Can Breach of Contract Also Be Fraud? (Part 1)
Every day, somewhere a business is breaching a contract with another company. The breach may cause significant financial damage to the non-breaching company. The harm and sense of deception may cause the damaged company to believe the breaching company is dishonest and fraudulent. Does that mean that the company that breached the contract also committed fraud?
The question is a real-world issue. It arises in many different contexts and is not just academic. The damages from fraud can be significantly higher than the damages for breach of contract. Millions of dollars can hinge on the answer to that question.
Sometimes even a billion. The Second Circuit Court of Appeals in New York recently issued a major decision widely reported in the media reversing a $1.2 billion fraud judgment against Countrywide Home Loans (now owned by Bank of America) arising from the sale of questionable mortgages by Countrywide to Fannie Mae and Freddie Mac. United States ex rel. O’Donnell v. Countrywide Homes Loans, Inc. (May 23, 2016). Although the media gave almost no attention to the legal issue decided by the Second Circuit, the case hinged on this common issue in business cases: can breach of contract -- even intentional breach of contract -- also constitute fraud?
In the Countrywide case, the answer was No. Countrywide had entered into a contract with Fannie Mae and Freddie Mac to sell “investment quality” mortgages to them. The government alleged that the mortgages Countrywide later sold to Fannie Mae and Freddie Mac under that contract were poor loans and failed to meet the required investment quality. In fact, the government claimed that at the time the mortgages were sold to Fannie Mae and Freddie Mac, Countrywide actually knew the mortgages failed to satisfy the investment-grade requirement (although there was no allegation that Countrywide made contrary representations about the quality of the mortgages at the time they were actually sold).
The Second Circuit held -- even assuming an intentional breach of the contract -- the government neither alleged nor proved any fraud in connection with either the entering into the contract or in the subsequent breach of the contract by Countrywide in the sale of the questionable mortgages.
Yet most business cases involving a breach of contract also allege fraud and misrepresentation. In many cases, where breach of contract exists, fraud and deception also exist. Part II of this article will discuss some of the circumstances where breach of contract also involves fraud.
Topics: Business Fraud