Unwinding the deal
The remedial power of recission
Jeffrey W. Erdman
Julie S. Pearson
Once a contract is executed between parties, it is often assumed—wrongly—that the only remedy for a problem that may subsequently arise is to sue for breach of contract and seek money damages. In fact, depending on the circumstances under which the contract was formed, the best remedy for the problem may be to simply unwind the agreement entirely and restore the parties to their pre-contract position. This is the remedial power of the legal right of rescission.
“Rescission” is the process by which a contract is “extinguished” – or made “null and void” – as a matter of law. (Cal. Civ. Code § 1688.) In this sense, it is the opposite of the right to require “specific performance” of a contract – i.e. to affirm the contract and force another party to perform on its terms. (See Specific Performance: Enforcement of Real Property Purchase Agreements in Ahead of the Curve Issue #20, published August 2021.)
Rescission may be made by the express agreement of all of the parties to the contract regardless of what the contract otherwise provides (Cal. Civ. Code § 1689(a)) or, in some contracts, the right of rescission by one of the parties may be afford by the contract terms itself. For example, some contracts expressly provide for unilateral rescission (or cancellation) of a contract within a specific period of time after which time the right expires automatically. By statute, this includes certain contracts for dental services, “home solicitation contracts” and “seminar sales solicitation contracts.” (Cal. Civ. Code § 1689.3- 1689.23.)
Even if a contract expressly provides a right to unilateral rescission, whether through its express terms or by statute, a party to a contract retains the statutory right to rescission under certain circumstances even after the stated “cancellation period” expires. As discussed more below, the most common reasons for one party to rescind a contract is that the party’s acceptance of the contract was “given by mistake” or that it was “obtained through duress, menace, fraud, or undue influence…” (Cal. Civ. Code § 1689(b)).
Grounds for unilateral rescission
One party to a contract may unilaterally rescind the contract if the consent of the party seeking to rescind was given by mistake of a material fact or applicable law. The “mistake” must be considered “material” to the contract such that the rescinding party would suffer some harm if the contract were enforced as made. The “harm” does not necessarily have to be a monetary or “pecuniary” loss, but there must be some ascertainable negative consequence to the rescinding party if the contract were not rescinded. Otherwise, the mistake will not be deemed sufficiently “material” to the contract. For example, an error in the price term of a contract constitutes a mistake upon which the contract is made, whether too low or two high, may constitute the type of mistake of fact sufficient to warrant rescission of the contract. It does not matter, for purposes of rescission based on unilateral mistake, whether the mistake was intentional or innocent. However, if the mistake was the result of a failure by the rescinding party to exercise reasonable diligence in entering into the contract, the right of rescission may be denied. For example, if a buyer sought to rescind a contract for purchase of land because it was later discovered that the land was not buildable for the intended purpose, the buyer may be denied the right to rescind for having failed to investigate the suitability of the property before agreeing to purchase it.
A party may unilaterally rescind a contract if that party’s consent to the contract was intentionally obtained by a false representation or concealment of a material fact and such representation or concealed fact was relied upon by the rescinding party in entering into the contract. Whether the representation or concealed fact is sufficiently “material” to the contract may vary depending on the circumstances. Commonly, rescission is based on a representation or concealment of a condition of real property that could not be revealed to a buyer during their own inspection of the property or other reasonable due diligence and which would have impacted either the decision of the buyer to purchase the property in the first instance or the price the buyer would pay for the property.
Less commonly, rescission can be based on consent given by a party to a contract through duress or undue influence. For purposes of rescission, the duress need not be a threat of bodily harm or the like, but may be based on threats to one’s business enterprises or property interests. However, the threat must be sufficiently coercive to cause a reasonably prudent person faced with the threat no reasonable alternative but to succumb to the perpetrator’s pressure to consent to the contract.
