Rescission of a contract in California

A cause of action for rescission of a contract in California is the topic of this blog post.

Rescission of a contract in California is a powerful legal remedy that is governed by the provisions found in Civil Code sections 1688 though 1693.

The remedy of rescission of a contract in California assumes that a contract was properly formed, however rescission effectively extinguishes the contract ab initio as though it never came into existence so that its terms cease to be legally enforceable. See Civil Code section 1688.

Civil Code § 1689 states in pertinent part that,

“(a) A contract may be rescinded if all the parties thereto consent.

(b) A party to a contract may rescind the contract in the following cases:

(1) If the consent of the party rescinding, or of any party jointly contracting with him, was given by mistake, or obtained through duress, menace, fraud, or undue influence, exercised by or with the connivance of the party as to whom he rescinds, or of any other party to the contract jointly interested with such party.

(2) If the consideration for the obligation of the rescinding party fails, in whole or in part, through the fault of the party as to whom he rescinds.

(3) If the consideration for the obligation of the rescinding party becomes entirely void from any cause.

(4) If the consideration for the obligation of the rescinding party, before it is rendered to him, fails in a material respect from any cause.

(5) If the contract is unlawful for causes which do not appear in its terms or conditions, and the parties are not equally at fault.

(6) If the public interest will be prejudiced by permitting the contract to stand…”

Rescission of a contract in California can be accomplished by the mutual agreement of the parties or unilaterally by a party upon proper grounds.  A cause of action for rescission of a contract in California is a request to enforce the rescission by seeking appropriate relief (basically a return to the status quo) based on the rescission.

Grounds for rescission of a contract in California.

Grounds for rescission of a contract in California include:

Mutual consent of the parties:

A contract may always be rescinded upon the mutual consent of the parties to the contract.  See Civil Code § 1689(a).

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.  See Civil Code § 1689(b)(1)

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.”  See Civil Code § 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. See Civil Code § 1577.

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.

Rescission not available for the party bearing the risk of the mistake:

Rescission is not  available 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. See 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.  See Civil Code § 1578.

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 Civil Code § 1578 makes no reference to “negligence.”

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.  See Civil Code § 1572 (defining “actual fraud”) & § 1573 (defining “constructive fraud”.)

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:

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. See Civil Code § 1689(b)(2));

Where the consideration for the rescinding party’s obligation becomes entirely void from any cause. Civil Code § 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. Civil Code § 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.”  See Civil Code § 1689(b)(5).

Public interest:

A party may also rescind a contract where its enforcement would be prejudicial to the public interest. See Civil Code § 1689(b)(6)-“(i)f the public interest will be prejudiced by permitting the contract to stand”).

Particular statutory grounds:

Civil Code § 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 Civil Code § 1689(b)(7).

Notice requirement for unilateral rescission of a contract in California:

Any party that wants to unilaterally rescind a contract must give notice to the other party promptly upon discovering the facts that entitle them 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). See Civil Code § 1691(a). The notice itself affects 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).  Although giving notice of a unilateral rescission is 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. See Civil Code § 1691.

Waiver of right to rescind a contract in California:

A party can waive the right to rescind by words or actions indicating their intent to affirm 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.” See Neet v. Holmes (1944) 25 Cal.2d 447, 457-458; see also Saret-Cook v. Gilbert, Kelly, Crowley & Jennett (1999) 74 Cal.App.4th 1211, 1226

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. See Civil Code § 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). See Price v. McConnell (1960) 184 Cal.App.2d 660, 665-666.

Restoration of consideration:

In addition to giving prompt notice of rescission, the party seeking rescission of a contract in California 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.” See Civil Code § 1691(b).  This restoration of benefits accomplishes the ultimate purpose of rescission–i.e., to return the parties to their status quo positions as if the contract had never been executed. 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.  The service of the complaint filed by Plaintiff that seeks to rescind the contract “shall be deemed” to be the requisite offer. See Civil Code § 1691.

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. However, the court can condition its judgment awarding relief on plaintiff’s tender of restoration. See Civil Code § 1693.

Relief based upon rescission of a contract in California:

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. See Civil Code § 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.

Consequential damages that can be awarded to the rescinding party can 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 any liquidated offsets awarded to the seller), running from the date of notice of the rescission. The interest is awardable under Civil Code § 3287(a), providing for prejudgment interest as a matter of right on damages that are certain or capable of ascertainment.

Civil Code § 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.”  Thus, where the rescission is based upon fraud, and provided plaintiff (rescinding party) satisfies the applicable statutory standards (Civil Code § 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.

Sample complaint for rescission of a contract in California for sale.

Attorneys or parties in California that would like to view a portion of a sample 16 page complaint for rescission of a contract in California that also includes causes of action for fraud, , reformation of contract, usury violations, unfair business practices, cancellation of written instruments, declaratory relief, injunctive relief and an accounting sold by the author can see below.

 

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DISCLAIMER:

Please note that the author of this blog post, Stan Burman is NOT an attorney and as such is unable to provide any specific legal advice. The author is NOT engaged in providing any legal, financial, or other professional services, and any information contained in this blog post is NOT intended to constitute legal advice.

The materials and information contained in this blog post have been prepared by Stan Burman for informational purposes only and are not legal advice. Transmission of the information contained in this blog post is not intended to create, and receipt does not constitute, any business relationship between the author and any readers. Readers should not act upon this information without seeking professional counsel.

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Rescission of a contract in California
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Rescission of a contract in California is the topic of this blog post.
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