Joseph Eugene DODSON, a minor, by his next friend Gene DODSON, Plaintiff/Appellee, v. Burns SHRADER, Jr., and Mary Shrader, individually and d/b/a Shrader’s Auto Sales, Defendant/Appellant.

Supreme Court of Tennessee, at Nashville.

Jan. 27, 1992.

William S. Fleming, Fleming, Holloway & Flynn, Columbia, for defendant/appellant.

Barbara J. Walker, Columbia, for plaintiff/appellee.

OPINION

O’BRIEN, Justice.

This is an action to disaffirm the contract of a minor for the purchase of a pick-up truck and for a refund of the purchase price. The issue is whether the minor is entitled to a full refund of the money he paid or whether the seller is entitled to a setoff for the decrease in value of the pickup truck while it was in. the possession of the minor.

In early April of 1987, Joseph Eugene Dodson, then 16 years of age, purchased a used 1984 pick-up truck from Burns and Mary Shrader. The Shraders owned and operated Shrader’s Auto Sales in Columbia, Tennessee. Dodson paid $4,900 in cash for the truck, using money he borrowed from his girlfriend’s grandmother. At the time of the purchase there was no inquiry by the Shraders, and no misrepresentation by Mr. Dodson, concerning his minority. However, Mr. Shrader did testify that at the time he believed Mr. Dodson to be 18 or 19 years of age.

In December 1987, nine (9) months after the date of purchase, the truck began to develop mechanical problems. A mechanic diagnosed the problem as a burnt valve, but could not be certain without inspecting the valves inside the engine. Mr. Dodson did not want, or did not have the money, to effect these repairs. He continued to drive the truck despite the mechanical problems. One month later, in January, the truck’s engine “blew up” and the truck became inoperable.

Mr. Dodson parked the vehicle in the front yard at his parents home where he lived. He contacted the Shraders to rescind the purchase of the truck and requested a full refund. The Shraders refused to accept the tender of the truck or to give Mr. Dodson the refund requested.

Mr. Dodson then filed an action in general sessions court seeking to rescind the contract and recover the amount paid for the truck. The general sessions court dismissed the warrant and Mr. Dodson perfected a de novo appeal to the circuit court. At the time the appeal was filed in the circuit court Mr. Shrader, through counsel, declined to accept the tender of the truck without compensation for its depreciation. Before the circuit court could hear the case, the truck, while parked in Dodson’s front yard, was struck on the left front fender by a hit-and-run driver. At the time of the circuit court trial, according to Shrader, the truck was worth only $500 due to the damage to the engine and the left front fender.

The case was heard in the circuit court in November 1988. The trial judge, based on previous common-law decisions and, under the doctrine of stare decisis reluctantly granted the rescission. The Shraders were ordered, upon tender and delivery of the truck, to reimburse the $4,900 purchase price to Mr. Dodson. The Shraders appealed.

The Court of Appeals, per Todd, J., affirmed; Cantrell, J., concurring separately, Koch, J., dissenting.

The earliest recorded case in this State, on the issue involved, appears to be in Wheaton v. East, 13 Tenn. 35 (5 Yeager 41) (1833). In pronouncing the rule to apply governing infant’s contracts, the court said:

We do not perceive that any general rule, as to contracts which are void and voidable, can be stated with more precision that is done by Lord Ch.J.Eyre in Keane v. Boycott, 2 H.Black, 511, and quoted with approbation by Judge Story, 1 Mason’s Rep. 82, and by Chancellor Kent, 2 Com. 193, which is this: “that when the court can pronounce the contract to be to the infant’s prejudice, it is void, and when to his benefit, as for necessaries, it is good; and when the contract is of any uncertain nature, as to benefit or prejudice, it is voidable only, at the election of the infant.” ...

The law on the subject of the protection of infant’s rights has been slow to evolve. However, in Human v. Hartsell, 24 Tenn.App. 678, 148 S.W.2d 634, 636 (1940) the Court of Appeals noted:

The last case in Tennessee holding a minor’s contract void and adopting as the criterion for determining whether a given contract is void or only voidable [based upon] the prejudicial, uncertain or beneficial effect upon the rights and interests of the minor, appears to be the case of Robinson v. Coulter, supra, [90 Tenn. 705, 18 S.W. 250] decided November 12, 1891. In Tuck v. Payne, 159 Tenn. 192, 17 S.W.2d 8, in an opinion by Mr. Justice McKinney, the modern rule that contracts of infants are not void but only voidable and subject to be disaffirmed by the minor either before or after attaining majority appears to have been favored.

Under this rule the efforts of early authorities to classify contracts as beneficial or harmful and determine whether they are void or only voidable upon the basis of such classification are abandoned in favor of permitting the infant himself when he has become of age to determine what contracts are and what are not to his interest and liking. He is thus permitted to assume the burden of a contract, clearly disadvantageous to him, if he deems himself under a moral obligation to do so.

The adoption of this rule does not lead to any retrenchment of the infant’s rights but gives him the option of invoking contracts found to be advantageous but which, if held void, could not be enforced against the other party to the contract. Thus the minor can secure the advantage of contracts advantageous to himself and be relieved of the effect of an injudicious contract.

In Tuck, supra, 17 S.W.2d at p. 9, the court applied the rule based upon the maxims that he who seeks equity must do equity, that he who comes into equity must come with clean hands, that no one can take advantage of his own wrong, that he that has committed inequity shall not have equity, and that minors will not be permitted to use the shield of infancy as a cover, or turn it into a sword with which to injure others dealing with them in good faith.

As noted by the Court of Appeals, the rule in Tennessee, as modified, is in accord with the majority rule on the issue among our sister states. This rule is based upon the underlying purpose of the “infancy doctrine” which is to protect minors from their lack of judgment and “from squandering their wealth through improvident contracts with crafty adults who would take advantage of them in the marketplace.” Halbman v. Lemke, 99 Wis.2d 241, 245, 298 N.W.2d 562, 564 (1980).

There is, however, a modern trend among the states, either by judicial action or by statute, in the approach to the problem of balancing the rights of minors against those of innocent merchants. As a result, two (2) minority rules have developed which allow the other party to a contract with a minor to refund less than the full consideration paid in the event of rescission.

The first of these minority rules is called the “Benefit Rule.” E.g., Hall v. Butterfield, 59 N.H. 354 (1879); Johnson v. Northwestern Mut. Life Insurance Co., 56 Minn. 365, 59 N.W. 992 (1894); Berglund v. American Multigraph Sales Co., 135 Minn. 67, 160 N.W. 191 (1916); Porter v. Wilson, 106 N.H. 270, 209 A.2d 730 (1965); Valencia v. White, 134 Ariz. 139, 654 P.2d 287 (Ariz.App.1982). The rule holds that, upon rescission, recovery of the full purchase price is subject to a deduction for the minor’s use of the merchandise. This rule recognizes that the traditional rule in regard to necessaries has been extended so far as to hold an infant bound by his contracts, where he failed to restore what he has received under them to the extent of the benefit actually derived by him from what he has received from the other party to the transaction. See Porter v. Wilson, 106 N.H. 270, 209 A.2d 730, 13 A.L.R.3d 1247 (1965); Valencia v. White, supra, 2 Williston on Contracts, § 238, p. 43 (3rd Ed. Jaeger 1959). Berglund v. American Multigraph Sales Co., supra.

The other minority rule holds that the minor’s recovery of the full purchase price is subject to a deduction for the minor’s “use” of the consideration he or she received under the contract, or for the “depreciation” or “deterioration” of the consideration in his or her possession. See Carter v. Jays Motors, 3 N.J.Super. 82, 65 A.2d 628 (N.J.S.Ct., App.Div.1949); Creer v. Active Automobile Exch., 99 Conn. 266, 121 A. 888 (Conn.1923); Rodriguez v. Northern Auto Auction, 225 N.Y.S.2d 107 (N.Y.App.Div.1962); Pettit v. Liston, 97 Or. 464, 191 P. 660 (1920).

We are impressed by the statement made by the Arizona Appeals Court in Valencia v. White, supra, citing the Court of Appeals of Ohio in Haydocy Pontiac Inc. v. Lee, 19 Ohio App.2d 217, 250 N.E.2d 898 (1969):

At a time when we see young persons between 18 and 21 years of age demanding and assuming more responsibilities in their daily lives; when we see such persons emancipated, married, and raising families; when we see such persons charged with the responsibility for committing crimes; when we see such persons being sued in tort claims for acts of negligence; when we see such persons subject to military service; when we see such persons engaged in business and acting in almost all other respects as an adult, it seems timely to re-examine the case law pertaining to contractual rights and responsibilities of infants to see if the law as pronounced and applied by the courts should be redefined.

In Pettit v. Liston, supra, the Oregon court, endeavoring to resolve issues similar to those at hand in this case noted that in dealing with the right of the minor to rescind his contract and the conditions under which he may do so, the decisions of the courts in the different states have not only conflicted upon the main question involved, but many of the decisions of the same court in the same state seem to be inconsistent with each other; and often times one court has made its decision turn upon a distinction or difference not recognized by the courts of other states as a distinguishing feature. As a result rules have been promulgated which are considered to be suitable and appropriate upon considerations of principal and public policy.

Upon serious reflection we are convinced that a modified form of the Oregon rule should be adopted in this State concerning the rights and responsibilities of minors in their business dealings.

This is no quantum leap in the evolution of the common law. As early as 1842, in the case of Jacob v. The State, 22 Tenn. 372, 388, 3 Humphreys 514 (1842), Justice Turley delivered a profound dissertation on the policy and principles of the common law:

The common law has been aptly called the “lex non scripta,” because it is a rule prescribed by the common consent and agreement of the community as one applicable to its different relations, and capable of preserving the peace, good order, and harmony of society, and rendering unto every one that which of right belongs to him. Its sources are to be found in the usages, habits, manners, and customs of a people. Its seat is in the breast of the judges who are its expositors and expounders. Every nation must of necessity have its common law, let it be called by what name it may, and it will be simple or complicated in its details, as society is simple or complicated in its relations. A few plain and practical rules will do for a wandering horde of savages, but they must and will be much more extensively ramified when civilization has polished, and commerce and arts and agriculture enriched, a nation. The common law of a country will, therefore, never be entirely stationary, but will be modified, and extended by analogy, construction and custom, so as to embrace new relations, springing up from time to time, from an amelioration or change of society. The present common law of England is as dissimilar from that of Edward III. as is the present state of society. And we apprehend that no one could be found to contend that hundreds of principles, which have in more modern times been examined, argued, and determined by the judges, are not principles of the common law, because not found in the books of that period. They are held to be great and immutable principles, which have slumbered in their repositories, because the occasion called for their exposition had not arisen. The common law, then, is not like the statute law, fixed, and immutable but by positive enactment, except where a principle has been adjudged as the rule of action.

