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Rescission Of Contracts
- General Concepts
Rescission is a remedy that disaffirms the contract (Ca Civil
§ 1688 et seq.). The remedy assumes the contract was properly
formed, but effectively extinguishes the contract ab initio
as though it never came into existence; and its terms cease
to be enforceable. [Ca Civil § 1688]
A finding that there never was a meeting of the minds on the
essential terms--i.e., that the parties lacked contractual intent--means
that no contract was formed. If money has changed hands, or
one party has taken possession, there may be an equitable remedy.
But there is no remedy of rescission, "[s]ince a contract
cannot be rescinded if it has never been formed." [Hedging
Concepts, Inc. v. First Alliance Mortgage Co. (1996) 41 Cal.App.4th
1410, 1417-1418, 49 Cal.Rptr.2d 191, 196]
A contract can be rescinded by the parties' mutual agreement
or unilaterally by a party upon proper grounds.. In turn, an
"action for rescission" is actually a suit to enforce
the rescission by seeking appropriate relief (i.e., a return
to the status quo) based upon rescission.
Grounds for rescission may also support other contract remedies;
but, because rescission is predicated on a disaffirmance of
the contract, it is inconsistent with a damages suit for breach
of contract or fraud, a reformation suit, or a specific performance
suit, all of which effectively affirm the contract. Nonetheless,
absent a waiver, plaintiff may plead and pursue alternative
remedies (assuming they are based on consistent facts) and is
not finally put to an election of remedies until the case has
proceeded through trial and all evidence has been presented.
[See Ca Civil § 1692]
Grounds For Rescission
Mutual Consent Of The Parties: A contract
may always be rescinded upon the mutual consent of the parties
thereto. But rescission at only one party's behest requires
proper notice on statutory grounds and, if necessary to adjust
the equities, a court action to enforce the rescission. [Ca
Civil §§ 1689, 1691, 1692]
The parties' consent need not be in writing, even if the contract
to be rescinded was required by the statute of frauds to be
in writing. A consensual rescission may occur by the parties'
oral agreement; or it can be implied from their unequivocal
conduct that is inconsistent with continued existence of the
contract. [Martin v. Butter (1949) 93 Cal.App.2d 562, 565-566,
209 P.2d 636, 638; Bush v. Vernon (1955) 135 Cal.App.2d 33,
36-37, 286 P.2d 903, 906; see Unger v. Isaacs (1954) 123 Cal.App.2d
533, 535, 266 P.2d 869, 870--sale agreement impliedly rescinded
by subsequent execution of inconsistent exchange agreement]
Unilateral Rescission On The Basis Of Mistake, Fraud,
or Duress: A contract is subject to unilateral rescission
by a party whose consent to the contract (or the consent of
another party jointly contracting with the rescinding party)
was given by mistake or obtained through duress, fraud or undue
influence exercised by or with the connivance of the party against
whom rescission is sought or any other party to the contract
jointly interested with the party against whom rescission is
sought. [Ca Civil § 1689(b)(1)]
The wrongful acts of third persons who are not parties to the
contract may support an action for rescission if the party against
whom the rescission is sought had knowledge of the wrongdoing
before parting with consideration for the contract. Under the
court's broad equitable power, rescission may also lie against
a contracting party who was entirely innocent of any wrongdoing
but simply a "conduit" through whom a third party's
fraud was perpetrated.
Consent Mistakenly Given: Rescission may be
granted in favor of a party whose consent to the contract was
given under a material "mistake of fact" or "mistake
of law." [Ca Civil § 1576]
Mistake Of Fact: A party gives consent under
a "mistake of fact" when, not because of his or
her "neglect of a legal duty", he or she (i) is
ignorant of or has forgotten a past or present fact material
to the contract, or (ii) believes in the present existence
of something material to the contract, which does not exist,
or in the past existence of something which never existed.
[Ca Civil § 1577]
In effect, this type of mistake relates to an erroneous belief
about an objective existing or nonexisting fact material to
the contract.
Unilateral Mistake Of Fact: Rescission
for a unilateral mistake of fact is authorized where "the
effect of the mistake is such that enforcement of the contract
would be unconscionable." In such cases, it need not
be shown that the opposing (nonrescinding) party caused
or even knew of the mistake.
