Differentiation of Mistake and Fraud as Grounds for Rescission of Transaction

• Author: Kalev Saare, Karin Sein, Mari-Ann Simovart
• Pages: 142-151

Kalev Saare

Docent of Civil Law, University of Tartu

Karin Sein

Doctor iuris, Private International Law, University of Tartu

Mari-Ann Simovart

Lecturer of LL.M., Assistant Extraordinary of Civil Law, University of Tartu

Differentiation of Mistake and Fraud as Grounds for Rescission of Transaction

1. Introduction

The General Part of the Civil Code Act ¹ (GPCCA) that entered into force in Estonia on 1 July 2002 reflects positions of modern European contract theory. Inter alia, the regulation of transactions as provided in the GPCCA contains the main sets of substantive elements for rescission of transactions, including rescission on the grounds of mistake (§ 92) and fraud (§ 94). The Principles of International Commercial Contracts ² (PICC), prepared by the UNIDROIT Institute, the Principles of European Contract Law ³ (PECL), prepared by the Commission on European Contract Law acting under the leadership of Professor Ole Lando of the CopenhagenBusinessSchool, and the Dutch Civil Code (Burgerlijk Wetboek ⁴ , NBW) may be cited as the sources of the respective provisions⁵.

The general elements of mistake and fraud in the GPCCA are highly similar - both mistake and fraud defined in the GPCCA may consist in the disclosure of inaccurate circumstances or the non-disclosure of circumstances which should have been disclosed according to the principle of good faith by one party to the transaction to the other. The notion of fraud is defined through the notion of mistake, to which intent adds as the component describing the state of mind of the deceiving person. This gives rise to the issue of finding more specific criteria for differentiating these two institutes both on practical and theoretical grounds. Mistake and fraud are undoubtedly among the most common grounds for cancelling a transaction in legal practice because they relate to the discrepancy between the actual intent of a party to the transaction and the legal consequences brought about by the transaction⁶.

The issue of substantive identification of the sets of elements of mistake and/or fraud is topical and problematic in contemporary European legal order on a wider scale⁷. It appears from the published studies that in an identical factual situation some legal orders would allow rescission of a transaction based on either mistake or fraud only, others on both mistake and fraud. Furthermore, even within the same legal order, the practice need not always be uniformly clear as to whether a case involves a mistake or a fraud.

The main aim of this article is to analyse issues related to differentiation of the two institutes for cancelling transactions, and to pinpoint the main differences of these institutions. The article does not aim at describing all the substantive elements of mistake and fraud and the legal meaning of such components, but only at focussing on the elements that both allow for and complicate the distinction-making between those institutes. The limited scope of the article does not allow for a discussion on relationships of mistake and fraud with other institutes of civil law, above all with the violation of obligations arising from pre-contractual negotiations (culpa in contrahendo, see Law of Obligations Act (LOA) § 14) and failure to perform a prestation that entails liability (LOA Chapter 5) foreseen by the (LOA)⁸.

2. Substantive elements of mistake and fraud

Modern contract theory on which both the PECL and PICC can be considered to be founded, and which has been taken as the basis for the provisions of the NBW (article 6:228) and GPCCA (§ 92), proceeds from the principles of protection of trust and distribution of risks (see PECL article 4:103 and PICC article 3.5)⁹. Contrary to this, the classical transaction studies used as a guide by the compilers of the German Civil Code ¹⁰ (BGB), for example, have in its treatment of mistake, mostly proceeded from the theory of intent (above all, BGB § 119 (1)), according to which mistake can be interpreted as a discrepancy between the actual intent of a person and the objective declaration of intent. A situation in which legal consequences, which the person did not in fact desire, follow for a person declaring his or her intentions, is not in conformity with the right of self-determination of a person (principle of autonomy of will)¹¹. Such a subjective approach to mistake obviously does not take into account the need to protect the trust of third parties and the practice of legal transactions. Critical approaches towards the BGB have referred to the legal consequences of a unilateral subjective mistake arising regardless of its objective recognisability or outward expression¹².

Along the lines of modern legal theory, provisions of the GPCCA do not foresee mistake as nonconformity of the intent with the declaration of intent but rather as the development of intent - based on false circumstances. According to GPCCA § 92 (1), mistake is an erroneous assumption relating to existing facts. One cannot speak of a legally relevant mistake in a case where the risk of proceeding from the correct circumstances rests with the person who declared his or her intent (see GPCCA § 92 (5)). Thus, it may be presumed that modern contract theory proceeds from the principle that each person bears the risk of his or her intent having evolved from correct presumptions and having taken into account all circumstances relevant for the particular transaction. The mistake that entitles the person making a declaration of intent to cancel the transaction entered into, serves as an exception, and with the view to the protection of legal usage and trust presumes a situation in which the partner of the mistaken person does not have confidence in the other party making a declaration of intent that lacks mistakes. Such a situation may arise, above all, when the other party to the transaction acts in bad faith or is also mistaken about the relevant circumstances related to the transaction.

Proceeding from the above, three main sets of elements are identified in the PECL, PICC, NBW as well as GPCCA: (1) a mistake caused by the other party (GPCCA § 92 (3) 1)); (2) a mistake that was known/should have been known to the other party (GPCCA § 92 (3) 2)); (3) a common mistake of the parties (GPCCA § 92 (3) 3)). In the case of both a caused and a known mistake, the mistaken party is given the opportunity to cancel the transaction on the grounds that the other party to the transaction is related to circumstances or acts in bad faith concerning the circumstances about which the mistaken party erred, and consequently his or her confidence in maintaining the validity of the transaction does not deserve to be protected. In the case of a caused mistake, erroneous assumptions are directly caused by the other party, whereas in the case of the recognised (recognisable) mistake, the other party is blamed because he or she knew or should have known about the mistake, and proceeding from the principle of good faith, was obliged to inform the mistaken party thereof. In order to cancel a transaction due to a mistake, it must always be a relevant mistake, i.e., a mistake concerning a circumstance of sufficient importance to influence a reasonable person, similar to the person who entered into the transaction, to enter into the particular transaction under the particular circumstances (GPCCA § 92 (2)).

Similarly, fraud also involves a mistake, while the liability for the mistake arising rests with the other party to the transaction. Thus, fraud is associated with the two main sets of elements of the mistake, i.e., the mistake caused by the other party to the transaction and the recognised mistake. Fraud presumes that the other party to the transaction is led into or left in error either by disclosing false information or by failing to disclose such circumstances that are subject to the duty to disclose under the principle of good faith (see GPCCA § 94 (1) and (2)). A case of disclosing some information as correct without actually verifying its correctness is deemed to be equal to disclosure of false circumstances (GPCCA § 94 (2)) if subsequently such information proves to be false. It is important that, unlike a mistake, only intentional leading into or leaving in error can be regarded as a fraud.

In the situation where the notion of fraud is described through the notion of mistake and the sets of elements of both may be related to the disclosure or non-disclosure of circumstances by one party of the transaction to the other, a more precise delimitation of the sets of elements of mistake and fraud is vital. While in the case of mistake, the right to cancel the transaction, inter alia,procedurally presumes proving that the mistake by the mistaken person was relevant, in the case of fraud, the relevance of the mistake is of no significance. In case of fraud, it is necessary to establish the deceiving person's intent in leading into or leaving the other party in error, with the purpose of inducing the other person to enter into the transaction. Thus, the circumstances that need to be established and proved differ in the case of mistake and fraud.

3. Intent to deceive

In order to distinguish between fraud and mistake, the main criterion is the deceiving party to lead into or leave the other party in error and thereby induce the latter to enter into the transaction. Intent to deceive has been...