So, your bid is accepted. It's a huge contract. Your price beat everyone. Time to celebrate! Reality strikes weeks later: You realize that you erred in computing labor and material. You underestimated by 40 percent. You have mobilized and your crew is wondering how they can finish with the limited material you specified. But you have an even bigger problem. You executed a contract that, if fully performed, will cause you a substantial financial loss. You made a mistake ... a whopper. Other than thinking about a new line of work, what do you do?
Generally, the law prefers the finality of contracts. Once parties agree to terms, they are expected to honor their respective promises. Like so many other aspects of the law, however, there are exceptions, and the circumstances in each contract may allow one party to avoid the terms of a contract where a mistake truly affects the essence or heart of the parties' agreement.
The law of contracts is governed largely by state law, and each state differs in smaller and larger ways from other states in the manner and extent to which they permit mistaken contracting parties to avoid their contractual obligations. Despite these state-to-state differences, some basic rules are followed in most states. Here are the basic rules.
Under certain circumstances where both parties to a contract are mistaken as to their beliefs about significant aspects of the contract, legally either party may avoid the contract or a court may reform (i.e. rewrite) certain contract terms to establish the contract the parties originally intended. For example, a property owner hires a contractor to construct a building. A day before the contract is executed, however, the local government enacts strict changes to the building code, of which neither contracting party were aware. Now, the building cannot be constructed without considerable additional expense. Under these circumstances, both contracting parties were honestly mistaken about the building code, and the contract may be rescinded (i.e. cancelled). By contrast, had the code changes caused only a slight increase in the cost to newly required building features, the overall contract probably would not be rescinded, but some allowance would be permitted for the additional costs.
A different outcome occurs where the parties' contract allocates to one party the burden of determining certain facts. There, if that party fails reasonably to determine such facts, it bears the risk of mistake if the facts are other than it believed. Thus, if a bid invitation requires bidders to determine site conditions, including water drainage, and a bidder makes an inadequate investigation into such drainage, he cannot later seek to avoid the contract (except as discussed below) because the actual drainage is so inadequate that it greatly increases his costs to complete his work.
The Exception to the Rule
Where only one party makes a significant mistake, the contract still may be avoided, but the circumstances must be more compelling than where both parties are in error. Generally, a unilateral mistake will not avoid contractual obligations except where the mistake was made honestly and is so fundamental to the basic contract, or where the mistake is so obvious that the other party must reasonably have known of the mistake at the time the contract was made. Still, some courts still will not rescind the contract under these circumstances unless it is also shown that enforcement of the contract would be unconscionable.
Court decisions provide several examples arising in the construction bidding process. In one Tennessee lawsuit a bidder made a $4,000 error in a $9,000 bid. The court determined that the magnitude of the error was so great that the other party to the contract surely must have realized that a mistake occurred, and thus, the contract should not be enforced. New York cases similarly have held that there is no contract where one party knew or had reason to know that the other party was operating under a mistaken belief of critical facts. This could occur, for example, where ten parties bid on a job, and nine bids ranged from $200,000 to $225,000, whereas the tenth bid was only $100,000. Here, the discrepancy is so great that it could be argued that the bid inviter should have realized the possibility of mistake and made further inquiry of the low bidder before accepting it.
A more difficult situation arises where the bidding process imposes on the bidder the burden of determining site conditions and his bid, while lower than all other bids, is sufficiently close in price to those bids that the evaluating party cannot be expected to conclude that the lowest bidder merely erred. Here, not only are the bids closer in amount, but each bidder as allocated the risk to determining labor and material based upon its analysis of site conditions. It is unlikely that a court would rescind the contract.
Thus, a party generally cannot avoid the terms of a contract where the risk of a mistake is his burden to bear under the contract, or where, at the time the contract is made, he is aware that he has only limited knowledge about the circumstances and conditions that affect his ability to perform the contract, but still enters into the contract.
Regardless of whether one or both contracting parties makes the mistake, a party seeking to avoid a contract due to these circumstances must act promptly to notify the other party to the contract that he wishes to rescind the contract based on a mistake, and offer to fairly return what he has received to-date under the contract. Then, he can either demand return of what he has provided, sue for it, or prepare to defend himself in a breach of contract lawsuit using the defense of mistake. In some instances a party will commence litigation to obtain a court declaration rescinding the contract and ordering the parties to return what they have paid or performed to-date under the contract.
Mistakes happen. We are human. While the law provides in some cases a means to avoid contracts based on mistake, the costs of litigating a dispute involving a mistake may well exceed the loss the mistaken party would sustain if he merely fulfilled his contractual obligation. Where mistakes arise, compare the cost and loss of fulfilling the contract with the costs and uncertainty of litigating the dispute. Before litigating, certainly endeavor to negotiate a fair resolution.
In any event, don't argue; as I once heard, "Of course my figures were wrong! How is a guy with big stubby fingers like me supposed to hit the rights keys on this little calculator?" I sympathize. I have the same problem with cell phones. I just wish the court would see it that way.
Warren Lutz, Esq., is a Director with the Washington, D.C., law firm of Jackson & Campbell, P.C. He specializes in product liability, toxic torts and construction litigation. He may be reached at firstname.lastname@example.org.
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