In determining whether rescission is warranted for a unilateral
mistake of fact, substantive rather than procedural unconscionability
is often the determinative factor, because the oppression
and surprise ordinarily results from the mistake--not from
inequality in bargaining power.
Limitation - No Rescission For Party Bearing The
Risk Of The Mistake: Rescission is unavailable
to a contracting party who bears the risk of the mistake
at issue. A party bears the risk of a mistake when (i) the
risk is allocated to the party by the contract; or (ii)
the party is aware when the contract is made that he or
she has only limited knowledge regarding facts to which
the mistake relates, but treats that limited knowledge as
sufficient; or (iii) it is reasonable under the circumstances
to allocate the risk to the party. [Donovan v. RRL Corp.,
supra, 26 Cal.4th at 283, 109 Cal.Rptr.2d at 825; Rest.2d
Contracts § 154]
Rescission where unilateral mistake of fact unknown
to nonrescinding party: Rescission on the basis
of a unilateral mistake of fact is not barred by the fact
the other party was unaware of the mistake. However, where
the nonrescinding party had no reason to know of and did
not cause the other party's unilateral mistake of fact,
the following must be established to obtain rescission:
• the mistake concerns a basic assumption upon which
the contract was made;
• the mistake has a material effect on the agreed
exchange of performances under the contract that is adverse
to the rescinding party;
• the rescinding party does not bear the risk of
the mistake; and
• the effect of the mistake is such that enforcement
of the contract would be unconscionable.
Mistake Of Law: A mistake of law occurs
when a party to the contract knows the facts as they actually
are but has a mistaken belief as to the legal consequences
of those facts.
A mistake of law exists only when (i) all parties think they
know and understand the law but all are mistaken in the same
way, or (ii) one side misunderstands the law at the time of
contracting and the other side knows the correct law but does
not rectify the other party's misunderstanding. [Ca Civil
§ 1578]
The fact that one of the parties subjectively misunderstood
his or her contractual duties or other contractual terms,
or that both parties had differing subjective understandings
of the contract from its inception, does not warrant rescission
based on mistake of law.
Unlike cases where a party's "neglect of a legal duty"
precludes rescission or reformation based on a mistake of
fact, "freedom from negligence" is not a prerequisite
to rescission based on a mistake of law. This is because Ca
Civil § 1578 makes no reference to "negligence."
[Harris v. Rudin, Richman & Appel, supra, 95 Cal.App.4th
at 1341, 116 Cal.Rptr.2d at 559]
Duress Or Undue Influence: Courts consider
a variety of factors in determining whether the rescinding party's
consent was procured through duress or undue influence, including:
- the adequacy of the consideration involved;
- whether the rescinding party acted with a free mind;
- whether the contract was negotiated at arm's length; and
- whether the parties to the contract were in a confidential
relationship.
Fraud: The type of "fraud" sufficient
to support a unilateral rescission may be either an "actual
fraud" (misrepresentation with intent to deceive) or a
"constructive fraud" (misleading conduct without fraudulent
intent to the prejudice of the other party). A presumption of
constructive fraud may arise where there is inadequate consideration
for the rescinding party's performance and especially where
the parties are in a confidential relationship. [Ca Civil §
1572 (defining "actual fraud") & § 1573 (defining
"constructive fraud")]
Even an innocent misrepresentation, made in good faith and
with a reasonable belief in its truth, may provide a basis for
rescission if it related to a material fact upon which the rescinding
party relied in consenting to the contract. Although neither
a specifically-enumerated ground for rescission nor the equivalent
of "fraud," innocent misrepresentation supports rescission
as a type of "mistake".
Whereas proof of damages is an essential prerequisite to a
fraud cause of action seeking damages, a defrauded party has
the right to rescind a contract even without a showing of pecuniary
damages. The rule derives from the basic principle that a contracting
party has a right to what it contracted for, and so has the
right to rescind where he obtain[ed] something substantially
different from that which he [is] led to expect.
Since the goal of rescission is to restore the parties to the
precontract status quo, courts ordinarily will not grant relief
based upon rescission where the rescinding party is unable to
restore substantially all of the consideration he or she received
under the contract--i.e., unless the contract is divisible because
supported by severable consideration, it cannot be "partially
rescinded." However, this rule may be relaxed in cases
of fraud. Here, even though the contract is not severable and
the innocent party cannot restore the identical consideration,
courts may grant a partial rescission that nonetheless produces
an equitable result.