If, then, one generation be not so hedged in by the principles of the common law, established by another, as to be prohibited from extending them, by analogy and construction, to new relations and modifications of society, by what principle shall a sovereign state, which has adopted the common law of another as one of its rule of action, be so prohibited?

Such, then, is the common law, that though principles once established by judicial determination can only be changed by legislative enactment, yet such is its malleability (if we may use the expression) that new principles may be developed, and old ones extended, by analogy, so as to embrace newly-created relations and changes produced by time and circumstances. ...

The late Justice Joseph W. Henry, past member and former Chief Justice of this Court stated the message of the flexibility of the common law in more modern language in Dunn v. Palermo, 522 S.W.2d 679, 688 (Tenn.1975), as follows:

This Court in the past has not hesitated to depart from the rigid common law where “the reason for the common law rule does not exist.” Brown v. Shelby, 206 Tenn. 71, 332 S.W.2d 166 (1960).

The common law does not have the force of Holy Writ; it is not a last will and testament, nor is it a cadaver embalmed in perpetuity, nor is it to be treated like the sin of Judah — “written with a pen of iron and with the point of a diamond.” Jeremiah 17:1.

Former Chief Justice Frantz of Colorado, in his dissenting opinion in Tesone v. School Dist. No. Re-2, In County of Boulder, 152 Colo. 596, 384 P.2d 82 (1963), made this erudite observation on the common law:

“The common law of America is evolutionary; it is not static and immutable. It is in constant growth, going through mutations in adapting itself to changing conditions and in improving and refining doctrine. By its very nature, it seeks perfection in the achievement of justice.”

This is an eloquent description of the greatness and the glory of the common law.

We state the rule to be followed hereafter, in reference to a contract of a minor, to be where the minor has not been overreached in any way, and there has been no undue influence, and the contract is a fair and reasonable one, and the minor has actually paid money on the purchase price, and taken and used the article purchased, that he ought not to be permitted to recover the amount actually paid, without allowing the vender of the goods reasonable compensation for the use of, depreciation, and willful or negligent damage to the article purchased, while in his hands. If there has been any fraud or imposition on the part of the seller or if the contract is unfair, or any unfair advantage has been taken of the minor inducing him to make the purchase, then the rule does not apply. Whether there has been such an overreaching on the part of the seller, and the fair market value of the property returned, would always, in any case, be a question for the trier of fact. This rule will fully and fairly protect the minor against injustice or imposition, and at the same time it will be fair to a business person who has dealt with such minor in good faith.

This rule is best adapted to modern conditions under which minors are permitted to, and do in fact, transact a great deal of business for themselves, long before they have reached the age of legal majority. Many young people work and earn money and collect it and spend it oftentimes without any oversight or restriction. The law does not question their right to buy if they have the money to pay for their purchases. It seems intolerably burdensome for everyone concerned if merchants and business people cannot deal with them safely, in a fair and reasonable way. Further, it does not appear consistent with practice of proper moral influence upon young people, tend to encourage honesty and integrity, or lead them to a good and useful business future, if they are taught that they can make purchases with their own money, for their own benefit, and after paying for them, and using them until they are worn out and destroyed, go back and compel the vendor to return to them what they have paid upon the purchase price. Such a doctrine can only lead to the corruption of principles and encourage young people in habits of trickery and dishonesty.

In view of the foregoing considerations, we conclude that the rule, as we have indicated, and which we have paraphrased from that adopted in the State of Oregon, will henceforth be the rule to be utilized in this State.

We note that in this case, some nine (9) months after the date of purchase, the truck purchased by the plaintiff began to develop mechanical problems. Plaintiff was informed of the probable nature of the difficulty which apparently involved internal problems in the engine. He continued to drive the vehicle until the engine “blew up” and the truck became inoperable. Whether or not this involved gross negligence or intentional conduct on his part is a matter for determination at the trial level. It is not possible to determine from this record whether a counterclaim for tortious damage to the vehicle was asserted. After the first tender of the vehicle was made by plaintiff, and refused by the defendant, the truck was damaged by a hit-and-run driver while parked on plaintiff’s property.. The amount of that damage and the liability for that amount between the purchaser and the vendor, as well as the fair market value of the vehicle at the time of tender, is also an issue for the trier of fact.

The case is remanded to the trial court for further proceedings in accordance with this judgment. The costs on appellate review are assessed equally between the parties.

REID, C.J. and DROWOTA, DAUGHTREY and ANDERSON, JJ., concur.

Francis B. Ortelere, Individually and as Executor of Grace W. Ortelere, Deceased, Appellant, v. Teachers’ Retirement Board of the City of New York, Respondent.

Argued April 23, 1969;

decided July 2, 1969.

A. Mark Levien for appellant.

I. Plaintiff established that the decedent was mentally incompetent to make a rational choice among the optional forms of payment. (Matter of Ireland, 246 App. Div. 113.) II. The trial court properly annulled decedent’s retirement application. (Barnes v. Waterman, 54 Misc. 392; Faber v. Sweet Style Mfg. Corp., 40 Misc 2d 212; Schwartzberg v. Teachers’ Retirement Bd. of City of N. Y., 273 App. Div. 240; Martin v. Teachers’ Retirement Bd. of City of N. Y., 269 App. Div. 115; Beisman v. New York Gity Employees’ Retirement System, 275 App. Div. 836, 300 N. Y. 580.) III. The Appellate Division exceeded the limit on its power to review. (People ex rel. Mac Cracken v. Miller, 291 N. Y. 55; People v. Gaimari, 176 N. Y. 84; Kelly v. Watson Elevator Co., 309 N. Y. 49; Electrolux Corp. v. Val-Worth, Inc., 6 N Y 2d 556; Amend v. Hurley, 293 N. Y. 587; Boyd v. Boyd, 252 N. Y. 422; Barnet v. Cannizzaro, 3 A D 2d 745.) IV. That decedent was never adjudicated an incompetent nor hospitalized is not a valid basis for the intimation that decedent was not mentally incompetent. (Commercial Cas. Ins. Co. v. Roman, 269 N. Y. 451; Fichter Steel Corp. v. Cox Constr. Co., 266 App. Div. 347; Matter of Sebring, 238 App. Div. 281.) V. The apparently intelligent letter which decedent sent to the Retirement Board on February 8, 1965 was written either during a momentary lucid interval or without real comprehension of the text and was actually irrational. VI. Decedent’s choice of the maximum retirement payments was wholly irrational. VII. The weight and credibility to be given to the testimony of defendant’s witnesses was for the trial court. VIII. The decision of the trial court was also justified by principles of equity. (Green v. Roworth, 113 N. Y. 462; Morse v. Miller, 267 App. Div. 801, 293 N. Y. 936; Wurster v. Armfield, 175 N. Y. 256; Martin v. Teachers’ Retirement Bd. of City of N. Y., 269 App. Div. 115.)

J. Lee Rankin, Corporation Counsel (Robert T. Hartmann and Stanley Buchsbaum of counsel), for respondent.

Deceased was mentally competent when she executed her application for retirement and selected maximum monthly payments as her retirement allowance. (Beisman v. New York City Employees’ Retirement System, 275 App. Div. 836, 300 N. Y. 580; Paine v. Aldrich, 133 N. Y. 544; Moritz v. Moritz, 153 App. Div. 147, 211 N. Y. 580; Faber v. Sweet Style Mfg. Corp., 40 Misc 2d 212; Schwartzberg v. Teachers’ Retirement Bd. of City of N. Y., 273 App. Div. 240, 298 N. Y. 741.)

Breitel, J.

This appeal involves the revocability of an election of benefits under a public employees’ retirement system and suggests the need for a renewed examination of the kinds of mental incompetency which may render voidable the exercise of contractual rights. The particular issue arises on the evidently unwise and foolhardy selection of benefits by a 60-year-old teacher, on leave for mental illness and suffering from cerebral arteriosclerosis, after service as a public schoolteacher and participation in a public retirement system for over 40 years. The teacher died a little less than two months after making her election of maximum benefits, payable to her during her life, thus causing the entire reserve to fall in. She left surviving her husband of 38 years of marriage and two grown children.

There is no doubt that any retirement system depends for its soundness on an actuarial experience based on the purely prospective selections of benefits and mortality rates among the covered group, and that retrospective or adverse selection after the fact would be destructive of a sound system. It is also true that members of retirement systems are free to make choices which to others may seem unwise or foolhardy. The issue here is narrower than any suggested by these basic principles. It is whether an otherwise irrevocable election may be avoided for incapacity because of known mental illness which resulted in the election when, except in the barest actuarial sense, the system would sustain no unfavorable consequences.

The husband and executor of Grace W. Ortelere, the deceased New York City schoolteacher, sues to set aside her application for retirement without option, in the event of her death. It is alleged that Mrs. Ortelere, on February 11, 1965, two months before her death from natural causes, was not mentally competent to execute a retirement application. By this application, effective the next day, she elected the maximum retirement allowance (Administrative Code of City of New York, § B20-46.0). She thus revoked her earlier election of benefits under which she named her husband a beneficiary of the unexhausted reserve upon her death. Selection of the maximum allowance extinguished all interests upon her death.

Following a nonjury trial in Supreme Court, it was held that Grace Ortelere had been mentally incompetent at the time of her February 11 application, thus rendering it “null and void and of no legal effect ”. The Appellate Division, by a divided court, reversed the judgment of the Supreme Court and held that, as a matter of law, there was insufficient proof of mental incompetency as to this transaction (31 A D 2d 139).

