Lenawee County Board of Health v. Messerly
417 Mich. 17, 331 N.W.2d 203 (1982)
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Rule of Law:
A contract may be rescinded due to a mutual mistake about a basic assumption on which the contract was made which materially affects the agreed performances, unless the adversely affected party bore the risk of the mistake, which can be allocated by agreement such as an 'as is' clause.
Facts:
- Prior to 1971, a predecessor in title to the Messerlys installed a septic tank on the property without a permit and in violation of the health code.
- In 1971, William and Martha Messerly acquired the property, which included a three-unit apartment building, and used it as an income investment property.
- The Messerlys later sold the property to James Barnes, who in 1976 sold off a one-acre portion of the land, leaving the apartment building on a 600-square-foot parcel too small for a legally compliant sewage system.
- After Barnes defaulted, Carl and Nancy Pickles inspected the property and, on March 21, 1977, entered into a land contract directly with the Messerlys to purchase it as an income-generating rental property.
- The contract included a clause stating: 'Purchaser has examined this property and agrees to accept same in its present condition. There are no other or additional written or oral understandings.'
- Approximately one week after the sale, the Pickleses discovered raw sewage on the property.
- The Lenawee County Board of Health investigated, condemned the property, and prohibited human habitation due to the illegal and irreparable septic system, rendering the property valueless for its intended purpose.
- At the time of the sale, neither the Pickleses nor the Messerlys knew about the defective septic system.
Procedural Posture:
- The Lenawee County Board of Health initiated a lawsuit in the Lenawee Circuit Court (trial court) against both the Messerlys (vendors) and the Pickleses (vendees) to enjoin habitation of the property.
- The Messerlys filed a cross-complaint against the Pickleses, who had stopped payments, seeking foreclosure of the land contract.
- The Pickleses filed a counterclaim against the Messerlys seeking rescission of the contract.
- The trial court found for the Messerlys, ruling there was no fraud or misrepresentation and that the 'as is' clause was controlling, and ordered foreclosure against the Pickleses.
- The Pickleses, as appellants, appealed to the Michigan Court of Appeals.
- The Court of Appeals reversed the trial court's decision regarding the Messerlys, holding that the mutual mistake warranted rescission of the contract.
- The Messerlys, as appellants, were granted leave to appeal to the Supreme Court of Michigan.
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Issue:
Does a latent, unknown defect in a property's sewage system, which renders the property uninhabitable and worthless as an income-generating asset, constitute a mutual mistake of fact warranting rescission of the land contract, even when the contract contains an 'as is' clause?
Opinions:
Majority - Ryan, J.
No. While a mutual mistake as to a basic assumption of a contract that materially affects the agreed-upon performance may warrant rescission, the remedy is not available where one party has assumed the risk of that mistake. The court adopted the approach of the Restatement (Second) of Contracts, abandoning the older, confusing distinction between mistakes affecting the 'substance' versus the 'value' of the consideration. Here, both parties mistakenly believed the property was a habitable, income-generating asset, a mistake about a basic assumption that materially altered the contract's value. However, rescission is an equitable remedy granted at the court's discretion. In a case involving two innocent parties, the court must determine which party should bear the loss. The inclusion of the 'as is' clause in the contract served as an explicit agreement allocating the risk of unknown, latent defects to the purchasers, the Pickleses. By agreeing to accept the property in its 'present condition,' the Pickleses assumed the risk that the property's condition was not what it appeared to be. Therefore, equity does not justify rescinding the contract.
Analysis:
This case is significant for modernizing the doctrine of mutual mistake by formally adopting the risk-allocation framework of the Restatement (Second) of Contracts. It moves away from the difficult-to-apply 'substance vs. value' distinction established in cases like Sherwood v. Walker. The decision establishes that the existence of a mutual mistake is only the first step; the crucial inquiry is which party assumed the risk of that mistake. By giving dispositive weight to an 'as is' clause, the court affirmed that parties can contractually allocate the risk of latent defects, providing clarity and reinforcing the principle of freedom of contract in real estate transactions.
