A contract can be rescinded for fraudulent misrepresentation if the truth “might” have led to a different course of action

United KingdomScotland

The Commercial Court has clarified that the traditional “but for” test still applies in claims to rescind a contract for fraudulent misrepresentation, albeit in a weaker form than for negligent misrepresentation. The court also confirmed that a claimant can only recover losses on behalf of a third party if the contracting parties intended the contract to confer a benefit on that party.

Background

The parties in BV Nederlandse Industrie Van Eiprodukten v Rembrandt Enterprises Inc [2018] EWHC Civ 1857 (Comm) entered into a contract for the supply of dried egg products from the Netherlands to the US. The contract was later renegotiated to increase the price of the products. Subsequently, the supplier encountered some difficulties in supplying the contracted volume and arranged for a percentage of the products to be supplied by a third party on its behalf. The buyer agreed to pay the third party directly, but did not enter into a contract with it.

The buyer then audited the supplier’s production processes and concluded that:

  1. the seller was in breach of a number of warranties (present in both versions of the contract) to the effect that the products would be fit for human consumption as defined in US regulatory requirements; and
  2. the costs of complying with those requirements had been fraudulently misrepresented by the seller during the renegotiations.

The buyer therefore refused to accept further shipments of the products and sold on the shipments that it had already received at a lower price for use in pet food. The seller claimed damages of some €19m for breach of contract. The buyer sought to rescind the contract for fraudulent misrepresentation and counterclaimed some €4.7m for losses incurred in selling the products on.

The test for inducement

On the facts, Teare J held that the supplier was not in breach of warranty, but also found that it had put forward the costs figures as a negotiating device rather than a genuine estimate. There had therefore been a fraudulent misrepresentation, and the court had to decide whether or not that misrepresentation had induced the buyer to enter into the renegotiated contract. In Raiffeisen Zentralbank Österreich v Royal Bank of Scotland [2010] EWHC 1392, the Commercial Court held that a claimant seeking to rescind a contract for misrepresentation must show that “but for the misrepresentation, the claimant would not have entered into the contract on the terms that he did.” However, the supplier in BV Nederlandse argued that because the “but for” test had not been mentioned in the subsequent Supreme Court case of Zurich Insurance Co plc v Hayward [2017] AC 1342, it no longer applied.

Teare J rejected this argument. In Zurich, the Supreme Court had not been called upon to consider whether or not the misrepresentation had induced the contract, but whether or not it had been believed by the recipient, which was a different question. Inducement had simply not been discussed. The “but for” test was therefore still good law.

However, Teare J noted that in Raiffeisen Zentralbank, Clarke J had stated obiter that, where the misrepresentation was fraudulent, the “but for” test was weaker than where the misrepresentation was merely negligent. In the weaker form of the test, the claimant needed only to show that but for the misrepresentation, he might have acted differently, not that he would have done so. It was sufficient if the misrepresentation was one factor in his decision. Teare J adopted this distinction between fraudulent and negligent misrepresentation. He concluded on the facts that the misrepresentation was one of three factors the buyer took into account in agreeing to the price increase. Applying the weaker form of the test, this was sufficient to establish inducement.

Effect of rescission

The supplier argued that, even if the renegotiated contract had been induced by a fraudulent misrepresentation, the buyer should not be allowed to rescind the contract because it was no longer able to return the egg products (having sold them on). The usual aim upon rescission would be to restore the parties to the position they were in prior to entering into the contract, which would require the buyer to return the goods and the supplier to refund the full purchase price. Since the return of the goods was no longer possible, there should be no rescission. However, the buyer argued that it should be allowed to pay over the proceeds of the onward sale to the supplier in lieu of returning the products themselves, a solution which it referred to as “pecuniary counter-restitution”.

Teare J disagreed with both approaches. The effect of rescinding the renegotiated contract was to restore the original contract at the lower price. The appropriate order was therefore for the supplier to refund the difference between the price the buyer had paid for the delivered goods under the revised contract and the price it would have paid under the original contract. It was therefore unnecessary for the court to decide whether or not pecuniary counter-restitution was permissible.

Damages

Since the court had found that the supplier was not in breach of warranty, the refund to the buyer as a result of reverting to the original price had to be netted off against damages for the profits the supplier would have made on the improperly rejected shipments if they had been accepted and paid for at the original price. Teare J left the precise amount to be calculated by the parties, but on the figures mentioned in the judgment, the net result seems likely to be a seven-figure payment by the buyer to the supplier.

Transferred loss

There was a dispute as to whether the supplier could make a claim for “transferred loss” on behalf of the third party, since that party did not have a direct claim against the buyer. Having reviewed the authorities on this issue, Teare J held that such losses were only recoverable where, at the time of entering into the contract, both parties to the contract intended to confer a benefit on the third party. On the facts, there was no such intention in this case.

Comment

This was an unusual case in that rescission did not bring contractual relations between the parties to an end, but simply resulted in a return to an earlier version of the contract. It is unfortunate that as a result, the interesting concept of “pecuniary counter-restitution” suggested by the buyer was not fully examined by Teare J and will have to be considered by the courts on a future occasion.

However, the clarifications provided by the court as to the tests for inducement and transferred loss provide useful guidance for parties dealing with similar situations. In particular:

  • Parties should beware of taking a negotiating position that they cannot support with objective evidence, since if it proves persuasive, the counterparty may later be able to rescind the contract;
  • All parties in a supply chain should ensure that their rights and obligations are clearly documented, since a failure to formalise the arrangements may prevent them from recovering losses if the arrangement collapses.