Claims seeking damages for broken real estate deals may be more common, but the remedy of rescission often provides the most bang for the buck.

In a claim for damages due to breach of contract, the plaintiff affirms (or “stands on”) the contract, and attempts to recover the damages flowing from the other parties’ breach, which can generally be quantified in terms of the “benefit of the bargain.”

Rescission, in contrast, unwinds the deal completely and restores both parties to their pre-deal positions, and includes restitution of benefits conferred as part of the deal and sometimes an award of consequential damages.

A recent opinion by the California Court of Appeal (First District in San Francisco) — Wong v. Stoler — illustrates how effective rescission can be.

The facts: sewage system issues not disclosed before sale

Plaintiffs (the Wongs) bought a hillside home in San Carlos for $2.35 million from defendants (the Stolers).

Before escrow closed, the Stolers gave the Wongs transfer disclosure statements and a supplemental seller’s checklist, which stated that the property was connected to a public sewer system.  But a few months after escrow closed, the Wongs learned that the home (and 12 of their neighbors’ homes) were connected to a private sewer system that was not serviced by the City’s public system.

When the homes were built, the City required the developers to form a homeowners’ association to maintain and repair the private sewer lines, but no association was ever formally incorporated.  The Stolers had participated in forming an informal association to pay for periodic maintenance of the sewer system, but did not disclose that fact to the Wongs.

After moving in, the Wongs signed a contract for an extensive remodeling project costing approximately $300,000.  After the remodeling had started (most of the house was “down to the studs” due to the demolition work), the Wongs first learned of the private sewer system through an email from a neighbor.  The Wongs came to learn that there was no formal association overseeing the private system and no reserve funds for emergency repairs or long-term replacement, and the system had already incurred damage from landslides and sewage overflows.

The Wongs attempted to resolve the problem by asking the City to take possession of the system, and later by attempting to establish a formal howeowners’ association to oversee the system, but their efforts failed.

The Wongs sued.

The trial court denies rescission due to the “burden” of unwinding the sale

The Wongs sued for breach of contract, fraud and other torts, and alternatively, for rescission.  The court held a bench trial on the rescission claim first, and reserved the other claims for a jury trial if necessary.

The trial court found that the Stolers “acted with reckless disregard in negligently misrepresenting the material facts about the true nature of the sewer system and the existence of the informal association loosely established to maintain it.”  The court also found that the Wongs would not have bought the property had they known the truth.

Normally, those findings would result in rescission.

But the trial court denied rescission due to concerns over the “practicality of unwinding the transaction” — the Stolers had moved on and bought a new home (which they had also spent $100,000 improving); the Wongs had spent $300,000 improving the property and had substantially changed the landscaping and room configurations.  Given the “burden” to the Stolers of trying to restore the prior status quo, the trial court held rescission would not be fair.

The trial court went on to fashion a creative, mediator-like alternative order attempting to breath life into the informal association to oversee the private sewer system, and requiring the Stolers to indemnify the Wongs (capped at $360,000) for any required contributions to that association for a period of ten years (or until the Wongs sold the property).

The court of appeal reverses, and orders rescission

The court of appeal reversed the trial court’s judgment and held that the Wongs were entitled to rescission, including restitution of benefits and consequential damages.

The court pointed to the trial court’s finding that the Stolers had committed negligent misrepresentation, a species of fraud.  Under California’s rescission statutes, the court held, fraud provides “a complete ground for rescission.”

The court held it was improper for the trial court to deny rescission based on either the complications of unwinding the deal or the “prejudice” caused to the Stolers, stating that if someone’s “fraudulent acts have resulted in disastrous financial consequences to himself, it is no one’s fault but his own, and he must sustain the necessary inconveniences thereby entailed.”

The court summarized the relief the Wongs would be entitled pursuant to the rescission:

“rescission involving a real estate purchase requires the seller to refund the payments received and requires the buyer to restore possession to the seller. … And consequential damages are allowed such as real estate commissions, escrow payments, interest on specific sums paid to the other party, and even the cost of improvements. … Offsetting these amounts is the reasonable rental value of the property while the buyers possessed it.  While untangling the deal may not be easy, we are unaware of any insurmountable obstacles.”

Lesson

When a real estate deal (or any other deal) goes sideways, think about whether you’d be better off by standing on the agreement and suing for breach (“benefit of the bargain” damages) or instead rescinding the deal and going back to the pre-agreement status quo.  Sometimes the facts would support either remedy, and you can plead both in the alternative, but can ultimately only receive recovery under one theory.  There is often a measurable difference between breach and rescission recovery.

Conversely, if you have been sued on alternative claims for breach and rescission, think about whether you might be better off “accepting” the rescission and eliminating the plaintiff’s breach claims.  Unwinding the deal might be preferable to both parties.  Sometimes, a plaintiff will plead an alternative rescission claim just to include it as a “backup,” but if the defendant promptly accepts an offer of rescission, the courts will likely treat the rescission as fully accomplished by mutual agreement, rendering the breach claims moot and dismissed (with the court’s role limited to overseeing appropriate restitution of benefits).