What Constitutes Reformation in Contract Law?
Reformation is an equitable remedy that modifies an imperfectly expressed intent to reflect the true intention of the parties. Its origins lie within the common law and its continued use within the judicial system makes it relevant for contract lawyers today. Reformation assumes the prior existence of a valid contract which requires correction. Its usual purpose is to remove/ replace terms or provisions made as a result of mistake, fraud, duress, misrepresentation or inequitable conduct. It is frequently used within the context of a mistake but this is far from its only use. For example, it was applied in circumstances where the parties were under the impression that their lawyer drafted an enforceable contract when he had drafted a unilateral or voidable contract, though if this were to occur today, relief would be granted under the Solicitors Act 1974 instead.
There are two key principles of reformation: the first, to express the true agreement of the parties, and the second, that reformation is available when an act executed fails to justly express the true intentions of the parties to the bargain . As an equitable remedy, reformation is available:
• Only when the legal rights of one party would be unfairly affected.
• When the equities are equal.
• When it will be enforceable without the need for any further action.
Reformation acts retrospectively. Therefore, when granted, the judgment replaces the existing instrument with language that conveys the true intention of the parties. There is no pending cause of action or apprehended equity, meaning there is no choice but to proceed unless the court directs otherwise. It is, therefore, frequently used in rectifying a prior mistake of agreement. Superior to other remedies such as rescission and rectification, reformation is often the preferred remedy of choice by judges, due to its flexibility and ability to give effect to the true intention. Reformation addresses the underlying contract and disregards the original wording.
Legal Justifications for Contract Reformation
While contract law varies from state to state, there are generally three legal grounds that may justify a court altering a contract after its execution: mutual mistake, fraud, and misrepresentation. Mutual mistake occurs when each party is operating under a misunderstanding as to the land, buildings, or improvements of which the contract speaks. In a real estate case, each party may be under a misapprehension concerning the area, location, dimensions, boundaries, size, cost, or qualities of the real property, or that the property is not included in the purchase. Fraud involves a statement made with the intent to mislead another into believing anything is other than it actually is. Fraud can either be actual or constructive, the critical difference being that for constructive fraud, the wrongdoer did not specifically intend to deceive the other party. Misrepresentation occurs when one party communicates an untrue statement of facts material to the purpose for which it was made, and the other party relies on that misstatement to its detriment. In order to prove misrepresentation, the plaintiff must show that the statement made was one which could betray those to whom it is addressed.
Reformation Compared to Other Contractual Remedies
Reformation must be carefully distinguished from other legal remedies such as rescission, rectification, and specific performance. As in the case of rescission, time may bar the remedy of reformation; however, unlike rescission, the remedy of reformation is not based upon the impossibility of a contract’s being performed.
When considering whether to seek reformation, it is critical to remember that reformation will not occur where there is no contract in place or where the parties did not intend to make a contract with each other in the first place.
Parties may need to seek rescission or rectification rather than reformation if an error was made in reducing the parties’ agreement to writing, but not in the parties’ original agreement. Courts may, however, refuse to reform a contract that cannot be performed without violating law or public policy. Reformation, unlike rectification, does not require a showing of fault (i.e., fraud, mutual mistake, etc.) on behalf of either party.
Reformation also differs from a declaratory judgment, where the court may invalidate a document if the contract at hand is illegal, unconscionable, or against public policy.
Finally, reformation differs from specific performance to the extent that it does not perform an act required by a reasonable contract; rather, it merely corrects the terms of a contract that already exists.
How to Effectively Reform a Contract
Once a party has determined that it has grounds for reformation, it can commence the process by filing a complaint in either federal or state court. The plaintiff will be required to describe the original intent of the parties and how the written contract fails to express that intent. Such a description can include information regarding negotiations or other statements made by the parties that demonstrate their original intent. For instance, if the parties discussed incentive compensation while negotiating, but that subject omitted from the final agreement, the plaintiff can offer evidence of that discussion to show that the omission was a mistake subject to reformation. Moreover and importantly, a plaintiff should plead its grounds for reformation with particularity, including specific reference to the portions of the contract that need to be changed and the language to be substituted. The favorable treatment given reformation claims in equity makes it particularly important for the plaintiff not only to make claims that are sufficient at the pleadings stage, but also to provide clear information to the defendant as to what he has done to protect his rights.
