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“As Is” Contracts and the Mutual Mistake Defense

Tennessee breach of contract cases can sometimes be defended successfully by asserting the defense of mutual mistake. Here is a hypothetical example of a case in which the defense of mutual mistake would squarely apply: Seller sells a residential lot to Buyer. At the time Buyer and Seller sign their contract, unbeknownst to both, the property is in a flood plane and is unsuitable for a home.

Under the above hypothetical facts, both Buyer and Seller made a mutual mistake as to a material matter at the time they made their contract. Under Tennessee law, if the Buyer found out after the parties made their contract that the lot was unsuitable for a home; Buyer refused to pay; and, Seller sued buyer for breach of contract, then, Buyer could successfully defend those claims by pleading mutual mistake.

It is probably unlikely that the same facts as the above hypothetical will ever occur in a Tennessee case because of the prevalence of real estate contracts which have “as is” clauses in them. Such “as is” clauses in real estate contracts have taken away the defense of mutual mistake for more than one buyer of real estate in Tennessee.

Under Tennessee law, even where both parties entered into a contract under a mutual mistake about a material fact, if the contract allocated the risk of that mutual mistake to one party, that party cannot use the doctrine of mutual mistake. How does the risk of a mutual mistake become allocated to one of the parties? The answer is that “as is” and similar clauses do just that.

A recent decision involving a residential lot in Rutherford County, Tennessee illustrates how an “as is” clause can defeat an otherwise winnable mutual mistake argument held by the buyer. In Gibbs v. Gilleland (Tenn. Ct. App. 2016), the buyers (“Buyers”) paid the seller (“Seller”) $100,000 for a residential lot. At the time the Buyers purchased the property, the property was below the base flood elevation required by the county. At that time also, both Buyers and Seller did not know this fact, and both believed that Buyers could build their house on the lot.

After Buyers began construction, the county ordered them to halt construction because the lot was below the required base flood elevation. A professional engineer determined that the lot had been below the required base flood elevation at the time Buyers and Seller made the contract. He also determined that a home could not be built on the lot even if the lot were above the required base flood elevation. Lastly, he determined that there was no cost effective solution to make the lot suitable for building.

Since Buyers had already paid the purchase price and taken ownership, there was no need for the Seller to sue them for breach of contract. So, the case started by the Buyers filing a lawsuit against the Seller for rescission of the contract based on mutual mistake.

The court had no problem determining that, at the time Buyers and Seller signed their contract, all were under the mistaken belief that a home could be built on the lot. However, the real estate contract signed by the parties contained a term that stated: “closing of this sale constitutes acceptance of the property in its condition at the time of closing.”

Based on the above term, the court concluded that, while there had been a mutual mistake, the Buyers had contractually bound themselves to bear the risk of any mistake. So, the Buyers lost the case.

The idea that an “as is” clause nullifies the defense of mutual mistake in cases like Gibbs when the parties have contracted under not just a material mutual mistake, but a major material mutual mistake, strikes me as unfair and inconsistent with the spirit of the doctrine. Nevertheless, that is the law in Tennessee unless and until it is changed.

While the doctrine of mutual mistake is often referred to as a defense and used as a defense to a breach of contract lawsuit, it can be asserted as a cause of action by a plaintiff seeking rescission of a contract. In such cases, it is essentially still a defense since the plaintiff is trying to rescind the contract.

One last very important point about the doctrine of mutual mistake: It only applies to mistakes as to facts which are verifiable and existed at the time the contract was made.