Can a cause of action for fraud be asserted based upon an intentional and even fraudulent breach of a contract after the contract has been made? As explained by the United States Court of Appeals for the Second Circuit in U.S. ex rel. O’Donnell v. Countrywide Home Loans, Inc., 822 F.3d 650 (2d Cir. 2016), the answer is no.
On May 23, 2016, the Second Circuit decided O’Donnell, a case in which the Court decided whether common law fraud was alleged as the necessary predicate for penalties under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”), 12 U.S.C. § 1833a.
The Second Circuit initially determined that FIRREA incorporated and relied upon common law principles of fraud within its meaning and terms. The Court then analyzed whether a common law fraud case had been established based upon alleged representations that were made after the contract was entered into and in regard to a breach of that contract. The Court set out an interesting hypothetical to explain its decision. In the hypothetical, A is the seller and B is the purchaser of widgets during a five-year term. A represents in the contract that each delivery of widgets will comply with certain contractual standards. At the time of contracting, A intends to fulfill the bargain and provide conforming widgets. Later, after several successful and conforming deliveries to B, A experiences difficulties in its production so the widgets it produces fall below the specified contractual standards. Despite knowing the widgets do not meet the contractual standards, A decides to ship them to B without saying anything about their poor quality in breach of the contract. When A knowingly and intentionally provides substandard widgets in violation of its contractual promise that all widgets comply with contractual standards – a willful and knowing false statement made with intent to defraud B, does that constitute merely an intentional breach of contract or common law fraud?
The Court determined that because A, the seller, in fact intended to provide conforming widgets when it made the representation in the contract, its subsequent fraudulent breach of the contract did not constitute common law fraud, but merely a breach of the contract. Key to the Second Circuit was the fact that the representation was made after the contract had been entered into, and not as part of the formation of the contract. Also important was the fact that there was no allegation or proof that the contracting party did not intend to comply with its contractual promises when made at the outset of the contract formation.
Thus, regardless of how fraudulent a subsequent breach of contract may be, it does not constitute common law fraud. This is significant because remedies for the tort of fraud are broader and more liberal than a breach of contract. See my previous post here.