VOID AND VOIDABLE CONTRACTS

VOID AND VOIDABLE CONTRACTS

Distinction Between Void and Voidable Contracts

Certain defenses – generally those that affect assent – can render a contract voidable by the aggrieved party. Other defenses – typically those that pertain to law and public policy – may render a contract void. The distinction is not clear-cut; for example, while defenses such as incapacity, duress or mistake generally render a contract merely voidable, if the circumstances prevented a meeting of the minds, the contract will be deemed void. Likewise, contracts with an illegal purpose will generally be deemed void unless the parties are not in pari delicto .

The legal effects of a contract being deemed voidable as opposed to void are:

1)  Where a contract is merely voidable, the innocent party may enforce the contract, but the contract cannot be enforced against him. If a contract is void, neither party can enforce the contract.
2)  Rights in a voidable contract are transferable; rights cannot be transferred in a void contract.
3)  If a party improperly transfers property to a bona fide purchaser for value, the injured party may recover the property if the contract governing the transaction is void but not if it was voidable.
4)  Voidable contracts may be ratified by the party with the power to avoid the contract once the reason for such avoidance – such as minor age, mental impairment, duress, undue influence or mistake – no longer exists. Void contracts cannot be ratified.

 Defenses Affecting Assent

[1] Incapacity to contract

[a] Minors

Contracts entered into by a minor (an "infant") – one below the age at which state law deems persons to possess capacity to contract, currently 18 years old in most states – are generally voidable by the minor-party, even if he misrepresented his age. A minor can furthermore avoid contractual obligations for a reasonable time after attaining the age of majority. However, if he fails to disaffirm within a reasonable time, the contract will become binding against him.

[b] Mental Impairment

Mental incapacity can result from mental illness or defect – e.g., senility, insanity, retardation – or drug or alcohol intoxication.

A party that suffers a mental illness or defect at the time the contract is made may avoid the contract where the mental impairment prevented him from:

• understanding the nature and consequences of the transaction; or
• acting in a reasonable manner in relation to the transaction, and the other party had reason to know of his condition.

However, if the contract is made on fair terms and the other party was without knowledge of the mental illness or defect, the incapacitated party may be precluded from avoiding the contract where:

• the contract has been fully or partially performed; or
• the circumstances have changed such that avoidance would be unjust. [Restatement § 15]

A party that was intoxicated when the contract was made may avoid the contract only if the other party had reason to know that, by reason of intoxication, the party was unable to understand the nature and consequences of the transaction or was unable to act in a reasonable manner in relation to the transaction. [Restatement § 16]

[2] Duress

If assent to a contract was obtained by coercion constituting duress, the contract may be avoided by the person subjected to the duress. An improper threat of harm that induces the other party to assent to contract terms constitutes duress. "Improper threat" is established where:

• the threatened act would harm the recipient and would not significantly benefit the party making the threat;
• the effectiveness of the threat in inducing the manifestation of assent is significantly increased by prior unfair dealing by the party making the threat; or
• what is threatened is otherwise a use of power for illegitimate ends. [Restatement § 176(2)]

Examples of duress include threats to:

• commit a criminal or tortuous act against the party, his family or his property
• extort money
• commence a civil action under circumstances which could be deemed abuse of process
• refuse to do business with the party
• blackmail the party
• refuse to perform a contract in order to extract an economically unjustified modification
• terminate an employment contract unless the party or someone close to him consents to an agreement not connected with the employment contract.

The threat must be of sufficient gravity to make the contract voidable, determined based on an examination of the victim's experience, sophistication, age, and other relevant personal characteristics. The highest standard is applied in cases constituting "economic duress", such as refusals to do business with the victim.

[3] Undue influence

A defense based on undue influence may arise where:

• one party takes advantage of the other party's position of weakness, e.g., based on age, illness, mental state, intoxication, etc., thus preventing the latter from exercising free will in the transaction; or
• one party breaches a fiduciary relationship with the other party.

