requires: 1) A representation; 2) Its falsity; 3) Its materiality; 4) The speaker's knowledge of the representation's falsity or ignorance of its truth; 5) Intent that the representation be acted on in a manner reasonably contemplated; 6) The hearer's ignorance of the falsity of the representation; 7) The hearer's reliance on its truth; 8) The hearer's right to rely on the representation; and 9) Damage caused by the representation. Musgrave v. Lucas, 193 Or 401, 410, 238 P2d 780 (1951); Webb v Clark, 274 Or 387, 391, 546 P2d 1078 (1976).

[4] Derry v. Peek , (1889) L.R. 14 App. Cas. 337 (House of Lords).

[5] See Reporter’s Notes to § 526: “This Section adopts, in general effect, the opinion of Lord Herschell in Derry v. Peek, 14 A.C. 337, 374 (1889). The decision has been accepted and followed in numerous American cases . . .” . The First Restatement had the same wording for the rule but did not include the Recorder’s note.

[6] Sledge & Norfleet Co. v. Mann, 193 Ark. 884, 103 S.W.2d 630 (1937) [possible bad advice by lawyer to pay for quit claim deed]; Wishnick v. Frye, 111 Cal.App.2d 926, 245 P.2d 532 (1952) [citing Restatement § 526]; Dundee Land Co. v. Simmons, 204 Ga. 248, 49 S.E.2d 488 (1948) [built house on wrong lot]; Cantwell v. Harding, 249 Ill. 354, 94 N.E. 488 (1911) [failed to plead knowledge of fraud]; Boddy v. Henry, 113 Iowa 462, 85 N.W. 771 (1901) [ranch had 2,000 acres less than represented]; Lambert v. Smith, 235 Md. 284, 201 A.2d 491 (1964) [no proof that area rented was miscalculated]; Riggs v. Thorpe, 67 Minn. 217, 69 N.W. 891 (1897) [implied intent because statement was inaccurate]; Kountze v. Kennedy, 147 N.Y. 124, 41 N.E. 414 (1895) [no liability for failing to disclose pending lawsuit intentionally]; Lamberton v. Dunham, 165 Pa. 129, 30 A. 716 (1895) [representation signature was genuine]; Northwestern S.S. Co. v. Dexter Horton & Co., 29 Wash. 565, 70 P. 59 (1902) [misrepresentation of solvency and assets of purchaser].

[7] Id., § 552.

[8] Id., Comment: i. “Comparison with other Sections”.

[9] Id.

[10] The public duty exception has been applied primarily to public officials but the Restatement comment state that others (e.g. a corporation) which has a duty to file could be liable. The example given is an insurance company which must file financial information with a state insurance commissioner is liable to its policy holders who suffered losses by purchasing policies relying on the filing. Id.

[11] Id., § 552A.

[12] Id., § 552A(2).

[13] Id,. § 549(2).

[14] Id., § 552C, “Comment on Subsection (1)”.

[15] Id., (emphasis added).

[16] Id.