Mrs. Ortelere’s mental illness, indeed, psychosis, is undisputed. It is not seriously disputable, however, that she had complete cognitive judgment or awareness when she made her selection. A modern understanding of mental illness, however, suggests that incapacity to contract or exercise contractual rights may exist, because of volitional and affective impediments or disruptions in the personality, despite the intellectual or cognitive ability to understand. It will be recognized as the civil law parallel to the question of criminal responsibility which has been the recent concern of so many and has resulted in statutory and decisional changes in the criminal law (e.g., A. L. I. Model Penal Code, § 4.01; Penal Law, § 30.05; Durham v. United States, 214 F. 2d 862).

Mrs. Ortelere, an elementary schoolteacher since 1924, suffered a “ nervous breakdown ” in March, 1964 and went on a leave of absence expiring February 5, 1965. She was then 60 years old and had been happily married for 38 years. On July 1, 1964 she came under the care of Dr. D’Angelo, a psychiatrist, who diagnosed her breakdown as involutional psychosis, melancholia type. Dr. D ’Angelo prescribed, and for about six weeks decedent underwent, tranquilizer and shock therapy. Although moderately successful, the therapy was not continued since it was suspected that she also suffered from cerebral arteriosclerosis, an ailment later confirmed. However, the psychiatrist continued to see her at monthly intervals until March, 1965. On March 28, 1965 she was hospitalized after collapsing at home from an aneurysm. She died 10 days later; the cause of death was “ Cerebral thrombosis due to H[ypertensive] H[eart] D[isease].”

As a teacher she had been a member of the Teachers’ Retirement System of the City of New York (Administrative Code, § B20-30). This entitled her to certain annuity and pension rights, preretirement death benefits, and empowered her to exercise various options concerning the payment of her retirement allowance.

Some years before, on June 28, 1958, she had executed a “ Selection of Benefits under Option One ” naming her husband as beneficiary of the unexhausted reserve. Under this option upon retirement her allowance would-be less by way of periodic retirement allowances, but if she died before receipt of her full reserve the balance of the reserve would be payable to her husband. On June 16, 1960, two years later, she had designated her husband as beneficiary of her service death benefits in the event of her death prior to retirement.

Then on February 11, 1965, when her leave of absence had just expired and she was still under treatment, she executed a retirement application, the one here involved, selecting the maximum retirement allowance payable during her lifetime with nothing payable on or after death. She also, at this time, borrowed from the system the maximum cash withdrawal permitted, namely, $8,760. Three days earlier she had written the board, stating that she intended to retire on February 12 or 15 or as soon as -she received ‘ ‘ the information I need in order to decide whether to take an option or maximum allowance.” She then listed eight specific questions, reflecting great understanding of the retirement ¡system, concerning the various alternatives available. An extremely detailed reply was sent, by letter of February 15,1965, although by that date it was technically impossible for her to change her selection. However, the board’s chief clerk, before whom Mrs. Ortelere executed the application, testified that the questions were ‘ ‘ answered verbally by me on February 11th.” Her retirement reserve totalled $62,165 (after deducting the $8,760 withdrawal), and the difference between electing the maximum retirement allowance (no option) and the allowance under “ option one ” was $901 per year or $75 per month. That is, had the teacher selected “option one” she would have received an annual allowance of $4,494 or $375 per month, while if no option had been selected she would have received an annual allowance of $5,395 or $450 per month. Had she not withdrawn the cash the annual figures would be $5,247 and $6,148 respectively.

Following her taking a leave of absence for her condition, Mrs. Ortelere had become very depressed and was unable to care for herself. As a result, her husband gave up his electrician’s job, in which he earned $222 per week, to stay home and take care of her on a full-time basis. She left their home only when he accompanied her. Although he took her to the Retirement Board on February 11,1965, he did not know why she went, and did not question her for fear "she’d start crying hysterically that I was scolding her. That’s the way she was. And I wouldn’t upset her.”

The Orteleres were in quite modest -circumstances. They owned their own home, valued at $20,000, and had $8,000 in a savings account. They also owned some farm land worth about $5,000. Under these -circumstances, as revealed in this record, retirement for both of the Orteleres or the survivor of them had to be provided, as a practical matter, largely out of Mrs. Ortelere’s retirement benefits.

According to Dr. D ’Angelo, the psychiatrist who treated her, Mrs. Ortelere never improved enough to “ warrant my sending her back [to teaching].” A physician for the Board of Education examined her on February 2, 1965 to determine her fitness to return to teaching. Although not a psychiatrist but rather a specialist in internal medicine, this physician ‘ ‘ judged that she had apparently recovered from the depression ’ ’. and that she appeared rational. However, before allowing her to return to teaching, a report was requested from Dr. D ’Angelo concerning her condition. It is notable that the Medical Division of the Board of Education on February 24, 1965 requested that Mrs. Ortelere report to the board’s “ panel psychiatrist ” on March 11, 1965.

Dr. D’Angelo stated “ [a]t no time since she was under my care was she ever mentally competent"; that "[m]entally she couldn’t make a decision of any kind, actually, of any kind, small or large.” He also described how involutional melancholia affects the judgment process: “They can’t think rationally, no matter what the situation is. They will even tell you, ‘ I used to be able to think of anything and make any decision. Now,’ they say, ‘ even getting up, I don’t know whether I should get up or whether I should stay in bed.’ Or, 'I don’t even know how to make a slice of toast any more. ’ Everything is impossible to decide, and everything is too great an effort to even think of doing. They just don’t have the effort, actually, because their nervous breakdown drains them of all their physical energies.”

While the psychiatrist used terms referring to “ rationality ”, it is quite evident that Mrs. Ortelere’s psychopathology did not lend itself to a classification under the legal test of irrationality. It is undoubtedly, for this reason, that the Appellate Division was unable to accept his testimony and the trial court’s finding of irrationality in the light of the prevailing rules as they have been formulated.

The well-established rule is that contracts of a mentally incompetent person who has not been adjudicated insane are voidable. Even where the contract has been partly or fully performed it will still be avoided upon restoration of the status quo. (Verstandig v. Schlaffer, 296 N. Y. 62, 64; Blinn v. Schwarz, 177 N. Y. 252, 262; see, also, Ann., Contracts with Incompetent, 95 A. L. R. 1442; Ann., Incompetent—Contract Before Adjudication, 46 A. L. R. 416.)

Traditionally, in this State and elsewhere, contractual mental capacity has been measured by what is largely a cognitive test (Aldrich v. Bailey, 132 N. Y. 85; 2 Williston, Contracts [3d ed.], § 256; see 17 C.J.S., Contracts, § 133 [1], subd. e, pp. 869-862). Under this standard the ‘ ‘ inquiry ’ ’ is whether the mind was "so affected as to render him wholly and absolutely incompetent to comprehend and understand the nature of the transaction ” (Aldrich v. Bailey, supra, at p. 89). A requirement that the party also be able to make a rational judgment concerning the particular transaction qualified the cognitive test (Paine v. Aldrich, 133 N. Y. 544, 546; Note, “ Civil Insanity The New York Treatment of the Issue of Mental Incompetency in NonCriminal Cases, 44 Cornell L. Q. 76). Conversely, it is also well recognized that contractual ability would be affected by insane delusions intimately related to the particular transaction (Moritz v. Moritz, 153 App. Div. 147, affd. 211 N. Y. 580; see Green, Judicial Tests of Mental Incompetency, 6 Mo. L. Rev. 141, 151).

These traditional standards governing competency to contract were formulated when psychiatric knowledge was quite primitive. They fail to account for one who by reason of mental illness is unable to control his conduct even though his cognitive ability seems unimpaired. "When these standards were evolving it was thought that all the mental faculties were simultaneously affected by mental illness. (Green, Mental Incompetency, 38 Mich. L. Rev. 1189, 1197-1202.) This is no longer the prevailing view (Note, Mental Illness and the Law of Contracts, 57 Mich. L. Rev. 1020, 1033-1036).

Of course, the greatest movement in revamping legal notions of mental responsibility has occurred in the criminal law. The nineteenth century cognitive test embraced in the M’Naghten rules has long been criticized and changed by statute and decision in many jurisdictions (see M’Naghten’s Case, 10 Clark & Fin. 200; 8 Eng. Rep. 718 [House of Lords, 1843]; Weihofen, Mental Disorder as a Criminal Defense [1954], pp. 65-68; British Royal Comm, on Capital Punishment [1953], ch. 4; A. L. I. Model Penal Code, § 4.01, supra; cf. Penal Law, § 30.05).

While the policy considerations for the criminal law and the civil law are different, both share in common the premise that policy considerations must be based on a sound understanding of the human mind and, therefore, its illnesses. Hence, because the cognitive .rules are, for the most part, too restrictive and rest on a false factual basis they must be re-examined. Once it is understood that, accepting plaintiff’s proof, Mrs. Ortelere was psychotic and because of that psychosis could have been incapable of making a voluntary selection of her retirement system benefits, there is an issue that a modern jurisprudence should not exclude, merely because her mind could pass a “ cognition ” test based on nineteenth century psychology.

There has also been some movement on the civil law side to achieve a modern posture. For the most part, the-movement has been glacial and has been disguised under traditional formulations. Various devices have been used to avoid unacceptable results under the old rules by finding unfairness or overreaching in order to avoid transactions (see, e.g., Green, Proof of Mental Incompetency ' and the Unexpressed Major Premise, 53 Yale L. J. 271, 298-305).

In this State there has been at least one candid approach. In Faber v. Sweet Style Mfg. Corp. (40 Misc 2d 212) Mr. Justice Meyer wrote: “ [i]ncompetence to contract also exists when a contract is entered into under the compulsion of a mental disease or disorder but for which the contract would not have been made ” (at p. 216; noted in 39 N.Y.U. L. Rev. 356). This is the first known time a court has recognized that the traditional standards of incompetency for contractual capacity are inadequate in light of contemporary psychiatric learning and applied modern standards. Prior to this, courts applied the cognitive standard giving great weight to objective evidence of rationality (e.g., Beisman v. New York City Employees’ Retirement System, 81 N. Y. S. 2d 373, revd. 275 App. Div. 836, affd. 300 N. Y. 580; Schwartsberg v. Teachers’ Retirement Bd., 273 App. Div. 240, affd. 298 N. Y. 741; Martin v. Teachers’ Retirement Bd., 70 N. Y. S. 2d 593).

