When Does Mutual Mistake of Fact Justify Rescinding a Lease?

Two rulings illustrate how courts make this crucial determination.

Contracts Law, 101: A contract may be rescinded if it later becomes clear that the parties entered into the agreement with the same belief about something relating to the essence of the contract and that mutual belief later proves to be wrong. The justification for recission is that the parties wouldn’t have entered the agreement had they known the true facts.

Mutual Mistake of Fact Recission

The rule dates back to an 1887 case called Sherwood v. Walker that began when a banker agreed to pay $80 to buy an Angus cow named Rose 2d of Aberlone. The price was low because both sides believed that Rose was sterile. They were wrong. But it was only after they executed the contract that they learned that Rose was pregnant, and thus worth about 10 times more than the contract price. So, the seller sued, and the Michigan Supreme Court allowed it to void the contract because it was based on a mutual mistake about a material fact essential to its formation, namely, that Rose was barren.

Mutual mistake of fact recission applies not just to cattle sales but all contracts, including commercial leases. But limits apply. One of the key restrictions is that the mutual mistake must be about a fact that exists before or when the lease is signed. Recission isn’t allowed when the mistake relates to what the landlord and tenant thought was going to happen in the future after they cut the deal. Unfortunately, it’s not always easy to draw the line. Here are two rulings illustrating how courts make this crucial determination in actual mutual mistake of fact recission cases. While both cases come from California, the same principles apply in all parts of the country.

Tenant May Rescind

Here’s a case where a tenant was able to rescind its lease on the basis of mutual mistake of fact.

Situation: A tenant signed a lease on the second story of a San Francisco building to operate a restaurant. After preparing the construction plans to convert the space to restaurant use, the tenant learned that there were structural weaknesses in the building, including the exterior walls, roof, and columns and beams supporting the second floor. Local building and fire codes required that these problems be corrected before the premises could be used as a restaurant. But the landlord refused to fix the problems, insisting that the tenant was solely responsible for making the repairs and alterations necessary to make the premises legally suitable for restaurant use. Rather than paying for the work, the tenant sued to rescind the lease.

Ruling: The California appeals court upheld the trial court’s ruling rescinding the lease based on mutual mistake of fact.

Why Recission Was Allowed: The testimony clearly showed that both parties entered into the lease believing that the tenant could legally install and operate a restaurant on the second floor without the need for any substantial structural alterations or repairs to the building itself. Both parties were ignorant of the structural weaknesses of the building that would prevent such use unless certain work was done. Had they known all of this, the lease, had they even signed one at all, would have looked much different.

The court also stressed that the structural weaknesses affected the entire building and not just the second floor. This was important because it essentially meant that the lease clause requiring the tenant to take the property “as is” didn’t preclude recission for mutual mistake [Williams v. Puccinelli, (1965) 236 Cal.App.2d 512, 46 Cal. Rptr. 285].

Tenant May Not Rescind

Here’s the Yin to the Williams case Yang rejecting a tenant’s attempt to rescind a lease based on mutual mistake of fact.

Situation: A tenant signed a lease for two suites in a downtown building requiring it to complete at its own expense all improvements necessary to make the space suitable for use as a dental office. The tenant, who also had to secure the required permits, was expecting to pay nearly $700,000 for the improvements. While both sides were aware of the current permitting rules in effect at the time of signing, including with regard to Americans with Disabilities Act (ADA) accessibility requirements, the city subsequently adopted a new policy requiring that 20 percent of all improvements to accessibility be spent on the building’s common areas.

The tenant asked the landlord to pay for the common area accessibility improvements. When the landlord refused, the tenant sued to rescind the lease claiming that both parties were mistaken about what the tenant would have to do to get the permit necessary to use the space for a dental office. We wouldn’t have entered the lease had we known about the new ADA requirement, the tenant argued. The jury ruled in the tenant’s favor, but the court granted the landlord’s motion for a new trial.    

Ruling: The California appeals court affirmed the order granting a new trial.

Why Recission Was Not Allowed: The evidence showed that both sides assumed the city would apply the permit rules as they existed at the time the lease was signed, the court acknowledged. And that assumption turned out to be wrong. However, the court continued, a mistake warrants recission only when it concerns facts existing at or before the time the agreement was executed. The assumption that the tenant would have to navigate the permit rules as they existed at the time wasn’t actually a mistake of fact but a “mere hope, prediction, or error in judgment,” according to the court. Result: The jury’s verdict allowing the tenant to rescind the lease was wrong, and the case had to go back for a new trial [Wash. 111 v. Kelsey, 2024 Cal. App. Unpub. LEXIS 5005, 2024 WL 3754835].

Takeaway

Failure to anticipate future developments is not a mistake of fact justifying lease recission. Mistakes about future facts or errors in judgment aren’t grounds to rescind the lease even when the mistakes are mutual and relate to an essential condition of the lease. One effective way to tell the difference between a mistake of past or present fact that justifies recission and a mistake of future fact or error in judgment that doesn’t is to ask whether the truth or falsity of the proposition of fact depends upon the occurrence or nonoccurrence of a future event.

That’s the approach the Kelsey court used to distinguish the case from Williams. In Williams, there was a mutual mistake about a present fact—namely, that the entire building was structurally sound enough to support the operation of a restaurant on the second floor without the need to make structural alterations or improvements. “The condition of the building was a fact that was in existence and could be determined as true or false when the lease was executed,” the Kelsey court reasoned. It then added that “the same cannot be said of [the Kelsey tenant’s] ability to construct the tenant improvement without the city later requiring [ADA] improvements to the common areas as a condition to issuing permits.”

This distinction between past/present and future mistake also explains why tenants have failed in their attempts to use the COVID-19 pandemic to get out of their leases. Tenants’ argument: The lease was based on a mutual mistake of fact—that is, that the tenant would be able to conduct its normal business without substantial interruption during the lease term. Neither landlords nor tenants anticipated how the subsequent COVID-19 pandemic and closure orders would turn this into a false assumption.

However, courts have rejected this argument that not anticipating COVID wasn’t a mistake relating to facts that existed when tenants signed their leases but a failure to foresee facts that would happen after that. And mistakes and false assumptions about things that haven’t yet happened aren’t grounds for mutual mistake of fact recission.