6.7.2.2 Measure of damages for fraudulent misrepresentation or deceit

The measure of damages for the tort of deceit is an award which serves to put the claimant into the position he would have been in, if the representation had not been made to him. Alternatively, if there is a breach of condition or warranty in a contract, the claimant is to be put into the position he would have been in, if the representation had been true.1 If the statements are other than a contractual condition or a warranty, the compensation awarded is such that the claimant is put in a position he would have been in, if he had not relied on the defendant's statement. He is not to be brought in the position that the assumption made in the statement was actually true.2 However, the claimant is entitled to be awarded the profit on an alternative investment he forfeited as a result of his reliance on the defendant's statements, i.e. the alternative hypothetical profit.3

The claimant, who was induced by the fraudulent misrepresentation in the prospectus to conclude a securities sales contract, is not entitled to recover for the loss of bargain, i.e. the profit, he would have made, if the information in the prospectus with respect to the prospects or the value of the company had been true. The misrepresentation in the prospectus is not a contractual term, and for that reason, there is no breach of contract. Furthermore, the statements in a prospectus are neither a condition nor a warranty. Consequently, the investor can only claim in tort for deceit.

The proper measure of damages in this case is the price at which the securities were purchased less the actual value of the securities at the time of purchase; the value of the securities as represented in the prospectus less their actual value at allotment are not to be awarded.4 In Doyle v Olby (Ironmongers),5 the Court of Appeal unreservedly ruled in favour of the tortious measure with respect to claims for deceit. The calculation of consequential losses in this case proved that the tortious measure is not necessarily lower than damages awarded onder the contractual measure. The House of Lords implicitly affirmed this position in Smith New Court Securities v Scrimgeour Vickers .6Unlike the contractual measure of damages where damages cannot be awarded for losses that were not in the reasonable contemplation of the parties, an action for deceit, contrary to the general tort measure of damages, allows damages to be awarded for losses that have been reasonably foreseeable by the defendant.

The proper measure of damages (purchase price of the securities less their actual value, if any) is based on the very likely assumption that had the claimant known the true facts about the company, he would never have purchased the securities. However, if it were possible to show, as the defendants in Smith New Court Securities v Scrimgeour Vickers unsuccessfully tried at first instance, that in the absence of the representation the claimant would have been able to buy, and would have bought, the securities at a lower price, then the measure of damages is the difference between the price paid less the price the claimant would have paid if there was no misrepresentation, i.e. the pure actual value.

The date at which the actual value of the securities has to be calculated is in case of an issue of shares the day of allotment,7 and in case of a transfer of shares the day that the sales contract was concluded. It is noteworthy that the actual value of the securities need not be assessed as the market price at the day of allotment or transfer, because this price may be false and artificial as a result of the deceit which the claimant complains about.8 Lord Browne-Wilkinson in Smith New Court Securities v Scrimgeour Vickers: `where the open market at the transaction date was a false market, in the sense that the price was inflated because of a misrepresentation made to the market generally by the defendant, the market value is not decisive: in such circumstances the `crue' value as at the transaction date has to be ascertained but with the benefit of hindsight.'9

Furthermore, in Smith New Court Securities v Scrimgeour Vickers, the House of Lords held that, in this case, it was inappropriate to calculate the actual value of the shares at the date of acquisition. The claimants, who purchased the shares in the Ferranti company from the defendants, were induced by the defendants' agent's fraudulent statement that third parties were interest in acquiring the shares as well. Subsequently, the claimants acquired the shares with the intention of holding these shares for sale at a later date, and the price paid for the shares was determined with this intention in mind. When it was revealed that a fraud, unrelated and occurring before the purchase, had affected the company, the value of the Ferranti shares declined. The claimants sold their shares eventually over a period of five to six month and incurred substantial losses. The House of Lords reversed the decision of the Court of Appeal and restored the decision of Justice Chadwick that the claimant's damages should be assessed by deducting from the purchase price not the actual value of the shares, either at the date of acquisition or at any other date, but the price at which the claimants sold their shares over the five to six months period.

The House of Lords accepted that the claimants had acted reasonably in retaining the shares for as long as they did and in reselling them in a manner in which they did, because the fraud had continued to influence the claimants after the shares were acquired and, because the claimants, in the particular circumstances of their purchase, were locked into holding the shares. A crucial element in this case is the fact that the third party fraud had taken place before the sale to the claimants such that the shares were doomed from the start.10 Lord Steyn ruled categorically that 'the position would have been different, if the loss suffered by Smith arose from a subsequent fraud'.11 The defendant's fraud would have made no great difference between the price paid for the shares and either their true value at the date of acquisition or the prices at which the claimants would eventually have been able to sell, because in that case the actual value of the shares at the date of acquisition would be lower due to the defendant's fraud.

Until now, English courts have not been inclined to compensate claimants for a fall in the market price on the basis that but for the fraud (factual causation test, condicio sine qua non) the claimants would not have acquired the securities at all and would therefore not have incurred the losses due to the decline in the market price at all.12 The claimants might have acquired other shares which would also have suffered from the general fall in the market price. However, the damages awarded to the claimant need not to be reduced because the claimant might have been able to sell the shares before the fraud was discovered at a price above their real value.13 However, if the claimant actually sold his shares at a higher price than the actual value of the shares at the date of allotment, he must give credit for the higher sales price.14

With respect to consequential losses incurred by the claimant and the profits the claimant would have made but for the fraudulent misrepresentation (in the prospectus), the general rule in Clark v Urquhart15 that the proper measure of damages should be based on the actual damage directly flowing from the fraudulent inducement was applied by the Court of Appeal in East v Maurer. 16 In this case, the claimants bought a business rather than shares on the basis of fraudulent misrepresentation in the annual accounts. The Court of Appeal allowed recovery for the loss of both income and capital profits which the claimant would have expected to make from the acquisition of an alternative business (investment) which, in the absence of the defendant's fraudulent misrepresentation, it would have bought. Damages for deceit compensated the claimant for all losses suffered, including loss of profits that could reasonably have been anticipated by the defendant.17

However, it is necessary to take into account that investments in the securities market in general have a higher risk profile with respect to expected profits compared to an investment in an ordinary business. Profits to be expected from an alternative investment in the securities market should, therefore, be measured more cautiously. Furthermore, the claimant has to provide evidence what the alternative investment would have been. The general fall in securities market prices, after the claimant's acquisition of the securities, cannot be compensated for; the alternative investment would have brought about the same losses. The claimant has a duty to mitigate his losses as soon as he discovers the fraud.18 In securities fraud cases, this duty to mitigate implies that the investor is under an obligation to sell the securities he holds as soon as he discovers the fraud.