It is quite significant that Restatement, 2d, Contracts, states the modern rule on competency to contract. This is in evident recognition, and the Reporter’s Notes support this inference, that, regardless of how the cases formulated their reasoning, the old cognitive test no longer explains the results. Thus, the new Restatement section reads: “ (1) A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect * * * (b) he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition.” (Restatement, 2d, Contracts [T.D. No. 1, April 13, 1964], § 18C.) (See, also, Allen, Ferster, Weihofen, Mental Impairment and Legal Incompetency, p. 253 [Recommendation b] and pp. 260-282; and Note, 57 Mich. L. Rev. 1020, supra, where it is recommended ‘ ‘ that a complete test for contractual incapacity should provide protection to those persons whose contracts are merely uncontrolled reactions to their mental illness, as well as for those who could not understand the nature and consequences of their actions ” [at p .1036]).

The avoidance of duties under an agreement entered into by those who have done so by reason of mental illness, but who have understanding, depends on balancing competing policy considerations. There must be stability in contractual relations and protection of the expectations of parties who bargain in good faith. On the other hand, it is also desirable to protect persons who may understand the nature of the transaction but who, due to mental illness, cannot control their conduct. Hence, there should be relief only if the other party knew or was put on notice as to the contractor’s mental illness. Thus, the Restatement provision for avoidance contemplates that “ the other party has reason to know ” of the mental illness (id.).

When, however, the other party is without knowledge of the contractor’s mental illness and the agreement is made on fair terms, the proposed Restatement rule is: “ The power of avoidance under subsection (1) terminates to the extent that the contract has been .so performed in whole or in part or the circumstances have so changed that avoidance would be inequitable. In .such a case a court may grant relief on such equitable terms as the situation requires.” (Restatement, 2d, Contracts, supra, § 18C, subd. [2].)

The system was, or should have been, fully aware of Mrs. Ortelere’s condition. They, or the Board of Education, knew of. her leave of absence for medical reasons and the resort to staff psychiatrists by the Board of Education. Hence, the other of the conditions for avoidance is satisfied.

Lastly, there are no significant changes of position by the system other than those that flow from the barest actuarial consequences of benefit selection.

Nor should one ignore that in the relationship between retirement system and member, and especially in a public system, there is not involved a commercial, let alone an ordinary commercial, transaction. Instead the nature of the system and its announced goal is the protection of its members and those in whom its members have an interest. It is not a sound scheme which would permit 40 years of contribution and participation in the system to be nullified by a one-instant act committed by one known to be mentally ill. This is especially true if there would be no substantial harm to the system if the act were avoided. On the record none may gainsay that her selection of a “ no option ” retirement while under psychiatric care, ill with cerebral arteriosclerosis, aged. 60, and with a family in which she had always manifested concern, was so unwise and foolhardy that a factfinder might conclude that it was explainable only as a product of psychosis.

On this analysis it is not difficult to see that plaintiff’s evidence was sufficient to sustain a finding that, when she acted as she did on February 11, 1965, she did so solely as a result of serious mental illness, namely, psychosis. Of course, nothing less serious than medically classified psychosis should suffice or else few contracts would be invulnerable to some kind of psychological attack. Mrs. Ortelere’s psychiatrist testified quite flatly that as an involutional melancholiac in depression she was incapable of making a voluntary “ rational ” decision. Of course, as noted earlier, the trial court’s finding and perhaps some of the testimony attempted to fit into the rubrics of the traditional rules. For that reason rather than reinstatement of the judgment at Trial Term there should be a new trial under the proper standards frankly considered and applied.

Accordingly, the order of the Appellate division should be reversed, without costs, and the action remanded to Trial Term for a new trial.

Jasen, J. (dissenting).

Where there has been no previous adjudication of incompetency, the burden of proving mental incompetence is upon the party alleging it. I agree with the majority at the Appellate Division that the plaintiff, the husband of the decedent, failed to sustain the burden incumbent upon him of proving deceased’s incompetence.

The evidence conclusively establishes that the decedent, at the time she made her application to retire, understood not only that she was retiring, but also that she had selected the maximum payment during her lifetime.

Indeed, the letter written by the deceased to the Teachers’ Retirement System prior to her retirement demonstrates her full mental capacity to understand and to decide whether to take an option or the maximum allowance. The full text of the letter reads as follows:

February 8, 1965

Gentlemen:

I would like to retire on Feb. 12 or Feb. 15. In other words, just as soon as possible after I receive the information I need in order to decide whether to take an option or maximum allowance. Following are the questions I would like to have answered:

1. What is my ‘ average ’ five-year salary?

2. What is my maximum allowance ?

3. I am 60 years old. If I select option four-a with a beneficiary (female) 27 years younger, what is my allowance?

4. If I select four-a on the pension part only, and take the maximum annuity, what is my allowance?

5. If I take a loan of 89% of my year’s salary before retirement, what would my maximum allowance be?

6. If I take a loan of $5,000 before retiring, and select option four-a on both the pension and annuity, what would my allowance be?

7. What is my total service credit? I have been on a leave without pay since Oct. 26,19,64.

8. What is the ‘ factor ’ used for calculating option four-a with the above beneficiary®

Thank you for your promptness in making the necessary calculations. I will come to your office on Thursday afternoon of this week.

It seems clear that this detailed, explicit and extremely pertinent list of queries reveals a mind fully in command of the salient features of the Teachers’ Retirement System. Certainly, it cannot be said that the decedent could possess sufficient capacity to compose a letter indicating such a comprehensive understanding of the retirement system, and yet lack the capacity to understand the answers.

As I read the record, the evidence establishes that the dependent’s election to receive maximum payments was predicated on the need for a higher income to support two retired persons — her husband and herself. Since the only source of income available to decedent and her husband was decedent’s retirement pay, the additional payment of $75 per month which she would receive by electing the maximal payment was a necessity. Indeed, the additional payments represented an increase of 20% over the benefits payable under option 1. Under these circumstances, an election of maximal income during decedent’s lifetime was not only a rational, but a necessary decision.

Further indication of decedent’s knowledge of the financial needs of her family is evidenced by the fact that she took a loan for the maximum amount ($8,760) permitted by the retirement system, at the time she made application for retirement.

Moreover, there is nothing in the record to indicate that the decedent had any warning, premonition, knowledge or indication at the time of retirement that her life expectancy was, in any way, reduced by her condition.

Decedent’s election of the maximum retirement benefits, therefore, was not so contrary to her best interests so as to create an inference of her mental incompetence.

Indeed, concerning election of options under a retirement system, it has been held: “Even where no previous election has been made, the court must make the election for an incompetent which would be in accordance with what would have been his manifest and reasonable choice if he were sane, and, in the absence of convincing evidence that the incompetent would have made a different selection, it is presumed that he would have chosen the option yielding the largest returns in his lifetime.” (Schwartzberg v. Teachers’ Retirement Bd., 273 App. Div. 240, 242-243, affd. 298 N. Y. 741; emphasis supplied.)

Nor can I agree with the majority’s view that the traditional rules governing competency to contract “are, for the most part, too restrictive and rest on a false factual basis ”.

The issue confronting the courts concerning mental capacity to contract is under what circumstances and conditions should a party be relieved of contractual obligations freely entered. This is peculiarly a legal decision, although, of course, available medical knowledge forms a datum which influences the legal choice. It is common knowledge that the present state of psychiatric knowledge is inadequate to provide a fixed rule for each and every type of mental disorder. Thus, the generally accepted rules which have evolved to determine mental responsibility are general enough in application to encompass all types of mental disorders, and phrased in a manner which can be understood and practically applied by juries composed of laymen.

The generally accepted test of mental competency to contract which has thus evolved is whether the party attempting to avoid the contract was capable of understanding and appreciating the nature and consequences of the particular act or transaction which he challenges. (Schwartzberg v. Teachers’ Retirement Bd., supra; Paine v. Aldrich, 133 N. Y. 544; Beisman v. New York City Employees’ Retirement System, 275 App. Div. 836, affd. 300 N. Y. 580.) This rule represents a balance struck between policies to protect the security of transactions between individuals and freedom of contract on the one hand, and protection of those mentally handicapped on the other hand. In my opinion, this rule has proven workable in practice and fair in result. A broad range of evidence including psychiatric testimony is admissible under the existing rules to establish a party’s mental condition. (See 2 Wigmore, Evidence [3d ed.], §§ 227-233.) In the final analysis, the lay jury will infer the state of the party’s mind from his observed behavior as indicated by the evidence presented at trial. Each juror instinctively judges what is normal and what is abnormal conduct from his own experience, and the generally accepted test harmonizes the competing policy considerations with human experience to achieve the fairest result in the greatest number of cases.

As in every situation where the law must draw a line between liability and nonliability, between responsibility and non-responsibility, there will be borderline cases, and injustices may occur by deciding erroneously that an individual belongs on one side of the line or the other. To minimize the chances of such injustices occurring, the line should be drawn as clearly as possible.

The Appellate Division correctly found that the deceased was capable of understanding the nature and effect of her retirement benefits, and exercised rational judgment in electing to receive the maximum allowance during her lifetime. I fear that the majority’s refinement of the generally accepted rules will prove unworkable in practice, and make many contracts vulnerable to psychological attack. Any benefit to those who understand what they are doing, but are unable to exercise self-discipline, will be outweighed by frivolous claims which will burden our courts and undermine the security of contracts. The reasonable expectations of those who innocently deal with persons who appear rational and who understand what they are doing should be protected.

Accordingly, I would affirm the order appealed from.

Chief Judge Fuld and Judges Burke and Bergaet concur with Judge Breitel; Judge Jaseet dissents and votes to affirm in separate opinion in which Judge Scileppi concurs.

Order reversed, without costs, and a new trial granted.

LENAWEE COUNTY BOARD OF HEALTH v MESSERLY

Docket No. 65513.

Argued November 9, 1981

(Calendar No. 3).

Decided December 23, 1982.

Force & Baldwin (by Lawrence C. Force) for the Messerlys.

Robertson, Bartlow, Des Chenes & Sautér, P.C. (by Michael J. Sauter), for the Pickleses.

Ryan, J.

