A contract is traditionally supposed to be based upon a meeting of minds – a consensus ad idem. Thus, where one or both parties have made a mistake that is operative at the time that they contract1 , then this may, in some circumstances affect the enforceability of the agreement. However, the emphasis in contract law on the outward appearance of what the parties have said and done (the objective approach) means that if a party makes a mistake, but to outward appearances looks as if he intended to enter the contract on particular terms, then, except in exceptional circumstances, he will be bound. The main reasons for this approach are that it is impractical to allow someone to escape an apparent contract merely by claiming that they have made a mistake and the need for certainty.
Nonetheless, the courts have recognised that in some situations the mistake of one or more of the parties can be a basis for setting aside the apparent contract. Although terminology is not used consistently, there are three types of mistake. Firstly, unilateral mistake – where only one of the parties is mistaken and the other is aware of this. This often follows a fraudulent misrepresentation by a party as to their identity and was used successfully in the recent Court of Appeal decision in Hudson v Shogun Finance Limited. 2 Secondly, common mistake – where both parties make the same mistake (often referred to as mutual mistake). Thirdly, mutual mistake – where the parties are at cross purposes as to the subject matter or terms of the contract.
In practice mistake is seldomly used successfully to escape a contract, although over the years it has been the subject of extensive debate by academics and the judiciary, and it was considered in a report of The Law Reform Committee. These debates usually concern exactly what kind of mistake will be sufficient to allow the parties to escape being contractually bound and, of significance in the present case, whether the result is that the contract is void at common law or voidable in equity or both.
Specifically, the decision in the present case raised the question of whether a contract which was valid at common law could nevertheless be set aside in equity.
The parties entered into a contract of hire of a ship, The Great Peace , to go to the assistance of another ship, The Cape Providence , which was seriously damaged and awaiting salvage. The salvage vessel was due to take or days to arrive and in the meantime a nearer vessel was required to assist and evacuate the crew, if necessary. Both parties entered the contract of hire on the mistaken belief that The Great Peace was only hours sailing time away, about 35 miles from the stricken vessel. However, after the contract was concluded it transpired that The Great Peace was 410 miles away and could have altered course and rendezvoused in about hours. Upon discovering the true situation the defendants did not want to cancel immediately as they first wanted to see if they could find a nearer vessel. Fortuitously a vessel called The Nordfarer passed the stricken vessel by chance and so was available to assist. The defendants then cancelled the hire of The Great Peace.
The claimants required payment of $82,500 as damages for what they claimed was wrongful repudiation of the contract. The defendants maintained that the contract of hire was either void at common law or voidable in equity on the grounds of the common mistake both parties had made. Coulson J gave judgment for the claimants in the High Court and the defendants appealed to the Court of Appeal.
The defendants claimed that there was a common mistaken assumption of fact as to the distance between the ships so as to render the services under the contract, if it were performed, essentially different from what the parties had contemplated. In these circumstances could the defendants escape being bound? In Bell v Lever Brothers 5 the House of Lords confirmed that in some circumstances a contract could be void for mistake. Subsequently there were a series of decisions that gave rise to the belief that, alongside the very rare cases where there was a sufficiently fundamental mistake that the contract would be void at common law, there was also the possibility of the courts using their equitable jurisdiction to allow the setting aside of the contract where the mistake was not quite so fundamental.6 In this case the Court of Appeal addressed the issue of whether there was indeed a separate and more flexible jurisdiction in equity. The Court of Appeal also considered whether the basis for contracts being affected by mistake was a matter of law rather than being based on the terms in the contract, either express or implied
The Decision Of The Court Of Appeal
The Court of Appeal dismissed the appeal and held that there was no separate basis for setting aside a contract in equity. On the facts they concluded that the mistake was not such that the hire contracted for would be essentially different from what the parties believed. Therefore, there was a binding contract and as the defendants were in breach, they were liable to pay the cancellation fee provided for in the contract.
Lord Phillips MR, delivering the judgment of the Court, reviewed the decision in Bell v Lever Bothers and noted that although their Lordships did not all agree on the application of the law, they were in general agreement as to the principles. It was noted that in Bell there had been examination of the issue whether a contract being void was based on “an implied term that its validity shall depend on the existence at the time of the contract and during its performance, of a particular state of facts, or (whether)… there is a mutual mistake of the parties…believing that a particular foundation to it exists which is…. essential to its existence”7 . In particular, Lord Atkin, in Bell , had drawn a comparison with the law on frustration of contract and thought that in both there was the possibility of there being implied terms as to existing facts in mistake cases and future facts in frustration cases. Lord Phillips also noted that this approach had not been accepted by all of their Lordships in Bell , and that Lord Thankerton had rejected that approach and the comparison with frustration.