Business contracts between an attorney and his client are presumptively invalid but can be overcome if the attorney demonstrates that:

1)  the transaction was fair and equitable;
2)  the attorney informed the client of the nature and consequences of the transaction;
3)  the attorney fully disclosed his own interest in the matter; and
4)  the attorney encouraged the client to obtain independent advice or rendered the client the type of advice that a disinterested attorney would have given a client.
[4] Mistake

A mistake is an erroneous belief related to the facts as they exist at the time the contract is made.

[a] Mutual mistake

The adversely affected party may void a contract based on mutual mistake made at the time of the contract formation where:

1)  the mistake concerned a basic assumption on which the contract made;
2)  the mistake materially affects the agreement; and
3)  the adversely affected party does not bear the risk of the mistake. [Restatement § 152]

The Restatement's requirement that the mistake concern a basic assumption deviates from early case law that required the mistake to concern the subject matter of the contract. E.g., Sherwood v. Walker, 66 Mich. 568 (1887).

[b] Unilateral mistake

Common law provides that a party may avoid a contract based on a unilateral mistake where the mistake was palpable, i.e., the other party knew or had reason to know of the mistake, such as where the contract contains an egregiously erroneous recording of a price. If the unilateral mistake is not palpable, the aggrieved party may avoid the contract where:

1)  enforcement of the contract against the mistaken party would be unconscionable; and
2)  avoidance would not result in substantial hardship to the non-mistaken party.

Additionally, the following circumstances must exist in order to avoid a unilateral impalpable mistake:

1)  the agreement is entirely executory or the other party can be placed in the status quo ante;
2)  the mistake is substantial (but not astronomical as that would likely make the mistake palpable); and
3)  mistake is of a clerical or computational error or other such misconstruction of the terms.
[c] Mistakes that do not give rise to a defense

A party seeking to avoid the contract may not rely on mistake as a defense where the party:

• assumed the risk of mistake with respect to the accuracy of facts existing at the time the contract was made
• is at fault for the mistake, e.g., erroneous calculation of costs or prices, but generally only where the fault amounts to gross negligence, violation of a legal duty or failure to act in good faith and in accordance with standards of fair dealing
• failed to read the contract (with some exceptions for adhesion contracts or where a writing does not accurately reflect an existing agreement between the parties).

[d] Void Contracts based on Mistake

Mistakes that prevent a meeting of the minds render a contract void, such as where:

• the offeree knows that the offer is the product of a mistake
• the offeror makes the offer to a party intending it for another who is aware of the mistake
• the parties attach a materially different meaning to the communications and neither party is aware or has reason to be aware of the meaning attached by the other.

[5] Misrepresentation

[a] Generally

An aggrieved party may avoid a contract based on misrepresentation where:

•  the assertion was either material or fraudulent; and

•  the person seeking to avoid the contract reasonably relied to his detriment on such assertion. [Restatement § 162]

A misrepresentation is material if:

• it would be likely to induce a reasonable person to agree to the bargain, or
• the party who made the misrepresentation knew or should have known that it was likely to induce the other party to manifest assent to the bargain, whether or not a reasonable person would have been induced.

A misrepresentation is fraudulent if it was made with:

1)  the intention of inducing the other party to rely on it, and
2)  knowledge of its falsity or lack of adequate foundation for the representation. (scienter)

Reasonableness of the reliance is assessed based on the totality of the facts, including the party's age, education, and experience, and the transaction's subject matter, nature, and circumstances under which it was made. Reliance on opinion may be reasonable in some cases where the opinion is expressed by one who possesses or appears to possess superior knowledge on such matter, such as when there exists a special relationship of trust between the parties (e.g., attorney-client).

[b] Misrepresentations of Law and Opinion

Misrepresentations of fact may render a contract voidable. Misrepresentations regarding the law or that constitute an opinion do not render the contract voidable, except where:

• there is a relationship of trust and confident between the parties (particularly important in cases regarding a misrepresentation of the law where the maker of the statement is a lawyer)
• the maker of the statement is in fact or claims to be an expert on such matter
• the maker of the statement has superior access to facts underlying the false opinion
• the statement is made by a third person posing as a disinterested person
• the statement is such that no reasonable person in the position of the maker of the statement could legitimately hold such opinion.

