Opinion ID: 346815
Heading Depth: 1
Heading Rank: 2

Heading: Mutual Mistake of Fact

Text: 17 Reliance also sought rescission on the theory that neither buyer nor seller was aware that financial statements, relied upon during the parties' negotiations, significantly understated the liabilities due Romer's clients. Although this issue has repeatedly been tagged as a trust account problem, it is important to note that the difficulty did not arise in connection with the trust bank account, but rather with Romer's accounting procedures. It is undisputed that Romer's trust account properly reflected monies received from debtors and that no defalcation of funds had occurred. Rather, by retracing disbursements later made to clients, appellants attempted to show that the accounting entry which purported to represent the sums due clients out of trust account funds was in error and should have been significantly higher. This understatement of liabilities vis-a-vis funds received, they argue, led Reliance to assume that Romer had a higher profit margin than was in fact the case and to anticipate that a substantial sum could be safely diverted from the trust account to be used us working capital in the business. 18 Two key witnesses testified on this point at trial: John Kaneshige, an accountant with Kimble, Faris, McKenna & von Kaschnitz, who was responsible for the trust account study commissioned by Reliance, and Arnold Avritt, an accountant long associated with the Romer agency during Miller's tenure there. Their testimony was primarily directed to the legitimacy of the methods used by the Kimble firm to establish that an understatement existed. Little additional effort was directed to explaining whether the difference in the balances reflected in the Kimble study and those shown on the Romer books resulted merely from variances in accounting methods, or from procedures used to ensure an orderly transfer of money paid by debtors to creditors while providing for the proper handling of bad debtor checks and profits earned by the collection agency. 19 In the face of the rather confusing testimony and exceedingly slim documentary evidence, the trial court found as a matter of fact that the accounts were understated. Unfortunately, however, he did not specifically address the mutual mistake claim in any of his conclusions of law. Reliance therefore contends that at the very least the case must be remanded for further proceedings on this point. 20 The issue of whether there was a mutual mistake of fact, of course, must be determined under the Erie doctrine according to California law. Rather than leaving the matter solely to common law development, California has codified the requirements for rescission on the basis of mistake as part of the Civil Code. Section 1689(b) provides in pertinent part that A party to a contract may rescind the contract in the following cases: (1) If the consent of the party rescinding . . . was given by mistake . . . . Section 1577 defines mistake of fact, insofar as is relevant here, as a mistake, not caused by the neglect of a legal duty on the part of the person making the mistake, and consisting in: 1. An unconscious ignorance or forgetfulness of a fact past or present, material to the contract . . . . Section 1568 is also relevant: Consent is deemed to have been obtained through (mistake) only when it would not have been given had such (mistake) not existed. 21 California case law suggests that there is more to the law of mistake than might be apparent from the simple language of these statutes. While California courts appear never to have adopted the traditional requirement that rescission may be obtained only where mistake goes to the identity of the matter bargained for (e. g., Costello v. Sykes, 143 Minn. 109, 172 N.W. 907 (1919); Hecht v. Batcheller, 147 Mass. 335, 17 N.E. 651 (1888); Wood v. Boynton, 64 Wis. 265, 25 N.W. 42 (1885)), they require that, in addition to being material, the mistake must pertain to the essence of the contract. (Hannah v. Steinman, 159 Cal. 142, 112 P. 1094 (1911); Reid v. Landon,166 Cal.App.2d 476, 333 P.2d 432 (1958); Estate of Barton, 96 Cal.App.2d 234, 239, 214 P.2d 857 (1950)). 1 It has likewise been said by California courts that it must be other than incidental (Reid v. Landon, supra; Vickerson v. Frey, 100 Cal.App.2d 621, 224 P.2d 126 (1950)), and that it must involve more than a collateral matter (Hannah v. Steinman, supra; Wood v. Kalbaugh, 39 Cal.App.3d 926, 114 Cal.Rptr. 673 (1974); Bellwood Discount Corp. v. Empire Steel Buildings Co., 175 Cal.App.2d 432, 435, 346 P.2d 467 (1959)). Only if the difference between the real and supposed quality or characteristic of the item sold is of such magnitude as to make it virtually a different thing will relief be granted. (Vickerson v. Frey, supra ). In Roller v. California Pacific Title Ins. Co., 92 Cal.App.2d 149, 206 P.2d 694 (1949), the court detailed the rule as follows: 22 A mistake as to a matter of fact, to warrant relief in equity, must be material, and the fact must be such that it animated and controlled the conduct of the party. It must go to the essence of the object in view, and not be merely incidental. The court must be satisfied, that but for the mistake the complainant would not have assumed the obligation from which he seeks to be relieved. 92 Cal.App. at 157, 206 P.2d at 699, quoting Grymes v. Sanders, 93 U.S. 55, 60, 23 L.Ed. 798 (1876). 