In addition to(or even before) filing a complaint against the defendant, the plaintiff may request that the court issue preliminary injunctive relief. Such relief may be appropriate where the party seeking reformation has strong merits for the new contract (as well as a strong likelihood of success on the merits), the potential for irreparable harm if the injunction is denied, and the absence of harm to any opposing party if the injunction is issued. Although courts afford parties flexibility in providing the requisite proof at preliminary injunctions, they require that there be some basis that the change sought is necessary to ensure that they are protected should the reformation be granted. Parties are frequently encouraged to submit "living memorandums" instead of scheduling a hearing on a preliminary injunction. Such living memorandums are propositional injunctions where the parties are required to reach an agreement on how each would like the injunction to read. For example, an employee and employer may agree on a summary of the changes to temporary requested by the court should the parties reach an impasse and the employee is seeking preliminary injunctive relief. The parties would then submit their competing drafts to the court for review. More information on the requirements imposed upon parties seeking preliminary injunctions can be found in our post here.
Examination of whether the plaintiff has successfully met its burden in connection with a preliminary injunction generally occurs after the trial on the merits. At that point, the plaintiff must comparatively articulate the deficiencies in the existing contract as against the reformed contract, and convince the court why the new contract is necessary to reflect the true intent of the parties. (Notably, parties need only seek reformation of the contract as a whole or a portion thereof, as opposed to seeking wholesale alteration of its terms). Once it has done so, the court is required to impose a remedy that conforms to the contract as intended by the parties.
Court Cases that Illustrate Reformation
In their pursuit of a fair resolution, courts often rely upon reformation, as illustrated in the following cases.
Cedar Fair Limited Partnership v. Kiko, 2009-Ohio-110 (Ohio Court of Appeals) The Ohio Court of Appeals upheld a trial court decision ruling that a "Sales Agreement" be reformed based upon the existence of a mutual mistake. Cedar Fair sought to purchase the assets of Kings Island. A closing statement memorializing the sale was signed by both parties. Also signed by both parties was "a Settlement Statement designed to effectuate their agreement under the Sales Agreement. The problem however was that the "Settlement Statement" erroneously stated that the transfer between the parties would occur on June 30, 2007. However, the conveyance actually occurred on January 3, 2008. This error led Cedar Fair to re-open the negotiations regarding indemnification for liabilities incurred before January 3, 2008. If the Settlement Statement contained the correct date of June 30, 2007, then Cedar Fair would not have been entitled to indemnification for the post closing liabilities rather for pre-closing liabilities.
The trial court found that there was no disagreement as to the date of the closing. The intent of the parties was not that the closing occur on June 30, 2007. The Court of Appeals noted that the plaintiffs’ expert testified that the date of June 30 represented the book estimated date. Accordingly, the appellate court upheld the trial court’s decision to reform and give effect to the intent of the parties regarding the closing date in the closing documents.
EBN Group, Inc., 285 BR 726 (Bankr . E.D. Cal. 2002) The Bankruptcy Court precluded EBN Group, Inc., owner of a developer of golf courses, from avoiding its obligations to the trust represented by the trustee. The trust held a letter of credit issued by a bank in China, which EBN believed to be worthless. In response to a demand on the letter of credit, the holder demanded $1 million under a $10 million letter of credit based upon a clerical error that resulted from not sending the letter of credit to the same address as the prior letters of credit sent by the bank. EBN Group zeroed out its account and issued a voluntary petition in bankruptcy. The trust brought an action to enforce payment against the letter of credit.
