Mutual and Unilateral Mistake in Contract Law, 22 Journal of Legal Studies 309 (1993) (with Eric Rasmusen).


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INTRODUCTION

Much of private law is devoted to the prevention of mistakes on the one hand and the amelioration of their consequences on the other. In contract law, however, the term "mistake" is applied specifically to situations where the parties' beliefs about the world are incorrect at the time of contracting. If writing contracts were costless, the parties would specify which of their beliefs were crucial to the agreement and condition performance of those beliefs, just as they would avoid all ambiguity in defining performance by including all details that might be relevant. Since reading and writing contracts is costly, courts sometimes fill gaps in incomplete contracts by supplying the omitted terms, asking what the parties would have specified ex ante had the contract writing been costless. When beliefs are mistaken, the court might follow a similar rule, not by adding omitted terms (since the contract is unambiguous), but by modifying the contract to express the true intentions of the parties. Or, the court could reform the contractual obligations by voiding the contract, leaving the recontracting to the parties involved. Reforming or voiding contracts, however, goes beyond the gap-filling function in which courts customarily engage; it is an almost paternalistic change in the contract's express terms. Hence, contract law must be very careful how it treats "mistake."

The law makes a distinction between incorrect beliefs at the time of contracting - "mistake" and incorrect beliefs about events occurring after the agreement but before performance. Excuses for incorrect beliefs about later events are classified as performance excuses rather than formation excuses, and while they raise similar issues, we will not treat them here. :Mistake" itself covers a broad set of situations, and courts often distinguish between unilateral mistake and mutual mistake, a distinction that will be the focus of this article. A unilateral mistake is an incorrect belief of one party that is not shared by the other party. A mutual mistake is an incorrect belief shared by both parties. The conventional wisdom is that the contract is more likely to be voidable if the mistake is mutual, a distinction emphasized by courts for over a century.

Although judicial excuse for either unilateral or mutual mistake is relatively rare, courts continue to cite mutual mistake as grounds for avoidance. Law digests continue to list mutual mistake as a separate doctrine with regular new holdings, and the term appears frequently in contract cases. Informal excuse is also common. Many stores allow customers to return merchandise even when no promise to do so had earlier been made, and in transactions between businesses, purchasers are often allowed to cancel orders even though this may formally be a breach of contract. The distinction between mutual and unilateral mistake has been incorporated into the Restatement (Second) of Contracts. The Restatement provisions include the following three sections, excerpted here in part:

152. When Mistake of Both Parties Make a Contract Voidable

  1. Where a mistake of both parties at the time of contract was made as to a basic assumption on which the contract was made has a material effect on the agreed exchange of performances, the contract is voidable by the adversely affected party unless he bears the risk of the mistake under the rule stated in 154.
    It is more difficult to obtain excuse for unilateral mistake, which requires the same conditions as mutual mistake plus either condition 153 (a) or 153 (b):

153. When Mistake of One Party Makes a Contract Voidable

Where a mistake of one party at the time a contract was made as to a basic assumption on which he made the contract has a material effect on the agreed exchange of performances that is adverse to him, the contract is voidable by him if he does not bear the risk of the mistake under the rule stated in 154, and

  1. the effect of the mistake is such that enforcement of the contract would be unconscionable, or
  2. the other party had reason to know of the mistake or his fault caused the mistake

Both of these rules depend on the definitions of "basic assumption," which the Second Restatement leaves unclear, and "bears the risk," the subject of 154:

154. When a Party Bears the Risk of a Mistake
A party bears the risk of mistake when

  1. the risk is allocated to him by agreement of the parties, or
  2. he is aware, at the time the contract is made, that he has only limited knowledge with respect to the facts to which the mistake relates but treats his limited knowledge as sufficient, or
  3. the risk is allocated to him by the court on the ground that it is reasonable in the circumstances to do so.

Unsurprisingly, courts are left puzzled about when to void for mistake. One casebook says, "The case law in this area is confused beyond reconciliation. Courts cannot agree on what is 'mutual' and what is 'unilateral' and in many jurisdictions cases can be found in which relief is granted in both situations, however they are defined." In his classic treatise, Corbin says: "Statements are exceedingly common, both in texts and court opinions, that relief will not be given on the ground of mistake unless the mistake is 'mutual.' Such a broad generalization is misleading and untrue. Seldom is it accompanied by either definition or analysis.... The statement will seldom be found in cases in which relief is granted; in the cases refusing relief and making the statement as a reason for so doing, the court has always considered and weighed the additional factors that accompanied the mistake."

Robert Cooter and Thomas Ulen suggest that the courts use the terms for ex post rationalizations of their holdings: "In such disputes, the terms 'mutual mistake' and 'unilateral mistake' often become emptied of their original meanings .... Thus, the term 'mutual mistake' will be used to announce a decision not to enforce the promise, and 'unilateral mistake' will be used to announce a decision to enforce the promise."

Are there good reasons for distinguishing between mutual and unilateral mistake? A number of scholars in law and economics have examined mistake, but the emphasis has been on unilateral mistake and disclosure rather than on whether the mistake is mutual.

A normative assessment of the law of mistake needs not only to examine the different judicial treatment of unilateral and mutual mistakes but also the de facto rule of many courts to reject most claims of excuse based on mistake. This article analyzes the economic effects of three stylized excuse rules:

  1. Excuse for Unilateral Mistake. A party can rescind if he was mistaken, (regardless of whether the other party was mistaken or not).
  2. Excuse for Mutual Mistake. A party can rescind only if buyer and seller were both mistaken.
  3. No excuse. No party can rescind, regardless of mistakes.

With some latitude in interpretation, courts following the Second Restatement could end up with any of these rules. The unilateral mistake rule results if courts decide under Restatement 153(b) that defendants should have known that the plaintiff was mistaken. Excuse for mutual mistake is broadly mandated by 152 on its face. However, the no-excuse rule may result if a court concludes under 154 that plaintiffs generally assume the risk of mistake because they know that mistakes occur with some probability.

The classic case of mistake is Sherwood v. Walker. Seller Walker owned breeding cows, worth between $750.00 and $1,000.00 and barren cows, worth about $80.00. Buyer Sherwood inspected an apparently barren cow, Rose 2nd of Aberlone, and decided to buy her. A price was agreed on 5.5 cents per pound but before the exchange of money and cow, Walker found Rose was pregnant and refused to part with her. The court said that if both parties thought the cow was barren (a question for the jury), the contract was voidable on grounds of mutual mistake.

The three models of mistake below will highlight different ways that excuse rules affect efficiency. In model 1, the excuse rule affects the parties' ability to avoid transactions that have negative gains from trade. Model 2 shows how excuse rules influence parties' incentives to collect information. Finally, model 3 analyzes how different excuse rules distribute risk.

We will conclude that excuse for mistake is sometimes appropriate, but not just because the mistake is mutual. The common law's tendency to grant excuse for mutual but not unilateral mistake does not maximize the social surplus from contracting. Excuse for unilateral mistake can in a limited set of circumstances be justified as a way to (a) reduce the number of value decreasing transactions, (b) reduce the costs of collecting information, and (c) reduce the artificial risk of fluctuations in payoffs. Mutual mistakes rules are broadly dominated by the no excuse and unilateral mistake rules.


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