23 Although articulating this idea in a number of different ways, it is evident that the courts have rather universally hesitated to undermine the stability of commercial transactions without serious provocation. 24 While we recognize that some California cases have failed to apply any more stringent standard than that of materiality in determining whether rescission may be granted (Healy v. Brewster, 251 Cal.App.2d 541, 551, 59 Cal.Rptr. 752 (1967) (materiality); Williams v. Puccinelli, 236 Cal.App.2d 512, 46 Cal.Rptr. 285 (1965) (no stated test); Adams v. Heinsch,89 Cal.App.2d 300, 200 P.2d 796 (1948) (no stated test)), we here follow the more prevalent California rule which requires that the mistake go to the essence of the contract. But because rescission is also available in California on the basis of innocent misrepresentation (Crocker-Anglo Nat'l Bank v. Kuchman, 224 Cal.App.2d 490, 36 Cal.Rptr. 806 (1964)), it is all too easy to confuse these two distinct doctrines and to assume that a simple materiality test applies to both (e. g., Brown v. Klein, 89 Cal.App. 153, 264 P. 496 (1928)). Proof of innocent misrepresentation is more complex than might appear to superficial analysis. Traditionally, rescission may be granted on this theory where the misrepresentation is material (i. e., nontrivial), where it concerns a material fact (i. e., one that would be taken into account by a reasonable person in deciding whether to enter into the transaction) (Restatement of Restitution § 9, comment (b) (1937); Restatement of Contracts § 476, comment (b) (1932)), and where the rescinding party has both actually and reasonably relied on the representation in entering the contract to his detriment (Restatement of Restitution § 8, comment (e) (1937)). The prerequisites for relief based on mutual mistake, that the mistake be material (i. e., nontrivial) and that it go to the essence of the contract, may really encompass the same facts and concerns, although articulated in different terms. Despite this apparent overall equilibrium, care must be taken not to introduce an erroneous equation and one-to-one correspondence between individual elements of proof. Material, in any of its several connotations, is not the same as basic or essential, and there is a greater requirement of materiality when rescission is asked on the grounds of mistake than when the theory is 'fraud' (including innocent misrepresentation). Note, 12 Hastings L. J., 458, 465 (1961). We, therefore, also decline to treat the California innocent misrepresentation cases cited by appellants as controlling California law on the issue of mutual mistake. In each case the issue of materiality was either not disputed (Brown v. Klein, supra ) or assumed for purposes of the issue on appeal (Crocker-Anglo Nat'l Bank v. Kuchman, supra ). Similarly, the question under Civil Code § 1568 of whether plaintiffs would not have entered the transaction but for the misrepresentation was not before those appellate courts. We cannot therefore, say that the results reached in those cases should govern here, where the problem is framed in terms of the distinctive analytic framework of mistake. 25 As we have already noted, the trial court made only very limited findings concerning the status of Romer's liabilities due clients account and did not specifically direct any of its conclusions to appellants' mutual mistake theory. Although the district judge found the liability account to be understated, it might be inferred from his failure to hold that the understatement was of the amount claimed by Reliance, that appellants failed to meet their burden of proof in establishing the amount of understatement to be more than trivial (and therefore material). The district court's discussion of risk may also be seen to imply that appellants failed, pursuant to Civil Code § 1568 to prove that they would not have entered into the contract were it not for their belief that the accounts were as represented. We need not rest our affirmance on the trial court's refusal to grant relief on these grounds, however, for we are able to conclude from the present record, see Fluor Corp. v. United States ex rel. Mosher Steel Co., 405 F.2d 823, 828 (9th Cir.), cert. denied, 394 U.S. 1014, 89 S.Ct. 1632, 23 L.Ed.2d 40 (1969); Seligson v. Roth, 402 F.2d 883, 887 (9th Cir. 1968), that the mistake was less than basic. 26 Hannah v. Steinman, supra, 159 Cal. 142, 112 P. 1094 the leading California case on the issue, counsels that the court must look to the intention of the parties in determining whether the mistake goes to the essence of the contract. Here, appellants, relying on the trial testimony of their accountant Kaneshige, have characterized the effect of the alleged understatement as reducing the money available for working capital and decreasing their expected profits. While they have also suggested in a passing reference in their supplemental brief that an understatement of client liabilities affected the collection agency's value, they nowhere in the trial testimony or exhibits established or sought to establish to what extent this might be so. The availability of working capital is undoubtedly a collateral matter which, although it might be material to a potential purchaser, cannot be said to relate to the very essence of the bargain. Nor can an erroneous calculation of expected profits based on the figures provided by Miller justify rescission. While the expectation of profit was undoubtedly also an inducement to the contract, it does not lie so close to the heart of the bargain as to qualify as basic mistake. 27