14.2 Mistake, Misunderstanding, Misrepresentation & Nondisclosure

14.2 Mistake, Misunderstanding, Misrepresentation & Nondisclosure

Mistake and misrepresentation both involve a party who entered a contract on the basis of a false belief. The difference is the source: mistake concerns beliefs the parties formed on their own, while misrepresentation concerns a false assertion by the other party. Both usually make the contract voidable rather than void.

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Defects in Assent: Ambiguity, Mistake & Misrepresentation

A. Ambiguity / Misunderstanding (Raffles v. Wichelhaus - The Two Ships Peerless)

When parties attach materially different meanings to an essential contract term:

• Neither Party Knows / Has Reason to Know: No contract forms due to lack of mutual assent (e.g., both parties contracted for cotton arriving on the ship Peerless, but seller meant the December ship and buyer meant the October ship).
• One Party Knows / Has Reason to Know: A binding contract forms on the meaning understood by the innocent, unknowing party.

B. Mutual Mistake (Restatement § 152)

A contract is voidable by the adversely affected party if:

1. Both parties are mistaken at the time of contract formation as to an existing fact;
2. The mistake concerns a basic assumption upon which the contract was made;
3. The mistake has a material effect on the agreed exchange of performances; AND
4. The adversely affected party did not bear the risk of mistake.

Bearing the Risk of Mistake

A party bears the risk of mistake when:

• The contract allocates the risk to that party (e.g., "as is, where is"); OR
• The party enters the transaction with conscious ignorance—aware that they have limited knowledge of the facts but treating that knowledge as sufficient. In Wood v. Boynton (Wis. 1885), a woman sold a small stone to a jeweler for $1 when neither knew what it was; when it proved to be an uncut diamond, she could not rescind. Contrast Sherwood v. Walker (Mich. 1887), where both parties believed a cow was barren and the seller could rescind when she proved to be pregnant, because the shared mistake went to the very nature of the thing sold.
• The court allocates the risk to that party because it is reasonable to do so in the circumstances (Restatement § 154(c)).
• Mistake as to Market Value: A mistake regarding the monetary value or market price of the subject matter is never a basic assumption; market fluctuations and valuations are assumed business risks.

C. Unilateral Mistake (Restatement § 153)

A mistake by only one party generally does NOT excuse performance. A unilateral mistake about a basic assumption that materially affects the exchange, whose risk the mistaken party did not bear, makes the contract voidable only if:

1. The other party knew or had reason to know of the mistake, or caused it (e.g., an offeree spots an obvious typographical or computational error in a construction bid and attempts to "snap it up"); OR
2. The mistake was a clerical/computational error made in good faith, and enforcement of the contract would be unconscionable.

D. Misrepresentation & Fraud

• Fraudulent Misrepresentation: An intentional false assertion of material fact, made with scienter (knowledge of falsity or reckless disregard), intended to induce reliance, which does induce justifiable reliance. Contract is voidable; victim may rescind or sue in tort for damages.
• Material Non-Fraudulent Misrepresentation: An innocent or negligent false statement of fact. Contract is voidable if the statement was material and reasonably relied upon.
• Nondisclosure: Silence is generally not misrepresentation unless:
  1. Disclosure is necessary to correct a previous statement that has become misleading;
  2. A confidential or fiduciary relationship exists;
  3. Active concealment occurs (e.g., painting over structural rot); or
  4. The undisclosed fact concerns a basic assumption and non-disclosure violates good faith and fair dealing.

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Applying Mistake and Misrepresentation Rules

Mistake Details

• Existing facts only: Mistake concerns facts that exist when the contract is made. An incorrect prediction about future events—such as rising costs or a change in market conditions—is analyzed under impracticability or frustration of purpose (Section 17.1), not mistake.
• Negligence is not a bar: A mistaken party's failure to discover the facts before contracting does not bar relief unless it amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing (Restatement § 157).
• Reformation: If a writing fails to express the parties' actual agreement because of a mistake in expression—for example, a typographical error in a legal description—a court may reform the writing to match the agreement (Restatement § 155). The parol evidence rule does not bar the evidence needed to prove the mistake.
• Mistaken bids: A contractor that made a clerical error in a bid may rescind if the owner knew or should have known of the error (for example, because the bid was far below all others), the contractor gave prompt notice, and the owner has not materially relied (Elsinore Union Elementary School District v. Kastorff, Cal. 1960). Errors of judgment, as opposed to clerical errors, rarely justify relief.
• Remedies: A party who avoids a contract for mistake is generally entitled to restitution and must return benefits received; the court may also protect the other party's reliance interest (Restatement § 158).

Misrepresentation Details

• Avoidance elements (Restatement § 164): A misrepresentation that is either fraudulent or material, that induces the recipient's assent, and on which the recipient justifiably relies makes the contract voidable.
• Fraud in the factum: If a person signs a document after being misled about its very character—believing a promissory note is a receipt, for example—and had no reasonable opportunity to learn its true nature, there is no contract at all (Restatement § 163).
• Opinions, intentions, and law: Statements of opinion usually are not actionable, but reliance on an opinion is justified when the speaker has a relationship of trust, special expertise, or the recipient is especially vulnerable (Restatement § 169). A promise made with no intention of performing is a misrepresentation of the speaker's present intention.
• Justified reliance: A recipient's failure to investigate does not make reliance unjustified unless the failure amounts to bad faith (Restatement § 172), and a merger clause does not bar proof of fraud.
• Third-party misrepresentation: If someone other than the contracting party makes the misrepresentation, the contract is voidable unless the other party, in good faith and without reason to know, gave value or relied materially (Restatement § 164(2)).
• Remedies: The deceived party may rescind and obtain restitution, or affirm the contract and sue for damages for deceit or breach of warranty.
• Real estate disclosure: Many states require sellers of homes to disclose known latent defects that materially affect value (Johnson v. Davis, Fla. 1985); see the Real Property chapters.