Failure Of Consideration: A unilateral rescission
can be based on a failure of consideration in three situations
(Ca Civil § 1689(b)(2),(3) &(4)):
- Where the consideration for the rescinding party's obligation
fails, in whole or in part, through the fault of the other
party to the contract (Ca Civil § 1689(b)(2));
- Where the consideration for the rescinding party's obligation
becomes entirely void from any cause (Ca Civil § 1689(b)(3));
or
- Where the consideration for the rescinding party's obligation
fails in a material respect from any cause before it is rendered
(Ca Civil § 1689(b)(4)).
Illegality: A contract is subject to unilateral
rescission if it is unlawful "for causes which do not appear
in its terms and conditions" and "the parties are
not equally at fault." [Ca Civil § 1689(b)(5)]
Public Interest: A party may also rescind
a contract where its enforcement would be prejudicial to the
public interest. [Ca Civil § 1689(b)(6)--"(i)f the
public interest will be prejudiced by permitting the contract
to stand"]
Particular Statutory Grounds: Ca Civil §
1689 incorporates by reference several other statutes providing
a basis for rescission in particular contractual relationships
and also includes a "catch-all" provision recognizing
a party's right to rescind under "any other statute providing
for rescission" (see Ca Civil § 1689(b)(7)).
Notice Requirement For
Unilateral Rescission
A party intending to effect a unilateral rescission must give
notice to the other party promptly upon discovering the facts
entitling him or her to rescind (provided the aggrieved party
is "free from duress, menace, undue influence or disability"
and is aware of the right to rescind at that time). [Ca Civil
§ 1691(a)] The notice itself effects the unilateral rescission.
Thereafter, the rescinding party is entitled to bring an action
to obtain relief based upon the rescission (or, viewed another
way, an action to enforce the rescission). Though technically
a prerequisite to filing suit based upon rescission, if the
notice has not otherwise been given, plaintiff's service of
the complaint seeking rescission "shall be deemed to be"
the requisite notice. [Ca Civil § 1691]
Despite the statutory requirement that notice of rescission
be given "promptly" (above), delay in providing timely
notice will amount to a waiver of the right to relief based
upon rescission only if the delay has substantially prejudiced
the other party. [Ca Civil § 1693] In effect, this amounts
to a laches defense: "[R]easonable diligence or promptness
on the part of the party seeking rescission is [not] . . . a
prerequisite for the remedy. The . . . requirement is essentially
one of freedom from laches. Its application depends on whether,
under the particular facts, the delay has in any way prejudiced
the defendant. No waiver will be found where the delay is justified
under the facts--e.g., pursuit of settlement negotiations after
discovery of one party's fraud, or reliance on the other party's
promise to make the aggrieved party "whole.
A party may waive the right to rescind by words or actions
indicating an affirmance of the contract after learning of the
facts entitling him or her to rescind. A waiver commonly occurs
by accepting the benefits of the contract after knowledge of
the facts warranting rescission. A party wishing to rescind
"cannot play fast and loose. He cannot conduct himself
so as to derive all possible benefit from the transaction and
then claim the right to rescind . . . Waiver of a right to rescind
will be presumed against a party who, having full knowledge
of the circumstances which would warrant him in rescinding,
nevertheless accepts and retains benefits accruing to him under
the contract." [Neet v. Holmes (1944) 25 Cal.2d 447, 457-458,
154 P.2d 854, 859; see Saret-Cook v. Gilbert, Kelly, Crowley
& Jennett (1999) 74 Cal.App.4th 1211, 1226, 88 Cal.Rptr.2d
732, 743]
However, there is no such waiver if the acts indicating affirmance
of the contract were induced by the other party's fraud.
Continued acceptance of the benefits of the contract after
giving notice of rescission does not waive the right to relief
based upon rescission if the other party has rejected the notice
of rescission. In such event, the rescinding party may continue
to accept the benefits until the action for rescissionary relief
is concluded.
