Thursday, December 12, 2013

Types of Fraud in Contracts

"x x x.

Types of Fraud in Contracts

Fraud is defined in Article 1338 of the Civil Code as:

x x x fraud when, through insidious words or machinations
of one of the contracting parties, the other is induced to
enter into a contract which, without them, he would not
have agreed to.

This is followed by the articles which provide legal examples and
illustrations of fraud.

Art. 1339. Failure to disclose facts, when there is a duty to reveal
them, as when the parties are bound by confidential relations,
constitutes fraud. (n)

Art. 1340. The usual exaggerations in trade, when the other party
had an opportunity to know the facts, are not in themselves
fraudulent. (n)

Art. 1341. A mere expression of an opinion does not signify fraud,
unless made by an expert and the other party has relied on the
former's special knowledge. (n)

Art. 1342. Misrepresentation by a third person does not vitiate
consent, unless such misrepresentation has created substantial
mistake and the same is mutual. (n)

Art. 1343. Misrepresentation made in good faith is not fraudulent
but may constitute error. (n)

The distinction between fraud as a ground for rendering a contract
voidable or as basis for an award of damages is provided in Article 1344:

In order that fraud may make a contract voidable, it should be
serious and should not have been employed by both contracting

Incidental fraud only obliges the person employing it to pay
damages. (1270)

There are two types of fraud contemplated in the performance of
contracts: dolo incidente or incidental fraud and dolo causante or fraud
serious enough to render a contract voidable.
In Geraldez v. Court of Appeals,50 this Court held that:

This fraud or dolo which is present or employed at the time of birth
or perfection of a contract may either be dolo causante or dolo
incidente. The first, or causal fraud referred to in Article 1338, are
those deceptions or misrepresentations of a serious character employed by one party and without which the other party would
not have entered into the contract. Dolo incidente, or incidental
fraud which is referred to in Article 1344, are those which are not
serious in character and without which the other party would still
have entered into the contract. Dolo causante determines or is the
essential cause of the consent, while dolo incidente refers only to
some particular or accident of the obligation. The effects of dolo
causante are the nullity of the contract and the indemnification of
damages, and dolo incidente also obliges the person employing it
to pay damages.51

In Solidbank Corporation v. Mindanao Ferroalloy Corporation, et
al.,52 this Court elaborated on the distinction between dolo causante and
dolo incidente:

Fraud refers to all kinds of deception -- whether through insidious
machination, manipulation, concealment or misrepresentation --
that would lead an ordinarily prudent person into error after taking
the circumstances into account. In contracts, a fraud known as dolo
causante or causal fraud is basically a deception used by one party
prior to or simultaneous with the contract, in order to secure the
consent of the other. Needless to say, the deceit employed must be
serious. In contradistinction, only some particular or accident of
the obligation is referred to by incidental fraud or dolo incidente,
or that which is not serious in character and without which the
other party would have entered into the contract anyway.53

Under Article 1344, the fraud must be serious to annul or avoid a
contract and render it voidable. This fraud or deception must be so material
that had it not been present, the defrauded party would not have entered into
the contract. In the recent case of Spouses Carmen S. Tongson and Jose C.
Tongson, et al., v. Emergency Pawnshop Bula, Inc.,54 this Court provided
some examples of what constituted dolo causante or causal fraud:
Some of the instances where this Court found the existence of
causal fraud include:

(1) when the seller, who had no intention to
part with her property, was "tricked into believing" that what she
signed were papers pertinent to her application for the
reconstitution of her burned certificate of title, not a deed of sale;

(2) when the signature of the authorized corporate officer was
forged; or (3) when the seller was seriously ill, and died a week
after signing the deed of sale raising doubts on whether the seller
could have read, or fully understood, the contents of the documents
he signed or of the consequences of his act.55 (Citations omitted).

However, Article 1344 also provides that if fraud is incidental, it
follows that this type of fraud is not serious enough so as to render the
original contract voidable.

A classic example of dolo incidente is Woodhouse v. Halili.56 In this
case, the plaintiff Charles Woodhouse entered into a written agreement with
the defendant Fortunato Halili to organize a partnership for the bottling and
distribution of soft drinks. However, the partnership did not come into
fruition, and the plaintiff filed a Complaint in order to execute the
partnership. The defendant filed a Counterclaim, alleging that the plaintiff
had defrauded him because the latter was not actually the owner of the
franchise of a soft drink bottling operation. Thus, defendant sought the
nullification of the contract to enter into the partnership. This Court
concluded that:

x x x from all the foregoing x x x plaintiff did actually
represent to defendant that he was the holder of the exclusive
franchise. The defendant was made to believe, and he actually
believed, that plaintiff had the exclusive franchise. x x x The
record abounds with circumstances indicative that the fact that the
principal consideration, the main cause that induced defendant to
enter into the partnership agreement with plaintiff, was the ability
of plaintiff to get the exclusive franchise to bottle and distribute for
the defendant or for the partnership. x x x The defendant was,
therefore, led to the belief that plaintiff had the exclusive franchise,
but that the same was to be secured for or transferred to the
partnership. The plaintiff no longer had the exclusive franchise, or
the option thereto, at the time the contract was perfected. But while
he had already lost his option thereto (when the contract was
entered into), the principal obligation that he assumed or undertook
was to secure said franchise for the partnership, as the bottler and
distributor for the Mission Dry Corporation. We declare, therefore,
that if he was guilty of a false representation, this was not the
causal consideration, or the principal inducement, that led plaintiff
to enter into the partnership agreement.

But, on the other hand, this supposed ownership of an
exclusive franchise was actually the consideration or price plaintiff
gave in exchange for the share of 30 percent granted him in the net
profits of the partnership business. Defendant agreed to give
plaintiff 30 per cent share in the net profits because he was
transferring his exclusive franchise to the partnership. x x x.
Plaintiff had never been a bottler or a chemist; he never had
experience in the production or distribution of beverages. As a
matter of fact, when the bottling plant being built, all that he
suggested was about the toilet facilities for the laborers.

We conclude from the above that while the representation
that plaintiff had the exclusive franchise did not vitiate defendant's
consent to the contract, it was used by plaintiff to get from
defendant a share of 30 per cent of the net profits; in other words,
by pretending that he had the exclusive franchise and promising to
transfer it to defendant, he obtained the consent of the latter to give
him (plaintiff) a big slice in the net profits. This is the dolo
incidente defined in article 1270 of the Spanish Civil Code,
because it was used to get the other party's consent to a big share in
the profits, an incidental matter in the agreement.57

Thus, this Court held that the original agreement may not be declared
null and void. This Court also said that the plaintiff had been entitled to
damages because of the refusal of the defendant to enter into the partnership.
However, the plaintiff was also held liable for damages to the defendant for
the misrepresentation that the former had the exclusive franchise to soft
drink bottling operations.

To summarize, if there is fraud in the performance of the contract,
then this fraud will give rise to damages. If the fraud did not compel the
imputing party to give his or her consent, it may not serve as the basis to
annul the contract, which exhibits dolo causante. However, the party
alleging the existence of fraud may prove the existence of dolo incidente.
This may make the party against whom fraud is alleged liable for damages.

x x x."

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G.R. No. 171428
Nov. 1, 2013.