In this third part of Everything You Wanted to Know About Contracts, our San Diego based business litigation attorneys answer the question: “When May I Rescind a Contract in California?”
Rescission of Contract
In some instances, a party may rescind a contract he has entered into. A contract that is rescinded no longer exists. Consequently, when a contract is rescinded, the parties no longer need comply with their obligations under what has become a non-existent contract.
Naturally, if all parties to a contract want to rescind it, they can. Typically, though, only one, or at least less than all, parties to a contract desire to rescind it. Therefore, most rescissions are involuntary, and may be ordered only in certain specified instances. With minor exception, one may rescind a contract he has entered into only in the following instances:
(1) when both parties entered into the contract based on a mutual mistake of fact or law;
(2) if the consideration (quid pro quo) for the obligation of the rescinding party fails through the fault of the other party;
(3) if the consideration becomes void;
(4) when the consideration for the obligation of the rescinding party fails in a material respect;
(5) in the case of fraud, duress, menace or undue influence by the other party to the contract.
Mutual Mistake of Fact
A mistake of fact is a mistake that is not caused by the negligence of the party making the mistake that consists of his unawareness of a fact material to the contract. Ca. Civ. Code sec. 1577. The mistake must be “material,” meaning, a mistake which affects an essential element of the contract and is harmful to one of the parties. Guthrie v. Times-Mirror Co. (1975) 51 Cal. App. 3d 879, 884.
A party is entitled to rescind a contract based on mistake if the mistake is “mutual,” that is, a mistaken apprehension of the facts by both parties, and not simply a mistake by one of the parties to the contract. See Ca. Civ. Code §1580. As an example, if an injured party enters into a settlement agreement, whereby he releases the party at fault from liability in return for a specified payment, and it later turns out that the injuries are far more serious than contemplated by both parties, a “mutual mistake” has occurred, and the injured party may rescind the settlement agreement. See, e.g., Union Pac. R. Co. v. Zimmer (1948) 87 Cal. App. 2d at 24, 529.
Unilateral Mistake of Fact
However, if only one of the parties is mistaken, he will not be entitled to rescind, unless (1) the non-mistaken party had reason to know of the mistake and it was his fault which caused the mistake, or (2) the effect of the mistake is such that enforcement of the contract would be unconscionable. See, Larsen v. Johannes (1970) 7 Cal. App. 3d 491,503; Rest. 2d, Contracts §153(a). As an example of the latter situation, consider the case of Donovan v. RRL Corp. (2001) 26 Cal. 4th 261, in which, due to a proof- reading error made by a newspaper, defendant car dealer advertised an automobile for sale for $12,000 below its typical sales price. When the car dealer learned of this mistake, it refused to sell the automobile to the buyer at the advertised price. The Supreme Court ruled that, although only the car dealer was mistaken as to the price – i.e, the mistake was “unilateral” — the price differential was so severe that it would be unfair to require the car dealer to perform.
Mutual Mistake of Law
A party may also rescind a contract for a “mistake of law.” A mutual mistake of law is a mistake which arises from a misunderstanding of the law by all parties. Ca. Civ. Code §1578(1). As an example, assume that A places a $100 bet with B that a certain team will win a particular football game, B to keep the $100 if that team loses, but to pay A $200 if that team wins (i.e., a gambling contract). If both A and B entered into that contract with the understanding that gambling was legal in the state they were in, they would both be operating under a mutual mistake of law, and either could rescind the contract.
Unilateral Mistake of Law
If only one party is mistaken, the mistake is a “unilateral mistake” of law. One may rescind for a unilateral mistake of law only if the other party knows of, but does not correct, and takes advantage of or enjoys the benefit of the rescinding party’s mistake of law. See Civ. Code §1578(2). As an example, if a husband and wife entered into a marital settlement agreement based on the life’s misapprehension of the law relating to her property rights, and the husband fails to rectify her misunderstanding, or caused that misunderstanding by his own misconduct, the wife is entitled to rescind the marital settlement agreement based on her unilateral mistake of law. See, e.g., Simmons v. Briggs (1924) 69 Cal. App. 447.
Failure of Consideration
A party to a contract may rescind the contract if the consideration for his obligation fails through the fault of the other party, or becomes void from any cause, or fails in a material respect from any cause. Ca. Civ. Code §1689 (b)(2),(3),(4). The failure of consideration is material if it will render it impossible for the rescinding party to perform, or will frustrate the whole purpose of the contract. Crofoot Lumber, Inc. V. Thompson (1958) 163 Cal. App. 2d 324, 332-333.
Consider this example: The buyer of a property agrees to purchase it so that he may use it for a particular purpose, and the seller understands the buyer wishes to use it for that purpose. Both the buyer and seller are unaware that the zoning for the property has recently changed, such that the property may not be used for that purpose. In that instance, the consideration would have “failed,” entitling the purchasing party to rescind the purchase contract.
