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San Diego Business Contracts: Rescinding a Contract

Most contracts are enforceable as written and, once entered into, failure to perform one’s obligations can lead to a lawsuit. However, there are a few circumstances in which a party may rescind a contract. Rescinding is like revoking the contract. As California Civil Code section 1688 states: “A contract is extinguished by its rescission.” (Civ. Code, § 1688.) Rescission of contract is governed by California statutes. See Cal. Civil Code, § 1669. There are five listed circumstances:

  • Mutual mistake — of fact or law
  • If the consideration fails through the fault of the other party
  • If the consideration becomes void
  • When the consideration for the obligation of the rescinding party fails in a material respect
  • If there is fraud, duress, menace or undue influence by the other party to the contract

A mistake is not a “mistake” in the sense of “it was a bad idea” to sign this contract. Rather, a mistake is about some material fact or the law which was unknown and prevents one or both parties from obtaining the benefit of the bargain. An example might be when both parties thought a use permit could be issued for a small convenience grocery store for certain commercial property and a five-year lease was signed. However, the city changed its zoning laws just as the lease was signed. The tenant would be able to rescind the lease.

As we discussed here, consideration is something of value that is provided to make the contract enforceable. Money, promises, or something of value are the typical forms of consideration. Both sides to a contract must provide consideration. It happens only rarely, but consideration can fail or become void. As an example, if $5,000 in $20 bills is provided by one side of the contract — and then mysteriously, the cash dissolves into dust five minutes after the contract is signed, there would be a failure of consideration. Alternatively, if the government were to declare those particular $20 bills void, then the consideration would be been voided.

A party seeking rescission must restore to the other party whatever consideration they provided. That is, rescission requires that both parties be put in their original positions with respect to the contract at issue. This right to receive one’s paid consideration is generally the limit that one party can obtain if the other side rescinds. For example, in the case Imperial Casualty & Indemnity Co. v. Sogomonian, 198 Cal. App. 3d 169 (Cal. App. 2nd Dist. 1988), the California Court of Appeals held that, after an insurance policy was rescinded based on fraudulent statements in the application for insurance, the policy holder was only allowed to recover its paid premiums. The policy holder was not allowed to sue for various statutory claims under the California Insurance Code. The court held that after the policy was rescinded, the policy was extinguished “as though it had never existed.” As a consequence, the court held that the policy holder was never an “insured” under any insurance policy of insurance. Thus, the policy holder had no rights under the Insurance Code. This is the normal effect of rescission.

Contact San Diego Corporate Law

If you would like more information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides legal services related to business law, private securities offerings/sales, the sale/purchase of a business, and for mergers and acquisitions. Mr. Leonard can be reached at (858) 483-9200 or via email. Like us on Facebook.

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