When a party to a transaction was labouring under a mistake about the substance of the transaction, the party may be able to avoid the legal consequences of its stated intent to enter into the transaction. But what if the mistake arose in the preliminary stage leading up to the transaction, for example during the negotiations?
Under Polish contract law, a “mistake” is a typical defect in an expression of intent, and has a well-recognised position in the legal doctrine. A person who was operating under a mistake is entitled to avoid the legal consequences of their statement of intent to enter into the transaction. Given the severe legal consequences, it is essential to precisely identify the statutory grounds for the existence of a mistake allowing the party to apply this legal institution, and to properly classify the grounds in light of the circumstances.
Often the circumstances causing a mistake to occur arise out of the wording of the contract itself. But sometimes, the source of the mistake from which the injured party was suffering can be found not in the wording of the contract itself, but in the circumstances arising from the negotiations leading up to signing of the contract, which are not necessarily reflected in the provisions of the contract. In such cases, the question arises whether such circumstances should also be taken into account when determining whether the statutory grounds for alleging mistake have been fulfilled.
We will use the example where a tech company, “Big IT,” conducts an investment in which it has acquired a majority stake in another tech company, “Little IT.” The everyday operations of Little IT remain in the hands of the selling shareholders, while Big IT has undertaken to acquire the remaining stake of shares in Little IT within the next three years.
It was important for Big IT that during this period, there would be a restructuring of Little IT’s team and business model, in order to achieve the anticipated synergies and increased sales. However, this undertaking or expectation was not expressly stated in the transaction documentation, but was only a subject of discussion during the extensive negotiations between the parties.
The planned restructuring was not carried out within the expected time, because Little IT did not take certain required steps. Meanwhile, Big IT faced the need to go through with the purchase of the remaining stake of shares in Little IT, even though the intended business targets were not met.
Basic elements of mistake
The legal doctrine defines a “mistake” under contract law as an erroneous picture of the facts, i.e. an inconsistency between the facts and the beliefs about reality. Thus, whether one declares an intent to enter into a contract under the influence of a mistake is determined by the knowledge or belief of the person entering into the contract that a certain circumstance impacting the substance of the transaction (the contract) appears different from the reality.
Moreover, Art. 84 §§1–2 of the Polish Civil Code set forth quite clearly the necessary conditions for exercising the right to avoid the legal consequences of the statement of intent (i.e. the contract). In particular:
- The mistake must concern the substance of the transaction
- The mistake must warrant an assumption that if the person making a statement of intent under the influence of a mistake were to assess the matter reasonably, they would not have declared the same intent (i.e., it was a “material mistake”), and
- The mistake must have been caused by the other party (even without fault)—or the other party must have known of the mistake or could easily have noticed it.
In the example given, we could say there was a mistake if during the course of negotiation of the transaction documentation, Big IT developed an erroneous belief that Little IT would take steps to restructure its team and business model, when Little IT actually had no such intention.
But no mistake would be involved if Little IT actually did have the intention of taking such steps. In that case, there would be no inconsistency between Big IT’s belief about reality and the facts. Then, Big IT’s legal remedies would rather be based on Little IT’s non-performance or improper performance of its obligations.
It should be pointed out that asserting a claim of “mistake” with respect to the course of negotiations can be problematic from a litigation perspective. It can be difficult to demonstrate that the relevant statutory conditions have been met when they involve only the period of negotiations, when, by the nature of things, the discussions are still as an early stage and are held mainly through one-on-one meetings or email correspondence. Indeed, the evidence presented in such cases often consists of the emails exchanged between the parties, as well as witness testimony from the people who were involved in the negotiations.
Mistake as to the substance of the transaction
For the mistake to be regarded as legally relevant, it must be an error as to the substance of the transaction, and thus fall within the area of the legal relationship between the parties and its normative elements. The view is presented in the legal literature that a mistake involving the normative aspects of the transaction will be regarded as legally relevant, while a mistake concerning other, auxiliary circumstances of the transaction will not. But some commentators take a broader approach, arguing that the mistake does not necessarily have to involve the parties’ agreed declaration of their rights and obligations, but may also involve elements lacking a purely normative character. Examples given of such provisions include references to earlier negotiations or the motives guiding the parties.
Some commentators state that a mistake as to the substance of the transaction may also include an oversight with respect to circumstances not falling within the substance of the transaction or other elements of the declaration of intent. In this respect, a mistake closely tied to the declaration of intent or other elements of the transaction may be regarded as legally relevant. This interpretation is also found in the decisions by the courts, which stress the importance of the commercial aim pursued by the person signing the contract. In light of the views presented in the legal doctrine, there is a connection between the circumstance and the substance of the transaction when the circumstance involves the purpose communicated to the addressee before signing, where the addressee did not object to the circumstance which was the basis for action by the person signalling the intent to enter into the contract.