Consider another example: A seller agrees to sell, and a buyer agrees to buy, a piece of real estate on which a hotel is situated. The purpose of the deal from the buyer’s perspective is to operate the hotel. Before title changes hands, the hotel burns to the ground. The hotel is a material part of the consideration the buyer bargained for. Consequently, when that consideration “fails,” it entitles the buyer to rescind the contract.
If one obtains another’s consent to a contract through threats, duress or undue influence, the law considers the consent of the person who is subject to the duress, threats or undue influence to be involuntary and, therefore, voidable. An apparent consent is not real or free when obtained as a result of threats, duress or undue influence. Civ. Code §1567.
Duress is defined as anything which destroys a person’s free agency and constrains him to do something against his or her will. In Re Marriage of Baltins (1989) 212 Cal. App. 3d 66, 84. It includes, but is not limited to the unlawful confinement of a person or unlawful detention of his property or threat of unlawful or violent injury to the person or property of another, and any species of mental coercion. It may also consist of threats to a person’s business or property interests, in which case it is known as “economic duress.” One who can show that he has entered into a contract based on duress may rescind that contract.
Undue influence is defined as the taking of an unfair advantage of another’s weakness of mind, or taking a grossly oppressive and unfair advantage of another’s necessities or distress. Civ. Code §1575. It also includes misuse of a confidence reposed in a person for the purpose of obtaining an unfair advantage over the other. A person is entitled to rescind a contract entered into on the grounds of undue influence if he can show that his will was overborne by the acts of the other party, and that he would not have entered into the contract if he was left to act freely. Keithley v. Civil Service Bd. (1970) 11 Cal. App. 3d 443, 451.
Fraud and Misrepresentation
As most business litigation attorneys will tell you, the most typical basis for rescission of a contract is fraud. Fraud can be an intentional misrepresentation, a negligent misrepresentation, a failure to disclose an important fact, or the intentional concealment of that fact. Civ. Code §1572. It is anything that is intended to deceive, that results in injury to one who justifiably relies on it. Id.; Ach v. Finkelstein (1968) 264 Cal. App 2d 667, 674. The type of fraud which will entitle a party to rescind a contract is known as “fraud in the inducement.”
Fraud in the inducement is based on a representation or promise that is false, or a failure to disclose or a concealment of an important fact that deceives another, and which induces the other to enter into the contract.
For instance, if a seller of a house represents that the surrounding property has been designated as wetlands on which no structures may be built, when in fact, it has recently been rezoned commercial, and the seller is aware of that fact, the buyer may rescind for intentional misrepresentation. If the seller makes the same representation, but does not know it to be untrue, but does not have a reasonable basis for believing it to be true, the buyer may rescind for negligent misrepresentation. If the seller makes the same representation based on what he has been told by his real estate agent and, therefore, has a reasonable basis for believing his statement to be true, his statement is viewed as an “innocent misrepresentation,” for which the buyer may rescind. However, in that instance, rescission is not based on fraud, but on mutual mistake of fact, because both the seller and the buyer are mistaken as to the same fact – that no building may occur on the surrounding property.
Because rescission may be had for any form of deceit inducing a party to enter into a contract, there are circumstances in which, in the above example, the seller makes no representations whatsoever to the buyer. For instance, assume the buyer, in discussing his proposed purchase of the subject property declares that his main reason for purchasing the property is that it is wetlands and, therefore, no building will be permitted on the surrounding property. Assume further that the seller knows that to be incorrect, and in fact, that the surrounding property has recently been rezoned commercial. In that instance, the seller’s failure to disclose that fact to the buyer is a form of deceit for which the buyer may rescind once he learns the true facts.
Similarly, if the seller has taken action to prevent the buyer from learning of the true zoning status of the surrounding property, he is guilty of “concealment,” for which the buyer may similarly rescind once he learns the true facts.
Further Requirements for Rescission
A party seeking rescission of a contract must promptly inform the other party that he is rescinding the contract. Ca. Civ. Code §1691. He must also restore to the other party everything he has received of value under the contract on condition that the other party do the same. Id. However, if the other party is unable or refuses to restore to the rescinding party what he has received from the rescinding party, the rescinding party is not obligated to restore to the other party what he has received from that party. Id. The purpose of the requirement that the parties restore to each other what they received under the contract is based on the fact that the purpose of rescission is to restore the parties, to the extent possible, to the same position they were in before they entered into the contract.
There are a variety of grounds for rescinding a contract. While this article sets out some of the more common grounds for seeking the remedy of rescission, it is by no means exhaustive. For a thorough and affordable review of your contract remedies, contact our San Diego business litigation attorneys or browse our website for more information.