Articles Posted in Fraud

Many lawyers pursuing business litigation on behalf of their clients will file a whole panoply of claims rather than content themselves with a single count for breach of contract. As the law generally permits a wider range of remedies (and higher damages awards) for tort claims like fraud and tortious interference, plaintiffs seeking to enforce contract rights in court will often sue for various tort claims in addition to breach of contract. Sometimes this works and sometimes it doesn’t. Courts are guided by various principles to help them weed out contract-based claims disguised as tort claims. One such principle is known as the “source of duty” rule.

When a plaintiff alleges that the defendant violated some duty owed to him, the court will examine the source of the duty allegedly violated. If the source of the duty is a contract entered into by the parties, as opposed to common law or some provision of the Virginia or United States Code, the court will treat the claim as one for breach of contract and limit remedies accordingly. Of course, there are circumstances in which a defendant can both breach a contract and commit a tort by violating a common-law duty. It is up to the court, however, to dismiss any tort claims based on the alleged violation of a duty that exists solely by virtue of a contractual agreement. (See Preferred Sys. Sols., Inc. v. GP Consulting, LLC, 284 Va. 382, 408 (2012)).

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You may have heard that a group of Chinese investors filed a fraud action here in Virginia against Governor McAuliffe and others for $17,920,000, plus punitive damages exceeding $53,000,000. Earlier this month, a federal judge dismissed the case, finding that the allegations were insufficient to allow a jury to even consider the claim. Should you, dear reader, ever find yourself on the receiving end of a $71M fraud lawsuit, try to stay calm, and read my earlier blog post about what kind of facts are needed to make out a facially valid fraud claim. The plaintiffs in this particular case were unable to present such facts, so they lost. If a plaintiff cannot allege in good faith facts sufficient to satisfy each element of a fraud claim, the case will be dismissed no matter how much money is at stake.

According to the original complaint filed against Governor McAuliffe (it was originally filed in Fairfax County Circuit Court, then removed to federal court in Alexandria), the case was brought “to remedy a $120 million scam perpetrated by savvy and politically connected operatives and businessmen.” The Defendants allegedly offered–in exchange for a $500,000 investment from each plaintiff in an electric car company–to leverage their political connections to ensure that the plaintiffs’ visa applications would be approved by U.S. Citizenship and Immigration Services. The Chinese investors claimed that McAuliffe lied about a number of things in order to secure those $500,000 investments:

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The statute of limitations for fraud cases in Virginia is two years from the time the cause of action accrues. See Va. Code § 8.01-243. This is not necessarily two years from the time the fraud was committed. Fraud cases are subject to a “discovery rule,” meaning that the cause of action will not accrue until the alleged misrepresentation is either discovered, or, by the exercise of due diligence, reasonably should have been discovered. See Va. Code § 8.01-249(1). The clock on the two-year period does not begin ticking until that moment in time. As you might expect, precisely when that moment occurs is often the subject of fierce disagreement.

To exercise due diligence, as contemplated by the statute, a plaintiff must use “such a measure of prudence, activity, or assiduity, as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent [person] under the particular circumstances; not measured by any absolute standard, but depending on the relative facts of the special case.” (See Schmidt v. Household Fin. Corp., II, 276 Va. 108, 118 (2008)). Who gets to decide whether a plaintiff exercised this level of prudence, activity, and assiduity? In most cases, it will be the jury. A motion to dismiss or plea in bar based on the statute of limitations normally will not be successful unless all the facts necessary for resolving the “due diligence” question appear on the face of the pleadings or are not in dispute. If there’s a factual dispute about whether due diligence was exercised, the case will normally need to go forward so that the jury can hear evidence on the matter.

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Zealous lawyers seeking to maximize their clients’ monetary recovery in court will often sue for as many different claims as their highly trained legal minds can conjure up. And they will usually try to come up with at least one viable tort claim (such as fraud or business conspiracy) to pursue in addition to any breach-of-contract claims, because tort claims often allow the recovery of punitive damages in addition to compensatory damages. But there are important differences between the law of contracts and the law of torts. The law of torts is designed to protect broad societal interests such as safety of persons and property. Contract law, on the other hand, is concerned with the protection of bargained-for expectations. Therefore, several rules have developed to prevent turning every breach-of-contract claim into a tort action.