In March of 1977, Carl and Nancy Pickles, appellees, purchased from appellants, William and Martha Messerly, a 600-square-foot tract of land upon which is located a three-unit apartment building. Shortly after the transaction was closed, the Lenawee County Board of Health condemned the property and obtained a permanent injunction which prohibits human habitation on the premises until the defective sewage system is brought into conformance with the Lenawee County sanitation code.

We are required to determine whether appellees should prevail in their attempt to avoid this land contract on the basis of mutual mistake and failure of consideration. We conclude that the parties did entertain a mutual misapprehension of fact, but that the circumstances of this case do not warrant rescission.

I

The facts of the case are not seriously in dispute. In 1971, the Messerlys acquired approximately one acre plus 600 square feet of land. A three-unit apartment building was situated upon the 600-square-foot portion. The trial court found that, prior to this transfer, the Messerlys’ predecessor in title, Mr. Bloom, had installed a septic tank on the property without a permit and in violation of the applicable health code. The Messerlys used the building as an income investment property until 1973 when they sold it, upon land contract, to James Barnes who likewise used it primarily as an income-producing investment.1

Mr. and Mrs. Barnes, with the permission of the Messerlys, sold approximately one acre of the property in 1976, and the remaining 600 square feet and building were offered for sale soon thereafter when Mr. and Mrs. Barnes defaulted on their land contract. Mr. and Mrs. Pickles evidenced an interest in the property, but were dissatisfied with the terms of the Barnes-Messerly land contract. Consequently, to accommodate the Pickleses’ preference to enter into a land contract directly with the Messerlys, Mr. and Mrs. Barnes executed a quitclaim deed which conveyed their interest in the property back to the Messerlys. After inspecting the property, Mr. and Mrs. Pickles executed a new land contract with the Messerlys on March 21, 1977. It provided for a purchase price of $25,-500. A clause was added to the end of the land contract form which provides:

"17. Purchaser has examined this property and agrees to accept same in its present condition. There are no other or additional written or oral understandings.”

Five or six days later, when the Pickleses went to introduce themselves to the tenants, they discovered raw sewage seeping out of the ground. Tests conducted by a sanitation expert indicated the inadequacy of the sewage system. The Lenawee County Board of Health subsequently condemned the property and initiated this lawsuit in the Lenawee Circuit Court against the Messerlys as land contract vendors, and the Pickleses, as vendees, to obtain a permanent injunction proscribing human habitation of the premises until the property was brought into conformance with the Lenawee County sanitation code. The injunction was granted, and the Lenawee County Board of Health was permitted to withdraw from the lawsuit by stipulation of the parties.

When no payments were made on the land contract, the Messerlys filed a cross-complaint against the Pickleses seeking foreclosure, sale of the property, and a deficiency judgment. Mr. and Mrs. Pickles then counterclaimed for rescission against the Messerlys, and filed a third-party complaint against the Barneses, which incorporated, by reference, the allegations of the counterclaim against the Messerlys. In count one, Mr. and Mrs. Pickles alleged failure of consideration. Count two charged Mr. and Mrs. Barnes with wilful concealment and misrepresentation as a result of their failure to disclose the condition of the sanitation system. Additionally, Mr. and Mrs. Pickles sought to hold the Messerlys liable in equity for the Barneses’ alleged misrepresentation. The Pickleses prayed that the land contract be rescinded.2

After a bench trial, the court concluded that the Pickleses had no cause of action against either the Messerlys or the Barneses as there was no fraud or misrepresentation. This ruling was predicated on the trial judge’s conclusion that none of the parties knew of Mr. Bloom’s earlier transgression or of the resultant problem with the septic system until it was discovered by the Pickleses, and that the sanitation problem was not caused by any of the parties. The trial court held that the property was purchased "as is”, after inspection and, accordingly, its "negative * * * value cannot be blamed upon an innocent seller”. Foreclosure was ordered against the Pickleses, together with a judgment against them in the amount of $25,943.09.3

Mr. and Mrs. Pickles appealed from the adverse judgment. The Court of Appeals unanimously affirmed the trial court’s ruling with respect to Mr. and Mrs. Barnes but, in a two-to-one decision, reversed the finding of no cause of action on the Pickleses’ claims against the Messerlys. Lenawee County Board of Health v Messerly, 98 Mich App 478; 295 NW2d 903 (1980).4 It concluded that the

mutual mistake5 between the Messerlys and the Pickleses went to a basic, as opposed to a collateral, element of the contract,6 and that the parties intended to transfer income-producing rental property but, in actuality, the vendees paid $25,500 for an asset without value.7

We granted the Messerlys’ application for leave to appeal. 411 Mich 900 (1981).8

II

We must decide initially whether there was a mistaken belief entertained by one or both parties to the contract in dispute and, if so, the resultant legal significance.9

A contractual mistake "is a belief that is not in accord with the facts”. 1 Restatement Contracts, 2d, § 151, p 383. The erroneous belief of one or both of the parties must relate to a fact in existence at the time the contract is executed. Richardson Lumber Co v Hoey, 219 Mich 643; 189 NW 923 (1922); Sherwood v Walker, 66 Mich 568, 580; 33 NW 919 (1887) (Sherwood, J., dissenting). That is to say, the belief which is found to be in error may not be, in substance, a prediction as to a future occurrence or non-occurrence. Henry v Thomas, 241 Ga 360; 245 SE2d 646 (1978); Hailpern v Dryden, 154 Colo 231; 389 P2d 590 (1964). But see Denton v Utley, 350 Mich 332; 86 NW2d 537 (1957).

The Court of Appeals concluded, after a de novo review of the record, that the parties were mistaken as to the income-producing capacity of the property in question. 98 Mich App 487-488. We agree. The vendors and the vendees each believed that the property transferred could be utilized as income-generating rental property. All of the parties subsequently learned that, in fact, the property was unsuitable for any residential use.

Appellants assert that there was no mistake in the contractual sense because the defect in the sewage system did not arise until after the contract was executed. The appellees respond that the Messerlys are confusing the date of the inception of the defect with the date upon which the defect was discovered.

This is essentially a factual dispute which the trial court failed to resolve directly. Nevertheless, we are empowered to draw factual inferences from the facts found by the trial court. GCR 1963, 865.1(6).

An examination of the record reveals that the septic system was defective prior to the date on which the land contract was executed. The Messerlys’ grantor installed a nonconforming septic system without a permit prior to the transfer of the property to the Messerlys in 1971. Moreover, virtually undisputed testimony indicates that, assuming ideal soil conditions, 2,500 square feet of property is necessary to support a sewage system adequate to serve a three-family dwelling. Likewise, 750 square feet is mandated for a one-family home. Thus, the division of the parcel and sale of one acre of the property by Mr. and Mrs. Barnes in 1976 made it impossible to remedy the already illegal septic system within the confines of the 600-square-foot parcel.10

Appellants do not dispute these underlying facts which give rise to an inference contrary to their contentions.

Having determined that when these parties entered into the land contract they were laboring under a mutual mistake of fact, we now direct our attention to a determination of the legal significance of that finding.

A contract may be rescinded because of a mutual misapprehension of the parties, but this remedy is granted only in the sound discretion of the court. Harris v Axline, 323 Mich 585; 36 NW2d 154 (1949). Appellants argue that the parties’ mistake relates only to the quality or value of the real estate transferred, and that such mistakes are collateral to the agreement and do not justify rescission, citing A & M Land Development Co v Miller, 354 Mich 681; 94 NW2d 197 (1959).

In that case, the plaintiff was the purchaser of 91 lots of real property. It sought partial rescission of the land contract when it was frustrated in its attempts to develop 42 of the lots because it could not obtain permits from the county health department to install septic tanks on these lots. This Court refused to allow rescission because the mistake, whether mutual or unilateral, related only to the value of the property.

"There was here no mistake as to the form or substance of the contract between the parties, or the description of the property constituting the subject matter. The situation involved is not at all analogous to that presented in Scott v Grow, 301 Mich 226; 3 NW2d 254; 141 ALR 819 (1942). There the plaintiff sought relief by way of reformation of a deed on the ground that the instrument of conveyance had not been drawn in accordance with the intention and agreement of the parties. It was held that the bill of complaint stated a case for the granting of equitable relief by way of reformation. In the case at bar plaintiff received the property for which it contracted. The fact that it may be of less value than the purchaser expected at the time of the transaction is not a sufficient basis for the granting of equitable relief, neither fraud nor reliance on misrepresentation of material facts having been established.” 354 Mich 693-694.

Appellees contend, on the other hand, that in this case the parties were mistaken as to the very nature of the character of the consideration and claim that the pervasive and essential quality of this mistake renders rescission appropriate. They cite in support of that view Sherwood v Walker, 66 Mich 568; 33 NW 919 (1887), the famous "barren cow” case. In that case, the parties agreed to the sale and purchase of a cow which was thought to be barren, but which was, in reality, with calf. When the seller discovered the fertile condition of his cow, he refused to deliver her. In permitting rescission, the Court stated:

"It seems to me, however, in the case made by this record, that the mistake or misapprehension of the parties went to the whole substance of the agreement. If the cow was a breeder, she was worth at least $750; if barren, she was worth not over $80. The parties would not have made the contract of sale except upon the understanding and belief that she was incapable of breeding, and of no use as a cow. It is true she is now the identical animal that they thought her to be when the contract was made; there is no mistake as to the identity of the creature. Yet the mistake was not of the mere quality of the animal, but went to the very nature of the thing. A barren cow is substantially a different creature than a breeding one. There is as much difference between them for all purposes of use as there is between an ox and a cow that is capable of breeding and giving milk. If the mutual mistake had simply related to the fact whether she was with calf or not for one season, then it might have been a good sale; but the mistake affected the character of the animal for all time, and for her present and ultimate use. She was not in fact the animal, or the kind of animal, the defendants intended to sell or the plaintiff to buy. She was not a barren cow, and, if this fact had been known, there would have been no contract. The mistake affected the substance of the whole consideration, and it must be considered that there was no contract to sell or sale of the cow as she actually was. The thing sold and bought had in fact no existence. She was sold as a beef creature would be sold; she is in fact a breeding cow, and a valuable one.