Duress, Undue Influence, or Misrepresentation by a Third Party

The defenses of duress, undue influence and misrepresentation may be available to an aggrieved party even if committed by a third party, if the other party to the contract knew or had reason to know that the victim was improperly induced to enter the contract. Some cases have even allowed such defenses in the absence of the other party's knowledge, unless such other party materially relied on the agreement.

Remedies in Avoidable Contracts

[1] Reformation

When a record does not reflect the parties' agreement due to duress, mistake or misunderstanding, the remedy of reformation may be available, except where the rights of third parties, such as good faith purchasers for value, will be unfairly affected. Reformation addresses nonconformities – typically typographical and other inadvertent errors – in the record that evidences or embodies the agreement, not the contract itself. Reformation does not seek to remake the bargain.

[2] Restitution

Where enforcement of a contract is avoided, a party that has rendered full or partial performance under a contract may be entitled to restitution.
Special rules apply where a contract is avoided based on incapacity. Most states hold that a minor who is a plaintiff in an action to avoid a contract must make full restitution but a minor-defendant need only be liable for the value of tangible consideration still retained. A minority of states (lead by New Hampshire ) takes a different approach and holds a minor liable for the entire value of any benefits received, regardless of whether he is the plaintiff or the defendant.
A mentally incapacitated party who seeks avoidance may be liable for restitution if the other party had no reason to know of the incapacity. If the incapacity should have been obvious to a reasonable person, the incapacitated party will generally be liable only for the consideration received that he still has in his possession. A minority position holds that the mentally incapacitated party need only return consideration still retained, regardless of whether his incapacity was apparent to the other party.
In addition to restitution for consideration (in whole or in part), an incapacitated party will generally be held liable for the full value of any necessities furnished to him or his dependents, such as food and medical care.

Defenses Based on Unconscionability, Law and Public Policy
A contract, in whole or in part, may be void or voidable based on unconscionability, illegality, or violation of public policy. If the contract performances are severable, the court may refuse to enforce the terms that offend law or public policy and enforce the remainder of the contract.

[1] Unconscionability

Generally, a defense based on unconscionability must present both procedural and substantive unconscionability.
Procedural unconscionability, which is manifested by unfair surprise, relates to the aggrieved party's understanding of the contract terms due to factors such as:

• inconspicuous print in the writing
• unintelligible legal language
• lack of opportunity to read the contract or seek clarification of terms
• illiteracy
• imbalanced bargaining positions (such as in adhesion contracts)

Substantive unconscionability relates to contracts that are, in whole or in part, deemed to be oppressive, such as:

• provisions that deprive one party of the benefit of the agreement or an adequate remedy for the other party's breach
• provisions that bear no reasonable relation to the risk involved
• provisions that are substantially disadvantageous to one party without producing a commensurate benefit to the other party
• a great disparity between the cost and the selling price of the item that is the subject of the contract in absence of objective justification for such disparity

[2] Illegality and Violation of Public Policy

Contracts that violate law or public policy may be denied enforcement, such as contracts that involve:

• a crime
• a tort
• a violation of a licensing requirement
• a restraint of trade or interference with contractual relationships of others
• impairment of family relationships
• an interference with the administration of justice
• an agreement not to be bound by usury, limitations or consumer protection statutes
• an exculpatory clause that would absolve a party for liability for harm caused by intentional or reckless conduct
• an exculpatory clause that would absolve an employer for harm caused to an employee by simple negligence
• an exculpatory clause that would absolve a public utility or other public service for harm caused in the course of fulfilling the public service function
• a situation in which the parties are not in pari delicto (not equally at fault)

If a contract violates a law intended to protect a given class of persons, under the principle of in pari delicto, the contract may not be enforced against a party who is a member of such protected class but such member may nevertheless enforce the contract against the other party, e.g., an employment contract that violates the wage-hour law may be enforced against the employer despite the fact that the employer may not enforce the illegal wage-hour provision against the employee.