It’s a lie! It’s a fraud! These are fighting words, but they are too often spoken. In construction-contracting litigation, allegations of fraud, deceit and misrepresentation are also too often raised.

Generally, the law does not micromanage business dealings. There are many state and federal statutes that require disclosure of information and impose penalties for some kinds of deceptive practices, but commerce still runs on shaving the truth and inflating facts. “This is the only vacuum cleaner you will ever need.” “Half the calories of other butters.” “A new definition for luxury cars.”

There are instances, however, where the law says “enough.” One of those instances lies in common-law fraud.

Legally, what is a fraud?

Because deception can take many forms, there is no clear definition of what kinds of misrepresentation can justify a lawsuit. As a result, the courts instead have established criteria, each of which poses its own problems.

There are variations, but essentially a fraud requires these elements:

A representation of fact;

Which is false;

And material to the transaction;

The speaker knows the representation is false or is ignorant of its truth;

The speaker intends that the fact be relied on;

The hearer is ignorant of the fact asserted;

The hearer relies on the representation; and

Damages are a direct result.

That is a handful. If any of these elements is missing, there is no fraud. Translated: Fraud is easy to allege and hard to prove.

Some examples

Perhaps the more common frauds (misrepresentations) in contracting are differing site conditions. All of the criteria are met: detailed subsurface conditions are shown on the drawings and they are wrong. The contractor reasonably relies on this information in formulating its bid and incurs damages. In modern contracting, we do not call this a fraud and instead look to the differing-conditions clause in the contract.

The point was made in a California case:

[B]y failing to impart its knowledge of difficulties to be encountered in a project, the owner will be liable for misrepresentation if the contractor is unable to perform according to the contract provisions.... The nondisclosure of the cave-ins and special drilling techniques... transformed the [subsurface data] into misleading half-truths.

In a more atypical case, errors in the drawings for a building supported a fraud claim. It was a school renovation, and the contractor was to install a spiral staircase. The plans had serious errors and the state knew of them in advance. When a claim for the fix was submitted to the architect, it was rejected. The contract had a clause making the architect’s decision final. The court instructed the jury that the architect’s actions could be considered arbitrary and in bad faith, that is, fraudulent, permitting the arbitrator’s decision to be set aside.

Looks like fraud but it isn’t

Like the two cases discussed above, many fraud cases require another element that is not on the official list: bad motive.

In a Virginia lawsuit, the contractor made representations in each pay application that all construction was per plans. It turned out that these representations were false, and the owner sued for fraud. The court rejected the claim. It stated that the owner’s allegations of fraud “are nothing more than allegations of negligent performance of contractual duties. ...”

How could the court do that? By adding another element to the fraud definition for construction cases, also known as “judicial legislation.”

[I]n ruling as we do today, we safeguard against turning every breach of contract into an actionable claim for fraud.

What was really missing was bad motive. Had it been shown that defective materials were intentionally installed and somehow hidden from inspection, the result may have been different.

Fraud in the inducement

A subset to fraud law concerns deceits that cause a party to sign a contract. If fraud in the inducement to contract can be proven, the contract evaporates.

How does a construction contract get fraudulently induced?

There are not many cases directly on point, but here are some examples of allegations that have been made, albeit unsuccessfully: (1) that the contractor did not have the experience it claimed; (2) that the seller knew that its equipment would not work as represented; (3) that the owner knew that no time extensions would be allowed; (4) that the contractor or owner was financially unable to complete the project.

Conclusion

Fraud is almost always a tough case. There are times, however, when the claim is well founded and justified. This is a battle that you need to consider carefully before you engage in it. At a minimum, go through the checklist of the legal elements of fraud. Ask whether you have the facts to prove each element and don’t neglect to calculate the damages you’ve incurred.

If you do that exercise thoughtfully and thoroughly, you will be able to assess whether your claim has merit and whether it is worth the lawsuit. EC

ITTIG, of Ittig & Ittig, P.C., in Washington, D.C., specializes in construction law. He can be contacted at 202.387.5508, [email protected] or www.ittig-ittig.com.