"The court should have instructed the jury that if they found that the cow was sold, or contracted to be sold, upon the understanding of both parties that she was barren, and useless for the purpose of breeding, and that in fact she was not barren, but capable of breeding, then the defendants had a right to rescind, and to refuse to deliver, and the verdict should be in their favor.” 66 Mich 577-578.

As the parties suggest, the foregoing precedent arguably distinguishes mistakes affecting the essence of the consideration from those which go to its quality or value, affording relief on a per se basis for the former but not the latter. See, e.g., Lenawee County Board of Health v Messerly, 98 Mich App 478, 492; 295 NW2d 903 (1980) (Mackenzie, J., concurring in part).

However, the distinctions which may be drawn from Sherwood and A & M Land Development Co do not provide a satisfactory analysis of the nature of a mistake sufficient to invalidate a contract. Often, a mistake relates to an underlying factual assumption which, when discovered, directly affects value, but simultaneously and materially affects the essence of the contractual consideration. It is disingenuous to label such a mistake collateral. McKay v Coleman, 85 Mich 60; 48 NW 203 (1891). Corbin, Contracts (one vol ed), § 605, p 551.

Appellant and appellee both mistakenly believed that the property which was the subject of their land contract would generate income as rental property. The fact that it could not be used for human habitation deprived the property of its income-earning potential and rendered it less valuable. However, this mistake, while directly and dramatically affecting the property’s value, cannot accurately be characterized as collateral because it also affects the very essence of the consideration. "The thing sold and bought [income-generating rental property] had in fact no existence”. Sherwood v Walker, 66 Mich 578.

We find that the inexact and confusing distinction between contractual mistakes running to value and those touching the substance of the consideration serves only as an impediment to a clear and helpful analysis for the equitable resolution of cases in which mistake is alleged and proven. Accordingly, the holdings of A & M Land Development Co and Sherwood with respect to the material or collateral nature of a mistake are limited to the facts of those cases.

Instead, we think the better-reasoned approach is a case-by-case analysis whereby rescission is indicated when the mistaken belief relates to a basic assumption of the parties upon which the contract is made, and which materially affects the agreed performances of the parties. Denton v Utley, 350 Mich 332; 86 NW2d 537 (1957); Farhat v Rassey, 295 Mich 349; 294 NW 707 (1940); Richardson Lumber Co v Hoey, 219 Mich 643; 189 NW 923 (1922). 1 Restatement Contracts, 2d, § 152, pp 385-386.11 Rescission is not available, however, to relieve a party who has assumed the risk of loss in connection with the mistake. Denton v Utley, 350 Mich 344-345; Farhat v Rassey, 295 Mich 352; Corbin, Contracts (one vol ed), § 605, p 552; 1 Restatement Contracts, 2d, §§ 152, 154, pp 385-386, 402-406.12

All of the parties to this contract erroneously assumed that the property transferred by the vendors to the vendees was suitable for human habitation and could be utilized to generate rental income. The fundamental nature of these assumptions is indicated by the fact that their invalidity changed the character of the property transferred, thereby frustrating, indeed precluding, Mr. and Mrs. Pickles’ intended use of the real estate. Although the Pickleses are disadvantaged by enforcement of the contract, performance is advantageous to the Messerlys, as the property at issue is less valuable absent its income-earning potential. Nothing short of rescission can remedy the mistake. Thus, the parties’ mistake as to a basic assumption materially affects the agreed performances of the parties.

Despite the significance of the mistake made by the parties, we reverse the Court of Appeals because we conclude that equity does not justify the remedy sought by Mr. and Mrs. Pickles.

Rescission is an equitable remedy which is granted only in the sound discretion of the court. Harris v Axline, 323 Mich 585; 36 NW2d 154 (1949); Hathaway v Hudson, 256 Mich 694; 239 NW 859 (1932). A court need not grant rescission in every case in which the mutual mistake relates to a basic assumption and materially affects the agreed performance of the parties.

In cases of mistake by two equally innocent parties, we are required, in the exercise of our equitable powers, to determine which blameless party should assume the loss resulting from the misapprehension they shared.13 Normally that can only be done by drawing upon our "own notions of what is reasonable and just under all the surrounding circumstances”.14

Equity suggests that, in this case, the risk should be allocated to the purchasers. We are guided to that conclusion, in part, by the standards announced in § 154 of the Restatement of Contracts, 2d, for determining when a party bears the risk of mistake. See fn 12. Section 154(a) suggests that the court should look first to whether the parties have agreed to the allocation of the risk between themselves. While there is no express assumption in the contract by either party of the risk of the property becoming uninhabitable, there was indeed some agreed allocation of the risk to the vendees by the incorporation of an "as is” clause into the contract which, we repeat, provided:

"Purchaser has examined this property and agrees to accept same in its present condition. There are no other or additional written or oral understandings.”

That is a persuasive indication that the parties considered that, as between them, such risk as related to the "present condition” of the property should lie with the purchaser. If the "as is” clause is to have any meaning at all, it must be interpreted to refer to those defects which were unknown at the time that the contract was executed.15 Thus, the parties themselves assigned the risk of loss to Mr. and Mrs. Pickles.16

We conclude that Mr. and Mrs. Pickles are not entitled to the equitable remedy of rescission and, accordingly, reverse the decision of the Court of Appeals.

Fitzgerald, C.J., and Kavanagh, Williams, Levin, and Coleman, JJ., concurred with Ryan, J.

Riley, J., took no part in the decision of this case.

1

James Barnes was married shortly after he purchased the property. Mr. and Mrs. Barnes lived in one of the apartments on the property for three months and, after they moved, Mrs. Barnes continued to aid in the management of the property.

2

Linehan Realty Company and Andrew E. Czmer, doing business as Andrew Realty Company, were also named as third-party defendants, but were later dismissed from the lawsuit by stipulation of the parties.

3

The parties stipulated that this amount was due on the land contract, assuming that the contract was valid and enforceable.

4

Judge Mackenzie dissented from this part of the opinion. She would have held that the trial court’s refusal to grant rescission to Mr. and Mrs. Pickles was not an abuse of discretion.

"I would find that the trial court correctly denied rescission to Mr. and Mrs. Pickles, who received essentially the same property they bargained for and failed to prove that any mistake or failure of consideration existed at the time the parties entered into the contract.” 98 Mich App 494.

5

Mr. and Mrs. Pickles did not allege mutual mistake as a ground for rescission in their pleadings. However, the trial court characterized their failure of consideration argument as mutual mistake resulting in failure of consideration. Recognizing a potential difficulty in reversing the trial court on an issue not raised by the pleadings, the Court of Appeals devoted a footnote to an explanation of its decision to consider the mutual mistake argument.

"4 The pleadings below set forth the Pickleses’ theory as failure of consideration. However, it appears that the trial judge considered the failure of consideration issue to be essentially rooted in an allegation of mutual mistake. While issues not pleaded or otherwise presented to the trial court are not available for use on appeal, Long Mfg Co, Inc v Wright-Way Farm Service, Inc, 39 Mich App 546; 197 NW2d 862 (1972), rev’d on other grounds, 391 Mich 82 (1974), we address the issue of mutual mistake as one 'otherwise presented to the trial court’.

"We further note that an exception to the general rule that an issue not raised before the trial court cannot be raised on appeal exists where the issue has been fully briefed,’ and this Court in the interest of justice chooses to consider it. Turner v Ford Motor Co, 81 Mich App 521, 525, fn 2; 265 NW2d 400 (1978).” 98 Mich App 485, fn 4.

Since the mutual mistake issue was dispositive in the Court of Appeals, we find its consideration necessary to a proper determination of this case.

6

Mr. and Mrs. Pickles did not appeal the trial court’s finding that there was no fraud or misrepresentation by the Messerlys or Mr. and Mrs. Barnes. Likewise, the propriety of that ruling is not before this Court today.

7

The trial court found that the only way that the property could be put to residential use would be to pump and haul the sewage, a method which is economically unfeasible, as the cost of such a disposal system amounts to double the income generated by the property. There was speculation by the trial court that the adjoining land might be utilized to make the property suitable for residential use, but, in the absence of testimony directed at that point, the court refused to draw any conclusions. The trial court and the Court of Appeals both found that the property was valueless, or had a negative value.

8

The Court of Appeals decision to affirm the trial court’s finding of no cause of action against Mr. and Mrs. Barnes has not been appealed to this Court and, accordingly, the propriety of that ruling is not before us today.

9

We emphasize that this is a bifurcated inquiry. Legal or equitable remedial measures are not mandated in every case in which a mutual mistake has been established.

10

It is crucial to distinguish between the date on which a belief relating to a particular fact or set of facts becomes erroneous due to a change in the fact, and the date on which the mistaken nature of the belief is discovered. By definition, a mistake cannot be discovered until after the contract is executed. If the parties were aware, prior to the execution of a contract, that they were in error concerning a particular fact, there would be no misapprehension in signing the contract. Thus stated, it becomes obvious that the date on which a mistaken fact manifests itself is irrelevant to the determination whether or not there was a mistake.

11

The parties have invited our attention to the first edition of the Restatement of Contracts in their briefs, and the Court of Appeals cites to that edition in its opinion. However, the second edition was published subsequent to the issuance of the lower court opinion and the filing of the briefs with this Court. Thus, we take it upon ourselves to refer to the latest edition to aid us in our resolution of this case.

Section 152 delineates the legal significance of a mistake.

"§ 152. When Mistake of Both Parties Makes a Contract Voidable "(1) Where a mistake of both parties at the time a contract was made as to a basic assumption on which the contract was made has a material effect on the agreed exchange of performances, the contract is voidable by the adversely affected party unless he bears the risk of the mistake under the rule stated in § 154.

"(2) In determining whether the mistake has a material effect on the agreed exchange of performances, account is taken of any relief by way of reformation, restitution, or otherwise.

12

"§ 154. When a Party Bears the Risk of a Mistake

“A party bears the risk of a mistake when

"(a) the risk is allocated to him by agreement of the parties, or

"(b) he is aware, at the time the contract is made, that he has only limited knowledge with respect to the facts to which the mistake relates but treats his limited knowledge as sufficient, or

"(c) the risk is allocated to him by the court on the ground that it is reasonable in the circumstances to do so.”