Lord Phillips then reviewed the development of cases on frustration from Taylor v Caldwell. 8 He described the implied term approach in Bell , and the comparison with frustration, as being the more “solid jurisprudential basis for the test for common mistake,” stating that the two areas, of mistake and frustration, had “advanced hand in hand”. However he concluded that “the theory of the implied term is as unrealistic when considering common mistake as when considering frustration”. He proceeded to say that rather it was the result of “a rule of law under which, if it transpires that one or both of the parties have agreed to do something which it is impossible to perform, no obligation arises out of that agreement.”9
As with frustration, it is necessary to identify what exactly the parties had agreed would be performed, which involves looking at the express and implied terms of the contract. Mistake or frustration only arose as an issue, if the contract contained no provision that covered the position that arises.10 Thus, the question is whether either party has undertaken the risk; have they undertaken responsibility for the subsistence of the assumed state of affairs. His Lordship was of the view that in mistake cases the more likely position would be that a party had assumed such responsibility whereas by comparison with cases of claimed frustration it was more likely that neither party has assumed the risk.
In both Solle and Magee , Lord Denning, had expressly referred to the disputed power in equity to set aside a contract, stating that “a common mistake, even on a most fundamental matter, does not make a contract void at law; but it makes it voidable in equity.”11 However, as Lord Phillips pointed out, the other two members of the Court in Magee purported to follow Bell. Despite this, decisions after Solle and Magee had proceeded on the basis that there was a more flexible remedy in equity coexisting with that in common law. Steyn J, in the Japanese Bank case,12 had commented on this dual approach as being “entirely sensible and satisfactory”
Thus, the nub of the case was could the common law doctrine leave room for the intervention of equity? His Lordship noted that in the late 1800s it had been generally unclear when a contract could be avoided in equity, although in relation to innocent misrepresentation it was established that rescission could be available in equity.
Indeed, in Solle , Denning LJ in concluding that there was a separate jurisdiction in equity had relied on the case of Cooper v Phibbs, where the House of Lords had relieved the appellant from the effects of an agreement. The agreement had been to take a lease of property that, unknown to the appellant, was in fact already his property. However Lord Phillips explains the decision in Phibbs as being based on a situation resulting from innocent misrepresentation and that the agreement would have failed in equity and at common law. As the parties had been mistaken only as to their existing rights at the time of the agreement, it was possible to set it aside on terms, based on those existing rights, but not on any rights believed to have arisen from the disputed contract. Lord Phillips denied that Phibbs provided a general authority for allowing contracts to be set aside on such terms as the court decided were appropriate. He described the terms in Phibbs as being “no more than necessary to give effect to the rights and interests of the parties” (meaning the rights they had before the agreement was made). In analysing the decision in Bell , Lord Phillips concluded:
“the House of Lords in Bell v Lever Brothers considered that the intervention of equity, as demonstrated in Cooper v Phibbs , took place in circumstances where the common law would have ruled the contract void for mistake. We do not find it conceivable that the House of Lords overlooked an equitable right in Lever Brothers to rescind the contract. ” (emphasis added).
Such was the succession of cases following Solle , that Steyn J in Japanese Bank , had felt able to conclude “that the law has not stood still in relation to mistake in equity. Today it is clear that mistake in equity is not circumscribed by common law definitions. A contract affected by mistake in equity is not void but may be set aside on terms.” Evans LJ in Sindall had come to a similar conclusion, stating that there “was a category of mistake which is ‘fundamental’ so as to permit the equitable remedy of rescission, which is wider than the kind of ‘serious and radical’ mistake which means that the agreement is void and has no effect in law.” However the Court of Appeal in Great Peace concluded that the decision in Solle which allowed for the contract to be set aside in equity, on terms, was wrongly decided, and that the view of the law expressed by Steyn J and Evans LJ above was also incorrect. A further reason put forward by Lord Phillips for there not being the two categories of mistake, was that over the 50 years since Solle it had not “proved possible to define satisfactorily two different qualities of mistake” the one required at common law and the less radical one acceptable to allow rescission in equity. Lord Phillips referred to the explanation given in Snell for the reason for the rules and principles of equity being necessary as an appendage to the general law. In his opinion this was needed where the rules of the general law produced substantial unfairness. However he concluded that other existing rules relating to misrepresentation, undue influence and fraud catered for many situations and there had been only a very few cases decided based on the disputed equitable jurisdiction in mistake. Thus, by implication, there was no need for the intervention of equity. However, in conclusion, Lord Phillips acknowledged that there might be a need for some greater flexibility and suggested that there was scope for legislation to do this.
