Fraud under Indian Contract Act

Fraud under Indian Contract Act written by Garvit Daga student of NALSAR University of Law

FRAUD – DEFINITION

In simple terms, “Fraud” under section 17 of the Indian contract act, has been defined to include false representation of a material fact related to the contract—regardless of whether by words or by conduct, by bogus or misleading allegations, or by non-disclosure of what ought to have been revealed—that is intended to deceive and deceives the other in such a way that the person acting on such misrepresentation, acts to his own injury. Furthermore, it includes promises made without the intent of performing them and any other act/omission declared fraudulent by law.
Fraud is of infinite variety and is thus hard to define. The use of the phrase “includes” indicates the intent of the drafters to enlarge the definition of the phrase to include even those matters which would not be included within its ordinary meaning. The essential features of fraud include –

1. Fraud must be committed by a party to the contract directly or indirectly or by his agent. However, where the contract was a result of a 3rd person being instrumental for his own ulterior motives, the contract cannot be avoided;
2. Intention to deceive or inducing the other party to contract is a must.
3. In a suit against fraud, to claim relief, the plaintiff has to show that the defendant made fraudulent representations and the plaintiff was in fact deceived and acted to his prejudice. In lay terms, a plaintiff cannot claim any right to redress in cases of both deceit without damage and damage without deceit.

WHAT CONSTITUTES FRAUD?

Based on the definition of fraud under section 17, the circumstances that constitute fraud are:

1. ASSERTING FACTS WITHOUT BELIEF IN THEIR TRUTH

In the widely referred to the English case of Derry vs peek, a company had made a false representation. However, they honestly believed in the truth of the representation conveyed. This, it was observed by the court that “Fraud is proved when it is shown that a false representation has been made – (1) knowingly, or (2) without belief in its truth, or (3) recklessly careless whether it be true or false.” Therefore intentional misrepresentation is the essence of fraud and it is dealt with under the first three clauses of section 17. The ingredients contemplated under this clause of Fraud are – “(a) There should be a suggestion as to a fact, (b) the fact suggested should not be true (c) the suggestion should have been made by a person who does not believe it to be true, and (d) the suggestion should be found to have been made with intent either to receive or to induce the other party to enter into the contract in question.” However, if the plaintiff has the means to discover the truth by ordinary diligence, no fraud is proved.

2. ACTIVE CONCEALMENT

Active concealment is a situation where one party conceals material information related to the contract despite having a duty to disclose such information. In simpler words, it refers to failure in disclosing private information. It is more than mere passive concealment, that is to say, it requires an overt act for concealment. It is crucial to note here that passive concealment referred to above means silence. The section makes it clear that though mere silence doesn’t amount to fraud, it may constitute fraud under situations where the party has a duty to speak or where such silence is equivalent to speech.

WHEN DOES SILENCE AMOUNT TO FRAUD?

a. Where there arises a Duty to Speak – Duty to speak arises when a party reposes trust and confidence in the other party and the other party accepts the confidence reposed. Duty to speak may also arise in case of a contract that is uberrima fides or where one party is short of resources required to discover the truth and thus, has to depend on the information conveyed by the other party. Thus, where the parties share no such fiduciary relation, there is no duty to speak and mere silence will not amount to fraud, even if it is considered to be a misrepresentation. For example, in insurance contracts, the insurance company has no way to determine the truth of details given by the insured. Thus, it has to solely rely on the information provided by the insured. In situations where a party specifically enquires about a material fact related to the contract property, a duty to speak arises.
b. Where silence is deceptive – In some cases, silence itself becomes equivalent to speech. Where a person, despite the knowledge of his silence being deceptive, stays silent, is equally liable for fraud. For example, if the buyer comes to know about certain material facts of the seller’s property, which affects the value of the property, yet he decides to remain silent about it. Such silence may be considered fraud.
c. Change of Circumstances – It may sometimes happen that an assertion when made may be true; however, on account of change in circumstances, it may become false at the time when it is actually acted upon by the other party. In such cases, it is the duty of the person who originally made the representation, to inform the other party about the change in circumstances.
d. Half-Truths – Whenever a person discloses something, whether out of his duty to speak or not, he must disclose the information in toto. The informing party may be held guilty of fraud if he discloses something voluntarily and then stops halfway through. A half-truth is a lie. Suppressio very may amount to suggestio falsi.

3. PROMISE WITHOUT INTENTION OF PERFORMING THE CONTRACTUAL OBLIGATIONS

What has been contemplated under this clause is that the initial intention of not performing the promise that is made is a necessary element to constitute fraud and the existence of such an intention cannot be inferred. The fraud that has been contemplated under this clause is a one which is at the very inception, a fraud vitiating the transaction itself and not any subsequent conduct or representation on the part of the party or his representative. Various types of situations that fall under this clause include – where a person contracts with another without the intent to perform, only to prevent the other from contracting with some third person; contracting without the intending to pay the agreed consideration; one party promising the other, something which he is certain of not being able to accomplish in the given contractual period.