13

This risk-of-loss analysis is absent in both A & M Land Development Co and Sherwood, and this omission helps to explain, in part, the disparate treatment in the two cases. Had such an inquiry been undertaken in Sherwood, we believe that the result might have been different. Moreover, a determination as to which party assumed the risk in A & M Land Development Co would have alleviated the need to characterize the mistake as collateral so as to justify the result denying rescission. Despite the absence of any inquiry as to the assumption of risk in those two leading cases, we find that there exists sufficient precedent to warrant such an analysis in future cases of mistake.

14

Hathaway v Hudson, 256 Mich 702, quoting 9 CJ, p 1161.

15

An "as is” clause waives those implied warranties which accompany the sale of a new home, Tibbitts v Openshaw, 18 Utah 2d 442; 425 P2d 160 (1967), or the sale of goods. MCL 440.2316(3)(a); MSA 19.2316(3)(a). Since implied warranties protect against latent defects, an "as is” clause will impose upon the purchaser the assumption of the risk of latent defects, such as an inadequate sanitation system, even when there are no implied warranties.

16

An "as is” clause does not preclude a purchaser from alleging fraud or misrepresentation as a basis for rescission. See 97 ALR2d 849. However, Mr. and Mrs. Pickles did not appeal the trial court’s finding that there was no fraud or misrepresentation, so we are bound thereby.

The OPERA COMPANY OF BOSTON, INC., Appellee, v. The WOLF TRAP FOUNDATION FOR the PERFORMING ARTS, Appellant.

No. 86-2505.

United States Court of Appeals, Fourth Circuit.

Argued Nov. 13, 1986.

Decided May 4, 1987.

Rodney F. Page (David L. Kelleher, Arent, Fox, Kintner, Plotkin & Kahn, Washington, D.C., on brief), for appellant.

Edward Gross, for appellee.

Before RUSSELL and HALL, Circuit Judges, and McMILLAN, United States District Judge for the Western District of North Carolina, sitting by designation.

DONALD RUSSELL, Circuit Judge:

This is a breach of contract suit by the plaintiff to recover the agreed payment from the defendant for four operatic performances at the Filene Center in The Wolf Trap Park. The plaintiff asserts it was prepared, able and willing to perform as agreed but that it was prevented from giving one of the performances because of cancellation by the defendant of the performance on the ground it considered the performance impossible as a result of an electrical storm which terminated power to the pavillion during the time this performance was to be given. The court found against defendant’s claim of cancellation of the performance because of an unexpected occurrence and granted judgment in favor of plaintiff. Defendant has appealed. We reverse and remand with instructions.

I.

The parties in this suit are the The Opera Company of Boston, Inc., an operatic organization recognized both nationally and internationally. The defendant The Wolf Trap Foundation for the Performing Arts is an organization for the advancement of the performing arts headquartered at Vienna, Virginia, and as such sponsors at the Filene Center in the Wolf Trap Park1 operatic performances and similar artistic programs. The Filene Center is located in the Wolf Trap National Park and is a part of the various facilities maintained and controlled by the National Park Service. It consists of a main stage tower, an auditorium and an open lawn. The main stage tower contains the stage, dressing rooms and space for the scenery and electrical effects. In front of the tower is a covered auditorium seating approximately 3,500 people. Beyond this is the uncovered lawn providing seating for an additional 3,000 people. The Park provides parking space. This parking area is separated from the Center itself. A number of pathways leading from the parking area to the Filene Center are available. The distance of the parking area from the Center varies from approximately 300 to 700 yards. Ordinarily, when there are any night performances at the Center, the roads in the park, the parking area and the pathways to the Center are lighted for the guidance of patrons at performances at the Center.

This suit between the parties arises under a contract between the plaintiff The Opera Company of Boston, Inc. (Opera Company) and the defendant The Wolf Trap Foundation for the Performing Arts (Wolf Trap) by which the Opera Company for its part agreed to give four “fully staged orchestrally accompanied [operatic] performances to the normally recognized standards” of the Opera Company on the nights of June 12, 13, 14 and 15, 1980 at the Filene Center. For this the Opera Company was to be paid by Wolf Trap $272,000 payable under a schedule providing for payment of $20,000 at the signing of the contract and a further $40,000 on April 1, 1980, with the balance payable in four equal installments before the rise of the curtain on each performance. Wolf Trap, in turn, for its part under the contract was obliged to make the above payments and also to furnish the place of performance including an undertaking “to provide lighting equipment as shall be specified by the Opera Company of Boston’s lighting designer.”2

Both parties to the contract performed apparently all their obligations under the contract through the operatic performance on June 14. These performances had been fully sold as well as had the remaining performance on June 15. During this final day, the weather was described as hot and humid, with rain throughout the day. Sometime between 6:00 and 6:30 p.m. a severe thunderstorm arose causing an electrical power outage. As a result all electrical service in the Park, in its roadways, parking area, pathways and auditorium were out. Conferences were had among representatives of the Park Service and that of Wolf Trap. The public utility advised that it would be at least after eleven o’clock before any service by it could be resumed in the Park and that it was likely power might not be available before morning. Various alternatives for supplying power were considered but none was regarded as relieving the situation. Already some 3,000 people were in the Park for the performance; 3,500 more were expected before 8:00 p.m. when the performance was to begin. The Park Service recommended the immediate cancellation of the performance and advised Wolf Trap if the performance were not cancelled, it disclaimed any responsibility for the safety of the people who were to attend as well as those who were to perform. It was the Park Service’s view that a prompt cancellation was necessary to enable the parties to leave the park safely and to prevent others from coming. Wolf Trap agreed and the performance was cancelled. While some of these discussions were being carried on a representative of the Opera Company was present but she took no part in the decision to cancel, though she voiced no objection. Since the performance was cancelled, Wolf Trap failed to make the final payment under the contract to the Opera Company. Five years after the cancellation, the Opera Company filed this suit to recover the balance due under the contract. Wolf Trap defended on the ground that performance by it of its obligation under the contract was excused under the doctrine of impossibility of performance.3 The basis for this defense was that the final performance by the Opera Company for which payment was claimed had been cancelled because a performance was impracticable as a result of the power outage.

II.

The district judge began his oral opinion granting judgment in favor of the plaintiff by noting that the parties had stipulated the contract in question, a memorandum detailing the occurrence at the Park on the evening of June 15 by Craig Hankenson, an official of Wolf Trap, and the amount in issue. He then proceeded to find the storm, which caused the power shortage in the Wolf Trap Park, resulted in a complete loss of power at Filene Hall from about 6 o’clock on the evening of June 15. He apparently accepted the accuracy of Mr. Hankenson’s memorandum that the performance on the night of June 15 was cancelled “based on a public safety decision, that the performance should not go forward since there was no lighting in the parking area to the walkways, and very questionable as to whether or not a generator could be set up to provide additional light for the theater itself and still provide adequate light for the people who had to move backstage.” He found as a fact “that the Opera Company was there [at the Park] and was ready to go forward with the performance,” but that “the only reason the performance did not go on was the fact that there wasn’t adequate lighting.” As he read the contract Wolf Trap was obligated to provide sufficient lighting “for the performance to go on,” and that power outages were “reasonably foreseeable,” as there had been some outages in the past and while “none had affected a performance prior to this occasion,” it was “readily foreseeable that a power outage could affect a performance.” He, therefore, held Wolf Trap had not made out its defense of impossibility of performance and granted judgment for the plaintiff.

The single question on appeal is whether this dismissal of Wolf Trap’s defense of impossibility of performance was proper. The resolution of this issue requires a review of the doctrine of impossibility. We proceed first to that review.

III.

The doctrine of impossibility of performance as an excuse or defense for a breach of contract was for long smothered under a declared commitment to the principle of sanctity of contracts. This rationale for constrained application of the doctrine was expressed by the United States Supreme Court in Dermott v. Jones (2 Wall.), 69 U.S. 1, 8, 17 L.Ed. 762 (1864):

The principle which controlled the decision of the cases referred to rests upon a solid foundation of reason and justice. It regards the sanctity of contracts. It requires parties to do what they have agreed to do. If unexpected impediments lie in the way, and a loss must ensue, it leaves the loss where the contract places it. If the parties have made no provision for a dispensation, the rule of law gives none. It does not allow a contract fairly made to be annulled, and it does not permit to be interpolated what the parties themselves have not stipulated.

The growth of commercial activity in the nineteenth century, however, made this rigidity of the doctrine of impossibility both “economically and socially unworkable,” see Cook v. Deltona Corp., 753 F.2d 1552, 1558 (11th Cir.1985), and in Taylor v. Caldwell, 3 B. & S. 826, 122 Eng.Rep. 309, 324, 6 R.C. 603 (1863),. the English courts recognized these changed conditions and, relying largely on civil law precedents,4 relaxed the constraints on the doctrine by the principle of sanctity of contracts as followed by the English courts since Paradine v. Jayne, Alleyn, 27, 23d Charles II (1670). It based such relaxation on the theory of an implied condition arising without express condition in the contract itself. In stating this new rule on impossibility of performance as a defense to a breach of contract suit, the court said:

The principle seems to us to be that in contracts in which the performance depends on the continued existence of a given person or thing, a condition is implied that the impossibility arising from the perishing of the person or thing shall excuse the performance. In none of the cases is the promise in words other than positive, nor is there any express stipulation that the destruction of the person or thing shall excuse the performance, but that excuse is by law implied, because from the nature of the contract it is apparent that the parties contracted on the basis of the continued existence of the particular person or chattel.

Though the United States Supreme Court had not taken note of Taylor v. Caldwell in its decision in Dermott v. Jones, rendered the year after Taylor v. Caldwell, it, two decades later, adopted the reasoning and the restatement of the doctrine of impossibility as enunciated in Taylor v. Caldwell in its decision in The Tornado, 108 U.S. 342, 351, 2 S.Ct. 746, 752, 27 L.Ed. 747 (1883). In that case the Court said:

In Taylor v. Caldwell, 3 Best & Smith, 826, it is laid down as a rule, that, “in contracts in which the performance depends on the continued existence of a given person or thing, a condition is implied, that the impossibility of performance arising from the perishing of the person or thing shall excuse the performance.” The reason given for the rule is, that without “any express stipulation that the destruction of the person or thing shall excuse the performance,” “that excuse is by law implied, because, from the nature of the contract, it is apparent that the parties contracted on the basis of the continued existence of the particular person or chattel.”

