2.5 Mistake in Contract Formation

Mistake in Contract Formation

Even where the outward mechanics of offer and acceptance appear satisfied, a contract may be unenforceable if genuine mutual assent was defective. This section analyzes the primary formation defenses: mutual and unilateral mistake, fraud and misrepresentation, physical and economic duress, undue influence, and agreements void for illegality or unconscionability.

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I. Mistake Doctrine: Mutual vs. Unilateral

A legal mistake is an erroneous belief not in accord with the facts at the time the contract was executed (Restatement (Second) of Contracts § 151). A mistaken prediction regarding future events is not a mistake; it is evaluated under the doctrine of impracticability or frustration of purpose.

Mutual Mistake (Restatement § 152)

Where both parties share a mistaken belief at the time of contract formation, the contract is voidable by the adversely affected party if three elements are satisfied:

1. Basic Assumption: The mistake relates to a basic assumption on which the contract was made (e.g., the identity, existence, or core physical nature of the subject matter);
2. Material Effect: The mistake has a material adverse effect on the agreed exchange of performances (rendering the transaction substantially different from what was contemplated); AND
3. No Assumption of Risk: The adversely affected party did not bear the risk of the mistake under the rules stated in Restatement § 154.

Allocation of Risk (Restatement (Second) § 154)

A party bears the risk of a mistake when:

• Allocated by Agreement: The contract assigns the risk to that party (e.g., an explicit "as is" clause or disclaimer);
• Conscious Ignorance (Restatement § 154(b)): The party is aware at the time of contracting that they have only limited knowledge regarding the facts to which the mistake relates, but treats that limited knowledge as sufficient (e.g., selling an unknown stone or uncut mineral for $10 without an appraisal; the seller assumes the risk of its true identity and value);
• Allocated by Court: The court allocates the risk to that party on the ground that it is reasonable under the circumstances.

Seminal Precedents on Mistake:

• Raffles v. Wichelhaus (The Peerless): Mutual misunderstanding of an ambiguous material term (two ships named Peerless sailing from Bombay in different months). Where neither party knows or has reason to know of the ambiguity, or where both know, no mutual assent exists and no contract is formed.
• Sherwood v. Walker (Rose 2d of Aberlone): Mutual mistake as to the barrenness of a pedigreed cow. Because a breeding cow was a substantially different creature than a beef cow, the mistake went to the whole substance of the agreement, rendering it voidable.

Unilateral Mistake (Restatement § 153)

Where only one party is mistaken as to a basic assumption, the contract is generally enforceable. A unilateral mistake renders the contract voidable by the mistaken party only if the mistaken party did not bear the risk of the mistake, AND:

1. The non-mistaken party knew or had reason to know of the mistake, or the non-mistaken party's fault caused the mistake (e.g., "snapping up" a subcontractor bid that is 60% lower than all competing bids due to an obvious transposition error); OR
2. The effect of the mistake is such that enforcement of the contract would be unconscionable (severe, oppressive hardship), and the non-mistaken party has not substantially changed position in reliance.

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III. Mistakes That Do Not Excuse

Not every error is a legally operative mistake, and most wrong answers in this area rely on the distinction.

The distinction between a mistake of fact and a mistake of value does the heaviest work. In the classic barren-cow problem the mistake was operative because the parties were wrong about the animal's capacity to breed, an existing physical fact. Had they simply misjudged what a breeding cow was worth, no relief would follow.

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IV. Remedies

• Rescission unwinds the contract and returns the parties to their pre-contract positions, with restitution of benefits conferred.
• Reformation rewrites the instrument to reflect the actual agreement, and is the exclusive remedy for a scrivener's error or a mistake in transcription.
• A court sitting in equity may also impose conditions on rescission, requiring the avoiding party to compensate the other for reliance expenditures where that is necessary to avoid injustice.

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V. FYLSX Application Pattern

Mistake questions almost always follow one of three shapes:

1. The mispriced bid. A subcontractor's bid is dramatically below every competing bid because of an arithmetic slip, and the general contractor snaps it up. This is unilateral mistake, and the general contractor's reason to know of the error makes the bid voidable. Watch for the variant where the general contractor had already relied on the bid in its own successful tender — some courts then deny rescission.
2. The shared factual assumption. Both parties transact over a thing that turns out to be materially different from what they assumed — an unsigned painting believed authentic, land believed buildable. This is mutual mistake, voidable at the option of the adversely affected party unless that party bore the risk.
3. The ambiguity that defeats assent. Neither party knows the term has two meanings, and each attaches a different one. This is not really a mistake defense at all but a failure of mutual assent, and no contract forms in the first place.