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False Claims Act Statistics, News & Analysis

Once More, Unto the Breach of Contract…

The government and relators alike have long attempted to erode the distinction between breach of contract and fraud by bringing fraud cases based on conduct that, at most, gives rise to a claim for breach of contract. A recent case from the Second Circuit provides an illustrative peek into how one circuit is drawing a hard line in the sand this year when it comes to distinguishing between breach and fraud.

In United States ex rel. O’Donnell v. Countrywide Home Loans, Inc., Nos. 15-496, 15-499, slip op. (2d Cir. May 23, 2016), the government’s case began with a relator (a former employee of one of the defendant companies), but the government ultimately intervened and added its own claims, including claims under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), against the defendants — three banks, and one individual defendant, the former Chief Operating Officer of a division of Countrywide Home Loans. The government proceeded to trial only on the FIRREA claim, alleging that the defendants committed mail and wire fraud by selling loans to Fannie Mae and Freddie Mac that the defendants knew at the time of the sale did not meet the requirements of Countrywide’s contracts with Fannie Mae and Freddie Mac – in other words, the defendants had breached the contract but the question remained whether the mortgage sales were fraudulent. On May 23, 2016, however, the Court of Appeals handed the defendants a total victory by reversing and remanding the case finding that — for a fraudulent inducement claim — the government must prove that, at the time the defendants signed its contracts with Fannie and Freddie, they had no intention to keep their promise.

In rejecting the government’s theory of liability, the Court of Appeals drilled down to core common law fraud principles and held that:

a contractual promise can only support a claim for fraud upon proof of fraudulent intent not to perform the promise at the time of contract execution. Absent such proof, a subsequent breach of that promise — even where willful and intentional — cannot in itself transform the promise into a fraud. Far from being an arcane limitation, the principle of contemporaneous intent is . . . one without which the common law could not have conceived of fraud.

O’Donnell at 22.

Although a FIRREA case, the analysis should apply equally to the FCA and makes clear that the government and relators cannot magically transform a breach of contract into a fraud simply by showing a breach of contract. “Fraudulent inducement” requires proof that the defendants never intended to keep the promise in the first place. Yet, the decision has limitations. The decision ultimately involved analysis of “fraudulent scheme” under the mail and wire fraud statutes and claims under other fraud statutes would require additional analysis to identify any possible inconsistencies with common law. The Second Circuit’s opinion was also cabined to the charged theory of fraud through an affirmative misstatement. The Court of Appeals explicitly declined to address other situations, such as whether silence while under a duty to disclose material information could constitute fraud under federal statutes in the context of a breach of contract. This concept of “half truths” was addressed in part by the Supreme Court in Universal Health – analysis of which can be found here.

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