Under the example discussed above, because the plan to conduct restructuring was not expressly referred to in the transaction documentation, this circumstance could not be regarded as covered by the substance of the contract.
However, if Big IT did communicate to Little IT during the course of the negotiations that it expects restructuring to be carried out, and Little IT did not assert any objections to this expectation, this situation could be classified as a mistake as to circumstances not covered by the substance of the contract itself but closely related to it—thus meeting the statutory criteria.
“Materiality” of the mistake—legal relevance
A mistake concerning the substance of the transaction must also be “material” (i.e. relevant). This means that it must be found that if such a mistake had not occurred, a contract with a particular content would not have been entered into, no contract would have been entered into at all, or a contract would have been entered into with a content at least to some extent differing from the wording of the contract actually signed.
Under Civil Code Art. 84 §2, this review should be based on a “reasonable assessment,” which is interpreted as a reference to the model of a rational market participant, not as a reference to the actual person labouring under a mistake. In this sense, the mistake must be objectively material. By contrast, if the mistake involves a key circumstance for the specific person actually labouring under the mistake, it would be a subjectively material mistake. It is recognised in the legal literature that a legally material mistake must meet both criteria: it must be both objectively and subjectively material.
In our example, it is debatable whether it can be found under the “reasonable assessment” test that another company in the place of Big IT would have entered into a contract with the same wording as Big IT did, if it had not been labouring under a mistake. It does seem, however, that a “rational market participant” would have reached a contract at least somewhat different. From a litigation perspective, it may be hard for Little IT to find countervailing evidence, i.e. showing that Big IT (or a “rational market participant”), labouring under the same mistake or being aware of it, would have entered into a contract with exactly the same content.
Attitude of the addressee of the statement of intent
In the case of a statement of intent directed to another person, the mistake assumes legal relevance if the addressee did any of the following:
- Caused the mistake to arise
- Knew of the existence of the mistake, or
- Could easily have noticed the mistake.
Causing the mistake means a situation where the behaviour of the addressee, even without fault, leads to creation of an erroneous belief by the other party. A causal connection between the addressee’s behaviour and creation of the mistake may arise from an act but also from an omission, e.g. silence. It is not necessary for the addressee to act intentionally, but it is sufficient for its behaviour to have brought about the existence of an erroneous belief.
Apart from cases where the other party causes the mistake, a mistake can also be legally relevant if the addressee was aware of the mistake but did not inform the other party, or could have noticed the mistake without great effort. This provision is based on the assumption that an addressee who knows of a mistake should not remain passive. Easily noticing a mistake means a situation where failure to notice it is equivalent to gross negligence. It should be pointed out that the law uses the notion of “knowledge” and the “ability to notice the mistake,” rather than “fault,” because the motives guiding the addressee are irrelevant in this context.
In the case we are analysing, if prior to signing of the transaction documentation Big IT communicated to Little IT its business projections as to conducting a restructuring, and Little IT, being aware of those projections, did not object to them, then the condition of the relevant behaviour by the addressee of the statement of intent is met. It would be similar if Little IT, by its own act (or omission), misled Big IT, even unknowingly, into believing that it intends to conduct such restructuring. But this issue essentially depends on the available evidence to support Big IT’s allegations which could be offered in the course of potential litigation.
Summary
The institution in contract law of “mistake” with respect to the substance of a transaction opens up the possibility of escaping the legal consequences of a statement of intent to enter into a transaction by a party labouring under an erroneous impression as to the substance of the transaction. However, the Civil Code provides a set of conditions that must be met in order to benefit from this institution.
First and foremost, there must be an actual discrepancy between the facts and how they are understood by the injured party. This discrepancy must also go to the substance of the transaction, and thus involve elements of a normative character, or closely tied to the statement of intent or other elements of the transaction. Moreover, this discrepancy must be important enough that, were it not for the discrepancy, the substance of the transaction would be different or the transaction would not have been entered into at all. And the other party to the transaction must have given rise to the mistake by its own act or omission, or must have known of the mistake (or could easily have noticed it).
Thus it seems that if the wording of the transaction documentation does not (for any reason) fully reflect the terms agreed by the parties, the injured party can still pursue a legal remedy to protect its interests which may have been infringed. But this can be difficult in light of the need to identify evidence referring to the stage leading up to signing of the documentation. By the nature of things, such evidence may not be of high quality or probative value.
Adam Pawlisz, adwokat, Dominik Kaszuba, adwokat, M&A and Corporate practice, Wardyński & Partners