Rescission based on undue influence most commonly arises in transactions among family members or other individuals who are easily taken advantage by another individual. For example, where there has been a transfer of real property from an elderly or infirm person to a family member without adequate consideration or payment therefor, the transfer may be rescinded on behalf of the elderly or infirm person. Typically, such cases would involved situations in which the transferor was found to lack free will or was unable to resist the pressures or demands to enter into the contract. In some instances, a presumption of undue influence arises as a result of the relationship existing between the contracting parties which would have to be rebutted by the other party to show that the transaction was arm’s length and made freely for sufficient consideration.
Requirements of rescission
In most cases, to effect a rescission of a contract, the rescinding party must -- promptly upon discovering the facts which entitled that party to rescind – give notice of rescission to the other party or parties. The notice need not be formal or explicit about all the grounds for rescission, but it must clearly indicate that the rescinding party considers the contract to be terminated. The notice must also restore or offer to restore the other party or parties to the contract everything of value which the rescinding party received under the contract (and/or seek such restoration of whatever value was given) with the intent to restore the parties to their pre-contract position. For example, in the common example of the sale of real property, a buyer must offer to transfer title of the purchase property back to the seller and seek return of the purchase price. In some instances, the filing of a legal action seeking rescission is considered the necessary notification provided that it also states the intent to restore the defendant to the pre-contract position. The requisite promptness of the notice may be dependent on the circumstances, and the prejudice caused to the other party by any delay, but often the notice of rescission is delayed merely by the fact that the fraud by the other party is undetected for some period of time.
No partial rescission
As noted above, to rescind a contract, the rescinding party must restore to the other party everything of value which was received under the contract (or at least offer to do so). Thus, under most circumstances, the rescinding party must rescind the entire contract and may not retain some rights under the contract and reject others. Likewise, the rescinding party cannot simply retain a portion of the consideration paid and return only part. For example, a seller of property that seeks to rescind would have to return all of the monies paid by the buyer and not try to retain the earnest money deposit or down payment paid by the buyer. However, when the rescinding party cannot restore everything received because there has been some fraud perpetrated that prevents the rescinding party from restoring everything, rescission may be permitted if the rescinding party restores or offers to restore all that is possible to restore.
Relief granted by the court
In a legal action for rescission, the court is required to return the parties to the status they held before the transaction. This may include the granting of relief in the form of monetary compensation from one party to another to redress consequential damages that may have been caused by any wrongful conduct. For example, if one party expended additional funds after entering into the contract in reliance of false representations of the other contracting party, such as improvements to purchased property, they may also seek recovery of the damages (in addition to returning the party to the pre-contract position) that are also the consequence of the fraud. (Cal. Civ. Code § 1692.) (Conversely, the court may offset such consequential damages with the reasonable rental value of the property while the rescinding party was in possession of the property.)
In fact, California courts have even awarded attorney’s fees and costs to the rescinding party where the contract they have sought to rescind and render void includes the right of recovery by a prevailing party. While it may seem counterintuitive for a court to enforce an attorney’s fee provision of a voided contract, courts have found a statutory right to fees and costs remains after declaring the contract void. (Cal. Civ. Code § 1717.)
Furthermore, because the statutes pertaining to rescission also permit the rescinding party to obtain “any other relief to which he may be entitled under the circumstances” as long as it is not “duplicative or inconsistent” (Cal. Civ. Code § 1692), in circumstances involving fraud or deceit, a rescinding party is entitled to seek recovery of punitive damages just with any other action based on fraud. (See Cal. Civ. Code § 3294.)
In many circumstances, the best remedy to a problem that arises out of a contractual dispute is to seek rescission of the agreement itself, provided that one of the various grounds for rescission applies to the situation. This may be particularly so in circumstances in which harm arising from the contract is such that mere compensation for breach of contract would be insufficient to address the harm, and it would be better to simply return the thing bargained for. This is primarily because the statutory remedy grants to the court broad equitable power to not only return the contracting parties to their pre-contract position, but to also award additional relief, punitive damages and even attorney’s fees and costs in certain circumstances. While it would be inaccurate to say that the rescinding party may “have the cake and eat it too” in such circumstances, the remedy may taste just as sweet.