Contract Law: Misrepresentations and Mistakes

Introduction

Commercial contracts are often negotiated over various emails, calls, pitch documents, forecasts and informal assurances. What happens if, after signing a contract, you discover that something important you were told during negotiations was wrong? Depending on the circumstances, that statement may amount to a misrepresentation or mistake and could make the contract void or voidable.

Misrepresentation

A misrepresentation is an untrue statement of fact or law made by a party (or their agent) to the other party which induced them to enter into the contract, thereby causing that party a loss. A mere statement of opinion, which proves to be unfounded, will not generally be treated as a misrepresentation. For example, a wrong but genuine forecast of the future is not a misrepresentation.  

How did the Misrepresentation arise?

There are a number of ways in which a misrepresentation can occur and these include:

1. Fraudulent misrepresentation, when a false statement is made either with knowledge it is incorrect, or with carelessness as to whether it is true or false, and in any event without believing it is true in order to induce the other party into the contract. This is quite a high bar in practice.
2. Negligent misrepresentation which occurs where a statement is made by one contracting party to another carelessly or without reasonable grounds for believing its truth. The test is an objective one. A party accused of this will have to prove they believed the statement to be true.
3. Innocent misrepresentation which is only used to describe a misrepresentation made entirely without fault, i.e. where the maker of the statement can show that it had reasonable grounds to believe its statement was true.

What remedies may be available?

A misrepresentation makes the contract voidable. This means that the party which relied on the statement has a choice of whether to rescind the contract (reverse the contract and restore each party to their pre-contract position), or to affirm it by continuing with the contract despite the misrepresentation. The contract will continue to exist unless the wronged party takes steps to unwind it.

To determine what remedies may be available, it is necessary to determine whether the misrepresentation was fraudulent, negligent, or innocent.

Fraudulent and negligent misrepresentations may enable the party that relied on the statement to rescind the contract and claim damages. Where a claim is brought under section 2(1) of the Misrepresentation Act 1967, damages are assessed on the same basis as for fraudulent misrepresentation, although the loss must still have been caused by the misrepresentation. In some non-fraudulent cases, the courts may award damages ‘in lieu of rescission’ where it considers that fair.

A party wishing to rescind the contract should act quickly once they discover the misrepresentation to avoid being barred from doing so and be deemed to have affirmed it. This is crucial if they should have noticed the misrepresentation earlier, because the clock may already be ticking.

Sometimes reversing the contract is just no longer possible as the subject of the contract may have declined in value or changed completely. Similarly, if the subject of the contract has been purchased by a third party who had no knowledge of the previous misrepresentation, the contract may not be able to be reversed. In which case, damages are the appropriate measure.

Both wronged and innocent parties need to be mindful that they have a duty to mitigate their losses and, a failure to do so, may result in reduced damages.

Limiting liability for misrepresentation

Steps may be taken to try to minimise or exclude liability for misrepresentation, such as by

i)               inserting an exclusion clause into the contract limiting liability generally;

ii)              including wording within the entire agreement clause which excludes liability for misrepresentation. The effectiveness of such provisions will depend upon the application of the Consumer Rights Act 2015 (which applies to business to consumer contracts) and the Unfair Contract Terms Act 1977 (which applies to business-to-business contracts).

Mistake

Mistakes differ from misrepresentations in that they may render a contract void (as opposed to voidable). This means that when a mistake has arisen in negotiations, and the parties have entered an agreement on that basis, the contract is treated as if it had never existed because there was no true agreement in the first place.

A contract may be void for mistake in the following circumstances:

i)               Common mistake - Contrary to both parties’ belief, the subject matter of the contract had already ceased to exist when they entered into the contract. For example, a contract for an imported classic car which, the day before the contract was signed and unknown to both parties, went overboard the cargo ship that was carrying it and sank to the bottom of the sea. The contract would be void for common mistake because the subject matter contracted for does not exist.

ii)              Mutual mistake - Mutual mistake arises in situations where the parties are both mistaken about different, but substantial matters within the contract. If these mistakes taken together mean the contract is fundamentally different to what the parties contracted for, it is likely to be void.

iii)             Unilateral mistake - Unilateral mistakes occur when one party is mistaken as to the terms of a contract, and the other realises (or should realise) but does nothing to correct the mistake and therefore accepts it.

In some cases, the courts will correct a mistake in a contract to bring its terms in line with the parties’ intentions. The courts generally prefer to uphold the contract and adjust the parties’ obligations though the express and implied contract terms.

In extreme cases, a mistake may prevent formation of a valid contract at all, for example if the mistake renders the agreement too uncertain to enforce.

However, many mistakes have no impact on a contract’s formation or terms. The parties are held to the bargain they have made despite their misunderstanding as to the wording, or its legal effect, or their underlying rights, or the commercial benefits of the contract. It is each party’s responsibility to satisfy itself on all these points before agreeing to a contract.

Is there a remedy?

Damages are not (generally) available for void contracts because in theory, no contract ever existed to give rise to liability. It may be possible to rectify the mistake if the parties express a common intention under the contract, which can rectify the mistake, and which is evident by their expectations under the contract.

What to do if you think there has been a misrepresentation or mistake?

Misrepresentations and mistakes can be complex and the consequences of voiding a contract without proper grounds can be fraught with risk. 

We regularly advise businesses and individuals on their rights under void and voidable contracts and the risks associated with it. We can assess whether there has been a fundamental mistake, or a misrepresentation based on what was said and all the relevant evidence including the contract, and advise you on the legal and practical options available.