4. ANY OTHER ACT FITTED TO DECEIVE

Since fraud can be of an infinite variety, it is futile to make an attempt to define fraud precisely and exhaustively to cater to all the contingencies because it is highly likely that many loopholes may become available to escape liability. Human innovation and creativity know no bounds and thus, this clause has been drafted as a tool to enable the judiciary in doing effective and true justice. This clause may include all those acts which may be used to trick or cheat someone by unfair means to cause wrongful loss to the one cheated or wrongful gain to the one cheating. The intent of the person cheating must be to deceive the other person.

5. ANY ACT OR OMISSION SPECIALLY DECLARED TO BE FRAUDULENT BY LAW

For instance, concepts of “fraudulent transfer” under the Transfer of Property Act and “fraudulent preference” in Insolvency laws
NOTE – In the case of Avitel Post Studioz Limited and Ors. vs. HSBC PI Holdings (Mauritius) Limited and Ors. , the Supreme Court reiterated that “Section 17 of the Contract Act only applies if the contract itself is obtained by fraud or cheating. However, a distinction is made between a contract being obtained by fraud and the performance of a contract (which is perfectly valid) being vitiated by fraud or cheating. The latter would fall outside Section 17 of the Contract Act, in which the remedy for damages would be available, but not the remedy for treating the contract itself as being void”.
EVIDENCE AND BURDEN OF PROOF – The circumstances which comprise fraud have to be pleaded by the plaintiff by furnishing the specific details of the case. A case of fraud (irrespective of whether civil or criminal suit) has to be proved beyond a reasonable doubt. It is to be noted that every allegation of fraud must be specific and fraud of a type other than the one alleged cannot be proved. Fraud may not be directly proved but may have to be deduced from the surrounding circumstances and the conduct of parties prior to the agreement and post-contract. The conclusive decision of the commission of fraud cannot have its basis on mere speculation; such a conclusion must be based on some constructive and worthwhile material placed on record. The burden of proof in case of an alleged fraud is upon the plaintiff. However, where a party stands in a fiduciary relation to the other party, the former party is required to exercise extreme good faith and honesty in his dealings with the latter party and examine those transactions with vigilance and caution higher than that ordinarily required. In situations where the parties do not stand on the same level, an appropriate presumption of fraud is raised by law. However, where both parties to a contract stand in pari delicto, none of them can take advantage of such a transaction. The court shouldn’t insist on direct proof in case of fraud as fraud has been by its very nature – discreet, thereby leaving a higher unlikelihood of finding direct proof. Thus, fraud can be deduced from such circumstantial evidence that overcomes the natural presumption of good faith and fair transaction and convinces a reasonable person that such a presumption has been negated satisfactorily.
EFFECT OF FRAUD – When consent has been obtained by fraud, the contract becomes voidable u/s 19 of the Indian Contracts act. Thus, the party defrauded has an option either to rescind the contract or insist that the contract be performed to place him in such a position as he would have been if the misrepresentation had been true. If the defrauded party chooses to avoid the contract, he is liable to restore the benefit received (if any) back to the fraudulent party u/s 64 and may claim damages. In order to ascertain damages for fraud, the court ought to refer to certain principles which were laid down in Doyle v. Olby (Ironmongers) Ltd. and reiterated by the Hon’ble Supreme court in Avitel Post Studioz Limited and Ors. vs. HSBC PI Holdings (Mauritius) Limited and Ors. –
“(1) the Defendant is bound to make reparation for all the damage directly flowing from the transaction; (2) although such damage need not have been foreseeable, it must have been directly caused by the transaction; (3) in assessing such damage, the Plaintiff is entitled to recover by way of damages the full price paid by him, but he must give credit for any benefits which he has received as a result of the transaction; (4) as a general rule, the benefits received by him include the market value of the property acquired as at the date of acquisition; but such general Rule is not to be inflexibly applied where to do so would prevent him obtaining full compensation for the wrong suffered; (5) although the circumstances in which the general Rule should not apply cannot be comprehensively stated, it will normally not apply where either (a) the misrepresentation has continued to operate after the date of the acquisition of the asset so as to induce the Plaintiff to retain the asset or (b) the circumstances of the case are such that the Plaintiff is, by reason of the fraud, locked into the property; (6) In addition, the Plaintiff is entitled to recover consequential losses caused by the transaction; (7) the Plaintiff must take all reasonable steps to mitigate his loss once he has discovered the fraud.”
The right of rescission may however be lost, when – 1. The party affirms the contract even after becoming aware of his/her right to rescind; 2. The party doesn’t exercise his right of rescission within a reasonable period of time, i.e., by lapse of time ; 3. A third party, in good faith, has acquired rights in the subject matter of the contract. However, if the defrauded party rescinds/shows an intention to rescind the contract by doing an overt act before the 3rd party acquires any rights in the contract property, rescission shall be granted. For instance, in Car & Universal Finance Co. Ltd. v. Caldwell, the plaintiff gave possession of his car in return for a cheque, which later turned out to be worthless. He was unable to get the defendant to rescind the contract. Thus, he filed a plaint with the police and Automobile Association to tract his car. This overt act showed his intention to rescind the contract and he was granted relief.