A substantial number of inquiries I daily receive concerns the formation of contracts. Parties often sign a contract under certain assumptions, do not read it or rely on promises which prove to have been but false inducements. The contracts in question range from a wide variety of family issues (e.g. the elderly obligating the young) to landlord-tenant issues to boilerplate contracts with hotels or energy companies.
For a contract to be valid, there must be two competent people making it. This is sometimes referred to as a “meeting of the minds,” which is why contracts and agreements are virtual synonyms, although the latter often applies to an oral contract while the former refers to a written one.
Just as there is a consent necessary in order to make an agreement, there is one needed to “un-make” it. Legally, we speak of rescission. Mutual rescission is best evidenced in a written agreement.
However, there may be grounds for a unilateral rescission. When the consent is acquired by fraud, inducement, misrepresentation, force, wrong assumption of facts going to its essence (mistake), or lack of capacity, there will be grounds for the remedy called rescission.
Fraud is one of the most frequent of formation defects. Fraud is a false representation of facts related to the subject matter of the contract. Fraud must be pled and proven with specificity, which means that the plaintiff must show all its elements: (1) a false statement of (material) fact, (2) scienter or knowledge on the part of the defendant that the statement is untrue, (3) intent on the part of the defendant to deceive the alleged victim, (4) justifiable reliance by the alleged victim on the statement, and (5) injury to the alleged victim as a result.
Needless to say that these elements contain nuances that are not all easily proved. First, not all false statements are fraudulent. To be fraudulent, a false statement must relate to a material fact. It should also substantially affect a person’s decision to enter into a contract or pursue a certain course of action. A false statement of fact that does not bear on the disputed transaction will not be considered fraudulent.
Inducement is an advantage or benefit, pledge or promise that causes an individual to enter into a particular agreement or contract. Obviously, we are all induced to purchase something or exchange something for value. Such inducements are not actionable which are not false. A false promise is an actionable inducement, whereas consideration (a common give-and-take) is not.
Misrepresentation of a material fact causing damages goes hand in hand with inducement and fraud. If you would not have entered into the contract had the facts not been misrepresented to you, the misrepresentation was material and thus actionable (grounds for rescission).
If, however, the misrepresentation was only minor, not going to the essence of the contract, you will have the right of reformation (e.g. to alter the terms of the contract or receive a compensation for the difference). Similarly, if you were mistaken about a material fact and the other party had a reason to know of it, you have a grounds to rescind; or, if both of you were mistaken, you both may rescind.
There is also a rarely sought remedy of replevin or re-possession of the chattel sold. The most famous case in point here is well-known to all first year law students. It is a case of mutual mistake going to the essence of the contract: There was a cow called Rose the Second of Aberlone. The owner sold her under the assumption she was barren. Later, she became pregnant and the owner demanded rescission of the contract and replevin (return of the cow). See Sherwood v. Walker, 66 Mich. 568, 33 N.W. 919 (Mich. 1887)
The court in Sherwood declared that the contract was voidable because the mistake was mutual and went to the essence of the contract. The parties contracted for a heifer, not a cow, although they both said she was a “cow,” because a cow is the generic term for a cow, albeit a barren cow is technically a heifer and they should have known it. This may have been the defending argument but it would eventually lose because the mistake was operative as to the essence and there was no meeting of the minds as to a key material fact of the contract.
Finally, when one or both of the parties lack the capacity to understand the terms of the contract, to negotiate and enter into the agreement, that party shall have the grounds to rescind. The most frequent lack of capacity relates to an illness (be it mental incompetence, Alzheimer’s or other), intoxication, or being underage (under 18 years old).
Rescission is an equitable remedy, meaning that it is discretionary or up to the judge’s decision. It is not an immediate right and is only available under certain circumstances. Generally, if money can do justice, that is the preferred road: damages over rescission. If, however, the property is unique (the proverbial cow, a piece of real estate, family jewel) or money cannot do justice, there is a good chance the remedy of rescission will succeed.
A judge can deny a request for rescission based on any of the following grounds: 1) substantial performance (one party totally or substantially performed the contract: delivered the goods, provided the services…); 2) a third party has already received some benefit or acquired rights from the contract; 3) the party arguing rescission does not have “clean hands” (e.g. knew what the real deal was); 4) laches, when the plaintiff slept on their rights for too long and simply should have brought it up earlier, now causing undue damages or other unfair hardship to the other party.