The economic loss rule, for example, holds that where a contracting party’s loss is limited to disappointed economic expectations, his remedy is limited to one for breach of contract. A similar rule is known as the “source of duty” rule. It looks to the source of the duty alleged to have been violated. Before a court will allow a contracting party to recover on a tort theory, it must be satisfied that the duty tortiously or negligently breached is a common law duty, and not one existing solely by virtue of a contract between the parties. If the source of the duty allegedly violated is a contract, then the plaintiff should be limited to remedies available in breach-of-contract actions.

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Fraud is a confusing and widely misunderstood tort. I wrote about the elements of fraud on this blog a few years ago, and last month I dug deeper into what it means to make a fraudulent misrepresentation. This month, I’m going to elaborate a bit more about the requirement that fraudulent misrepresentations be made with the intent to mislead someone before liability will arise. In other words, we’re talking about the expectation on the part of the speaker that the person hearing the statement (i.e., the person being defrauded) will take some action–or refrain from taking some action–as a direct result of hearing the statement. To win a case for actual fraud, you need to establish that the defendant not only misrepresented a fact, but did so intending to influence your behavior.

Who can sue? Generally speaking, anyone whose conduct the speaker intended to influence and who was, in fact, influenced as intended. Sometimes the defendant intends to defraud a single person. Sometimes the defendant seeks to influence an entire group of people. Even if a defendant did not specifically intend to defraud a particular plaintiff, if the defendant had reason to expect that the plaintiff would act or refrain from acting in reasonable reliance on his untrue statement, liability may attach. There may be a valid defense, however, if the defendant could not have anticipated that a particular plaintiff would hear the fraudulent statement and take action upon it. Let’s look at some examples.

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In Virginia, a civil action for fraud requires more than just dishonest or unethical behavior on the part of the individual or business being sued. People lie all the time, and tort liability usually does not arise. The law of fraud is more concerned about pecuniary loss resulting from the intentional misrepresentation or nondisclosure of material facts. Several years ago, I posted a blog entry entitled “Fraud: What It Is, and What It Is Not.” There, I explained that a plaintiff bringing an action for fraud must allege and prove (1) a false representation, (2) of a present, material fact, (3) made intentionally and knowingly, (4) with intent to mislead, (5) reasonable reliance by the party misled, and (6) resulting damage. Today, I want to elaborate on the first of those elements: the requirement of a fraudulent misrepresentation.

First of all, when we talk of false or fraudulent misrepresentations, we’re not just dealing with the written word. Just as the hearsay rule can apply to nonverbal conduct intended as an assertion, the first element of fraud can apply to nonverbal conduct that amounts to an assertion of fact inconsistent with the truth. If a person acts in such a way as to suggest the existence of a fact, and that fact does not exist, a misrepresentation has occurred upon which a fraud action may potentially be based.

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Actual fraud is defined in Virginia as a misrepresentation of a material fact, made knowingly and intentionally, with the intent to mislead another person, when the person to whom the misrepresentation was made reasonably relies on that misrepresentation and suffers damages as a result. In other words, you commit fraud when you lie to someone for the purpose of tricking that person into doing something (or refraining from doing something), and the person believes you and falls for it. The misrepresentation does not need to be expressed in words; it can be communicated through nonverbal conduct. Sometimes even silent non-communication can amount to “fraud by omission.” If you know that remaining silent would cause someone to reasonably (but erroneously) infer certain facts and you intentionally fail to speak up, that could be actionable as fraud. If the misrepresentation causes the recipient to do something he would not have done had he not heard the lie, he is said to have relied on the misrepresentation.

If you don’t want your fraud lawsuit to get dismissed at the outset, be sure to allege in the complaint that the misrepresentation was made concerning a present or past fact. A common mistake is to confuse fraudulent misrepresentations with broken promises. You can sometimes sue for a broken promise, but a broken promise is not fraud because a promise is an undertaking to take some action in the future. Assuming you’re not psychic or clairvoyant (which is an assumption the judge is going to make, I assure you), you don’t know what the future holds, so you can’t “misrepresent” the future. If you say you will do something in the future but then you don’t actually do it, you have broken a promise and perhaps breached a contract; you haven’t committed fraud.