Nor does a party waive the right to rescind by bringing an
action based upon rescission or damages for breach of contract
in the alternative. Though the remedies are inconsistent (rescission
disaffirms the contract, while a damages suit affirms it), the
aggrieved party is not put to a final election of remedies until
after a trial upon presentation of the evidence. [Ca Civil §
1692] On the other hand, a party may be deemed to have waived
its right of rescission by bringing an action exclusively for
damages or specific performance (i.e., waiver by conduct unequivocally
affirming the contract). [Price v. McConnell (1960) 184 Cal.App.2d
660, 665-666, 7 Cal.Rptr. 695, 698]
A notice of rescission remains revocable up until the time
that the rescinding (innocent) party receives restitution of
the benefits (consideration) parted with.
Restoration Of Consideration
In addition to giving prompt notice of rescission, the party
seeking rescissionary relief must "promptly," upon
discovering the facts entitling him or her to rescind, restore
to the other party "everything of value" received
under the contract or offer to restore the benefits received
"upon condition that the other party do likewise"
. . . unless the other party "is unable or positively refuses
to do so." [Ca Civil § 1691(b)] This restoration of
benefits accomplishes the ultimate purpose of rescission--i.e.,
to return the parties to their precontract status quo positions.
Thus, in a real property purchase and sale transaction, a rescission
normally requires the buyer to return the property (title) to
the seller and the seller to return the funds received from
the buyer.
A formal offer to restore the contractual benefits received
is not required. Plaintiff's service of the complaint seeking
rescissionary relief "shall be deemed" to be the requisite
offer. [Ca Civil § 1691]
As with the notice of rescission, a delay in restoring the
benefits received under the contract or in tendering such restoration
does not waive the right to relief based upon rescission unless
the delay substantially prejudices the other party (again, the
issue is essentially one of laches; However, the court may condition
its judgment awarding relief on plaintiff's tender of restoration.
[Ca Civil § 1693]
Relief Based Upon Rescission
In an action based upon rescission, courts may order whatever
relief is necessary to adjust the equities between the parties
and ensure restoration to the precontract status quo. [Ca Civil
§ 1692] The goal is to reach an equitable result by returning
the parties to the position they were in before the contract
was entered into and avoiding unjust enrichment. Therefore,
such additional relief may operate in favor of either or both
parties.
For example, the court may order a restitution of benefits
conferred by the rescinding party and also award him or her
consequential damages incurred as a result of entering into
the contract (so long as the award does not include a double
or inconsistent recovery). The court may also award compensation
or other equitable relief to the nonrescinding party (e.g.,
an offset for the value of the rescinding party's use of the
property). [Ca Civil § 1692]
The authority to "adjust the equities" does not empower
the court to provide either party with greater relief than he
or she would have realized had the contract been affirmed. A
court cannot, in the name of "adjusting the equities,"
rewrite the terms of the parties' contract. Thus, e.g., relief
based upon rescission pursuant to Ca Civil § 1692 cannot
include an award of compensation that was subject to a contractual
contingency which never occurred.
Consequential damages in the rescinding party's favor may include
all out-of-pocket expenses incurred in reliance on the contract--including,
e.g., escrow fees, title charges, the value (or cost) of any
improvements made to the property, payments made by a rescinding
buyer on a mortgage imposed by the seller, and attorney fees
(if authorized by the rescinded contract).
A rescinding buyer is entitled to prejudgment interest on contract
payments made to the seller (net of liquidated offsets awarded
to the seller), running from the date of notice of the rescission.
The interest is awardable under Ca Civil § 3287(a), providing
for prejudgment interest as a matter of right on damages that
are certain or capable of ascertainment.
Ca Civil § 1692 expressly states that in an action to
enforce a rescission, the aggrieved party "shall be awarded
complete relief"; and it also states that a "claim
for damages is not inconsistent with a claim for relief based
upon rescission." [Ca Civil § 1692] Thus, where the
rescission is based upon fraud, and provided plaintiff (rescinding
party) satisfies the applicable statutory standards (Ca Civil
§ 3294), the court apparently has discretion to award the
rescinding party punitive damages. [See Mahon v. Berg (1968)
267 Cal.App.2d 588, 589-590, 73 Cal.Rptr. 356, 357-358]
Fees & Costs:
Breach of Contract actions are rarely taken by our office on
a contingency basis. The usual fee structure for these kinds
of cases is as follows:
- Attorney fees: $250 per hour with
a minimum fee varying with the size and complexity of the
case.
- Costs: Initial filing fee approximately
$300. Other fees which may or not be necessary in your particular
case are: motion fees, fees for service of process, deposition
fees, etc..
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