The Bankruptcy Court denied EBN Group’s motion for summary judgment. EBN Group argued that the issuance of the letter of credit was a mistake because it wanted the Chinese bank to issue a $1 million letter of credit, not $10 million. The court held that EBN Group was not entitled to rely on its own mistake without establishing either that the mistake was mutual or that there is fraud, accident, or unlawful surprise. Furthermore, because the defendant did not raise any fraudulent activity or a unilateral agreement, the court held that the plaintiff had not proven "conditions under which unilateral mistake could render an agreement void." The EBN Group decision highlights the fact that it is not necessarily enough for a party to merely claim that it misunderstood the terms of an agreement in order to reform a contract. Rather, the party must present evidence that the other party knew or should have known of the mistake.
Challenges and Constraints When Seeking Reformation of Contracts
When one or more parties seek reformation, challenges to this remedy may arise that complicate matters in negotiations and ultimately in court as well. A party seeking reformation has the burden of proof in California. (Reddam v. Union Bank of California (2007) 157 Cal.App.4th 744, 767.) This means that such a party has to prove the validity of the alleged contract by the preponderance of the evidence. (Findly v. McDaniel (2008) 159 Cal.App.4th 41, 60.) Also, if one party seeks the reformation of the contract, all parties to the contract must be joined in the action. (De Garmo v. County of Santa Barbara (1972) 26 Cal.App.3d 695, 698.) Even when the preponderance of the evidence shows that the mistake occurred, the adopted contract upon reformation may still be found to be unenforceable or void. (Findly at 60.) For instance, courts have refused to reform contracts where the contract was considered a contract of adhesion, or where it was also determined that the limited scope within which a contract is to be modified or terminated method was not followed. (Pettigrew v. Allen & Assoc. (2004) 120 Cal.App.4th 1075, 1079.) Additionally, even when a contract is modified, it may be discovered that the terms of this modified contract are voidable by the court. (Findly at 60.) Even with efforts to rectify a contract through the reformation process, one or more parties may not agree upon the extent of changes to be made or even whether so many changes are necessary. Parties may disagree as to the terms of the original agreement, the mistakes that have been made, and the basis upon which material facts should be changed. This can create the need for further litigation in relation to the reformation process itself, which could complicate matters and increase the cost of the process involved.
Strategies to Prevent Reformation of Contracts
The best way to avoid a dispute over whether reformation is needed is to avoid ambiguities in your contract. This starts with clarity of thought. It’s important to be in position to easily articulate what the parties intended their relationship to be at the outset — whether a simple sale, an employment relationship, or the like. Once you have that focused, crystallized expectation, you’re well on your way to transforming it into a written contract.
Try to minimize the use of legalese and the like. Not only can it obfuscate what you’re attempting to achieve, but the use of Latin-based terms (e.g., "pro rata", "inter alia" (here, always), "ex parte" (never), etc.) or other terms of art (such as "commercially reasonable" (defined how?)) can serve to confuse matters, particularly when your intent was to by-use by if-then scenarios. Focus instead on plain-language contract provisions. Our firm generally uses "provide" to imply a mandatory requirement (unless "may" is used), "should" to imply a best-effort promise (that is not, however, mandatory), and "may" to indicate permission or authority. Consider other plain-language words that may work for your drafting and reading style; consistency is key.
If you’re adamant that you’re using a technical term, use it but define it (and review it with your counsel) . Legal terms of art can have meaning dictated by court decisions and statutes, so if you’re using them because you want to be precise, ensure you are precise. Don’t assume that your view of it is shared. While you’re on the subject, specific terms should be used consistently through the document (or all together, context permitting). A defined term should always be defined in the same section, and should always retain the same meaning. (For example, in one paragraph, the term "the organization" can also have the defined term "Organization". The prefered form is the defined term, and it should always be used.)
Consider that a defined term from another contract may not be appropriate in yours, even if, on face, the contracts and circumstances appear similar. This is because the "person" definition can vary by state; the applicable statute of limitation can vary (sometimes widely) by state (and cause of action); and the availability of declaratory judgments can vary, as well.
Again, be wary of using disclaimers and other such language with your agreements. While you may feel it accurate to describe a contract as one that is made "without intention to create legal obligations", the court may well find that a contract cannot be made "without intention to create legal obligations", and may instead find the intention is clear, and that the contract was made with intention to create legal obligations.