Although there have only been a handful of cases where equitable remedies have been granted arising out of situations of common mistake, the flexibility of the now discredited principle had allowed a just outcome. As was acknowledged by Sir Christopher Staughton in West Sussex Properties “it can on occasion be the passport to a just result”. A particular advantage of a contract being dealt with in equity rather than at common law relates to the potential effect of a successful challenge to the validity of the apparent contract. In the area of unilateral mistake, the recent case of Shogun Finance illustrated that where a contract is found to be void at common law it can have very severe effects on innocent third parties. Such cases can involve situations where property has changed hands under an apparent contract and then comes into the possession of an innocent third party who has paid good money for it. If the original agreement is void for mistake then the third party has an inferior claim to the property and the court will order its return to its owner. This often leaves the third party with no effective means of redress for example if the party who sold him the property has disappeared. It was in relation to such types of situations that in 1966 the Law Reform Committee recommended that a contract made under a mistake as to the buyer’s identity should be voidable as against honest third parties and not void. If the contract is only voidable (rather than void), then where there is a bar, such as the acquisition of rights by a bona fide third party, the contract would not be set aside. In considering whether to set aside a contract in equity the court can have regard to the interests and possible hardship that would result to all concerned.
If the contract is void then unless the situation falls within the principles of restitution, there is the possibility of an injustice resulting for one of the parties, which the imposition of terms, if it were permissible, can try to ameliorate. For example in the West Sussex case rent was revised to a mistakenly large sum due to a common mistake. Although restitution enabled repayment of overpaid amounts to be ordered, the tenant, as part of the terms for setting aside the contract, was ordered to pay an amount to reflect what the parties would have agreed, but for the mistake. This was preferable to allowing a party to benefit from the common mistake and so the contract was set aside on terms which would not have been possible if dealt with solely at common law.
Lord Atkin in Bell acknowledged that “these cases involve hardship on A and benefit B, and most people would say unjustly. They can be supported on the ground that it is of paramount importance that contracts should be observed, and that if parties honestly comply with the essentials of the formation of contracts – in other words agree in the same terms on the same subject-matter – they are bound, and must rely on the stipulations of the contract for protection from the effects of facts unknown to them.”
Before the decision in Great Peace , it had already been commented by Treitel that “it may be suggested that the common law has over-stressed the need for certainty … the American rules on this subject are much closer to those of English equity than those of the English common law, and do not seem to have caused widespread inconvenience.” He then comments that in making comparison with the law on innocent misrepresentation, little inconvenience has resulted from contracts being set aside on the grounds of misrepresentation. Accordingly, the decision in Great Peace draws an illogical distinction between contracts coming about following an innocent misrepresentation leading to a common mistake, compared with the common mistake coming about as a result of some other innocent cause.
One must agree that it is unlikely that the House of Lords in Bell had overlooked the possibility of a jurisdiction in equity. There is, therefore, a difficulty in reconciling Solle with Bell. However it is a pity that the Court of Appeal felt required to reject the possibility of the existence of a more flexible approach to mistake in equity. In other areas of contract law equitable principles can temper the sometimes harsh effect of a rigid adherence to common law principles. One obvious example is in relation to Lord Denning’s more successful developments with promissory estoppel. Lord Denning often advocated the advantages of developing and using equitable principles, on an “if you’ve got it then use it” approach regarding the courts’ equitable jurisdiction following the Judicature Acts. Certainty in the law, particularly in relation to contract formation, is a desirable goal, but not at all costs. It is not suggested that equity has no place in relation to claims of mistake. The Great Peace case did not cast doubt on the ability of the court to order rectification in appropriate circumstances, such as where a written record of an agreement did not reflect the agreement made.
Furthermore, although the common law remedy of damages will be available for breach of contract, the court will have regard to equitable principles in deciding whether to order specific performance. Thus, if the contract was entered into on the basis of a mistake by one or both of the parties, this factor could be decisive if an order for specific performance was sought.
Although legislation could indeed introduce new powers to enable more flexibility, so could the House of Lords. Legislation is unlikely to be introduced in the foreseeable future so it is to be hoped that the House of Lords will have the opportunity to reconsider this area of contract law sooner rather than later. Even if they agreed that the decision in Bell was that there was no alternative to dealing with such situations at common law, they could decide to review the law on mistake . They could reflect on whether the development of equity should be curtailed in this way, especially when it was not expressly dealt with in Bell itself. Arguably the decrease in certainty, which the dual approach could allow, would be a price worth paying for allowing a more flexible approach in equity for the rare, but deserving, cases – more deserving, maybe than the defendants in the Great Peace case.