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To sue a business for fraud in Virginia, a plaintiff must allege (and eventually prove) (1) a false representation, (2) of a material fact, (3) made intentionally and knowingly, (4) with intent to mislead, (5) reliance by the party misled, and (6) resulting damage to the party misled. When a business breaches a contract, it is not necessarily indicative of fraud. Broken promises are covered by the law of contracts rather than the law of fraud. Some courts have recognized, however, that if a corporation, at the time of making a contractually-enforceable promise, had no intention of ever actually making good on that promise, an aggrieved party could sue for fraud on the theory that the defendant impliedly misrepresented its true intentions.

This does not mean that a plaintiff can convert any ordinary breach-of-contract case into a fraud case. It would be all to easy to simply claim, any time a contract with your company is breached, and with the benefit of hindsight, that the party breaching the contract must have never had any intention of ever performing it. Under Rule 9(b), fraud claims must be pled with particularity so that well-meaning defendants who are unable to perform contractual obligations don’t suffer undue harm to their reputations or have to defend against frivolous lawsuits. To file a fraud complaint on the mere assumption that a breaching party must have committed fraud based solely on its lack of performance is inviting the court to dismiss the case for failure to state a claim.

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To state a cause of action for fraud in Virginia, a plaintiff must plead that there was (1) a false representation of (2) a material fact, (3) made intentionally and knowingly, (4) with intent to mislead, and that the plaintiff (5) reasonably relied on that false representation and (6) that his reliance resulted in damages. What lawyers and judges often overlook is that to survive demurrer, a plaintiff must also show (as part of the causation requirement of elements 5 and 6) that the damage was proximately caused by the defendant’s alleged misrepresentation. (See, e.g., Cohn v. Knowledge Connections, Inc., 266 Va. 362, 369 (2003); Murray v. Hadid, 238 Va. 722, 731 (1989)). Not just caused–proximately caused.

The Virginia Supreme Court has defined proximate cause of an event as “that act or omission which, in natural and continuous sequence, unbroken by an efficient intervening cause, produces the event, and without which that event would not have occurred.” Beale v. Jones, 210 Va. 519, 522 (1970). According to the Restatement of Torts, the concept of proximate cause encompasses both (1) causation in fact, which exists where a plaintiff’s reasonable reliance is a “substantial factor in determining the course of conduct” that results in the plaintiff’s loss; and (2) legal causation, which exists where the loss might “reasonably be expected to result from the reliance.” (See Restatement (Second) of Torts §§ 546, 548A). It’s this second element that is most often neglected. Proximate cause is more than simple “but for” causation, which refers only to the first element of the test (i.e., causation in fact).

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The Racketeer Influenced and Corrupt Organizations Act (commonly known as “RICO“) became effective on October 15, 1970. It was originally intended primarily to assist in the prosecution of mafia leaders, as it permitted them to be tried for crimes they ordered others to do rather than committed themselves. Congress never intended to limit RICO to organized crime, however. G. Robert Blakey, the primary author of the statute, once told Time Magazine, “We don’t want one set of rules for people whose collars are blue or whose names end in vowels, and another set for those whose collars are white and have Ivy League diplomas.” The statute includes a civil provision, found at 18 USC § 1964(c), that has proven particularly popular in business litigation as it allows for the recovery of treble damages and attorneys fees.

RICO makes it unlawful for any person employed by or associated with any enterprise engaged in, or the activities of which affect, interstate or foreign commerce, to conduct or participate, directly or indirectly, in the conduct of such enterprise’s affairs through a pattern of racketeering activity or collection of unlawful debt. (See 18 USC § 1962(c)). Key concepts in civil RICO cases typically include whether a true “enterprise” exists, whether the defendant has engaged in “racketeering activity,” and, if so, whether such activity constitutes a “pattern.”
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