Other American cases had even earlier embraced the new rule as to impossibility of performance stated in Taylor v. Caldwell: Dexter v. Norton, 47 N.Y. 62, 65, 7 Am. Rep. 415 (1871); Wells v. Calnan, 107 Mass. 514, 516 (1817); Walker v. Tucker, 70 Ill. 527, 543 (1873). Based on all these authorities Lawson in his The Principles of the American Law of Contracts at Law and in Equity, § 425 at p. 465 (F.H. Thomas Law Book Co., St. Louis, 1893), stated as the prevalent American rule in this regard:

Where the contract relates to the use or possession or any dealing with specific things in which the performance necessarily depends on the existence of the particular thing, the condition is implied by the law that the impossibility arising from the perishing or destruction of the thing, without default in the party, shall excuse the performance, because, from the nature of the contract, it is apparent that the parties contracted on the basis of the continued existence of the subject of the contract.

This relaxed rule for the application of the doctrine of impossibility of performance was adopted by the Supreme Court of Virginia, in whose jurisdiction this action arose, in Virginia Iron, Coal & Coke Co. v. Graham, 124 Va. 692, 98 S.E. 659, 662 (1919), and again in Housing Authority, Etc. v. East Tenn. L. & P. Co., 183 Va. 64, 31 S.E.2d 273, 276 (1944). In the latter case, the Court, observing that “[t]he tendency of the law is towards an enlargement of the defense, ...” said:

It is, however, fairly well settled that where impossibility is due to domestic law, to the death or illness of one who by the terms of the contract was to do an act requiring his personal performance, or to the fortuitous destruction or change in the character of something to which the contract related, or which by the terms of the contract was made a necessary means of performance, the promisor will be excused, unless he either expressly agreed in the contract to assume the risk of performance, whether possible or not, or the impossibility was due to his fault.

In between these two Virginia cases, the United States Supreme Court in Texas Co. v. Hogarth Shipping Co., 256 U.S. 619, 629-30, 41 S.Ct. 612, 614, 65 L.Ed. 1123 (1921) declared:

[W]here parties enter into a contract on the assumption that some particular thing essential to its performance will continue to exist and be available for the purpose and neither agrees to be responsible for its continued existence and availability, the contract must be regarded as subject to an implied condition that, if before the time for performance and without the default of either party the particular thing ceases to exist or be available for the purpose, the contract shall be dissolved and the parties excused from performing it.

As we have indicated, Taylor v. Caldwell, the United States Supreme Court cases and the Virginia cases all relied in their statement of the doctrine on an implied, though unstated, condition in the contract. Increasingly, though, commentators and text writers were uncomfortable with the implied condition rationale for the new doctrine of impossibility of performance. In 6 Corbin on Contracts, § 1331, p. 360 (1962 ed.), the author puts his objection to the implied condition theory strongly and rephrased the rationale for the doctrine thus:

Though it has been constantly said by high authority, including Lord Sumner, that the explanation of the rule is to be found in the theory that it depends on an implied condition of the contract, that is really no explanation. It only pushes back the problem a single stage. It leaves the question what is the reason for implying a term. Nor can I reconcile that theory with the view that the result does not depend on what the parties might, or would as hard bargainers, have agreed. The doctrine is invented by the court in order to supplement the defects of the actual contract. The parties did not anticipate fully and completely, if at all, or provide for what actually happened.5

18 Williston on Contracts, § 1937, p. 33 (3d. ed. Jaeger 1978) is equally forceful in its rejection of the implied condition theory:

Any qualification of the promise is based on the unfairness or unreasonableness of giving it the absolute force which its words clearly state. In other words, because the court thinks it fair to qualify the promise, it does so and quite rightly; but clearness of thought would be increased if it were plainly recognized that the qualification of the promise or the defense to it is not based on any expression of intention by the parties.

Moreover, in line with the “tendency of the law ... towards an enlargement,”6 modern authorities also abandoned any absolute definition of impossibility and, following the example of the Uniform Commercial Code,7 have adopted impracticability or commercial impracticability as synonymous with impossibility in the application of the doctrine of impossibility of performance as an excuse for breach of contract. Matter of Westinghouse Elec. Corp., Etc., 517 F.Supp. 440, 451 (E.D.Va.1981).8

Under these revisions the doctrine of impossibility of performance is basically according to Corbin one “invented by the court in order to supplement the defects of the actual contract” in the interest of reason, justice and fairness. 6 Corbin on Contracts § 1331, p. 360. Williston is equally specific in recognizing that the revision in the doctrine as envisioned by both it and Corbin had made the doctrine "essentially an equitable defense, [which could] ... be asserted in an action at law.” 18 Williston on Contracts, § 1931, p. 6. And, in effect, that was the declaration of the court in Paddock v. Mason, 187 Va. 809, 48 S.E.2d 199, 202 (1948). Similarly, Restatement (Second) on Contracts has accepted this view in its statement of the doctrine.

In its Introductory Note to Chapter 11 on Impossibility of Performance (pp. 309-10) Restatement (Second) on Contracts said:

Even where the obligor has not limited his obligation by agreement, a court may grant him relief. An extraordinary circumstance may make performance so vitally different from what was reasonably to be expected as to alter the essential nature of that performance. In such a case the court must determine whether justice requires a departure from the general rule that the obligor bear the risk that the contract may become more burdensome or less desirable.9

This is but another way of declaring, as did Williston, that essentially the doctrine is an equitable one to be applied when fair and just.

The modern doctrine of impossibility or impracticability, deduced from these authorities, has been formulated in § 265, pp. 334-35 of the Restatement (Second) of Contracts in these words:

Where, after a contract is made, a party’s principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his remaining duties to render performance are discharged, unless the language or the circumstances indicate the contrary.

Supplementing this statement of the doctrine, the Restatement in § 263, p. 328, defines the event the “non-occurrence of which [may be] a basic assumption on which the contract was made”:

If, ... the existence of a specific thing is necessary for the performance of a duty ... its failure to come into existence or its destruction or deterioration makes performance impracticable, [is an event] ... “the non-occurrence of which was a basic assumption on which the contract was made.

This statement of the revised doctrine is restated in 2-615(a) of the Uniform Commercial Code which excuses non-delivery under a contract “if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made____”

In Eastern Air Lines, Inc. v. McDonnell Douglas Corp., 532 F.2d 957, 991 (5th Cir.1976), the court, adopting the modem statement of the doctrine, said impossibility-impracticability arises as a defense to breach of contract when “the circumstances causing the breach has made performance so vitally different from what was anticipated that the contract cannot reasonably be thought to govern.”

A shorter statement of the new rule is given in Mishara Const. Co., Inc. v. Transit-Mixed Con. Corp., 365 Mass. 122, 310 N.E.2d 363, 367 (1974) in which the court said: “It is implicit in the doctrine of impossibility (and the companion rule of ‘frustration of purpose’) that certain risks are so unusual and have such severe consequences that they must have been beyond the scope of the assignment of risks inherent in the contract, that is, beyond the agreement made by the parties.” Probably, though, the fullest statement of the modem doctrine of impossibility or impracticability is that of Judge Wright, speaking for the Court, in Transatlantic Financing Corporation v. United States, 363 F.2d 312, 315 (D.C.Cir.1966):

The doctrine of impossibility of performance has gradually been freed from the earlier fictional and unrealistic strictures of such tests as the “implied term” and the parties’ “contemplation.” Page, The Development of the Doctrine of Impossibility of Performance, 18 Mich.L.Rev. 589, 596 (1920). See generally 6 Corbin, Contracts §§ 1320-1372 (rev. ed. 1962); 6 Williston, Contracts §§ 1931-1979 (rev. ed. 1938). It is now recognized that “A thing is impossible in legal contemplation when it is not practicable; and a thing is impracticable when it can only be done at an excessive and unreasonable cost.” (citing authorities) The doctrine ultimately represents the ever-shifting line, drawn by courts hopefully responsive to commercial practices and mores, at which the community’s interest in having contracts enforced according to their terms is outweighed by the commercial senselessness of requiring performance. When the issue is raised, the court is asked to construct a condition of performance based on the changed circumstances, a process which involves at least three reasonably definable steps.

In line with these cases, we accept as the correct statement of the modem and prevailing doctrine of impossibility of performance as a defense to a breach of contract to be essentially as equitable in character “based [to quote Williston] on the unfairness or unreasonableness of giving [the contract] the absolute force which its words clearly state” and to be applied under the circumstances so well stated in Transatlantic.

Manifestly the first fact to be established in making out this modem defense of impossibility or impracticability of performance is the existence of an “occurrence of an event, the non-occurrence of which was a basic assumption on which the contract was made.” And, in determining the existence of such occurrence, it is necessary to have in mind the Restatement’s definition of an “occurrence” in this context as that which, because of the “destruction, or such deterioration” of a “specific thing necessary for the performance” of the contract “makes performance impracticable.” 10 The occurrence, as Transatlantic puts it, must be unexpected but it does not necessarily have to have been unforeseeable. A requirement of absolute non-foreseeability as a condition to the application of the doctrine would be so logically inconsistent that in effect it would nullify the doctrine. This was recognized by Judge Clark in L.N. Jackson & Co. v. Royal Norwegian Government, 177 F.2d 694, 699 (2d Cir.1949), where he said that to require an absolute absence of foreseeability would, if accepted,

practically destroy the doctrine of supervening impossibility, notwithstanding its present wide and apparently growing popularity. Certainly the death of a promisor, the burning of a ship, the requisitioning of a merchant marine on the outbreak of a war could, and perhaps should, be foreseen. In fact, the more common expression of the rule appears to be in terms which tend to state the burden the other way, e.g., that “the duty of the promisor is discharged, unless a contrary intention has been manifested” or “in the absence of circumstances showing either a contrary intention or contributing fault on the part of the person subject to the duty.”

Williston expressed the same objection to such an absolute rule. It said:

It is frequently said that where an event which causes impossibility “might have been anticipated and guarded against in the contract,” one who makes an absolute promise is bound by it unconditionally-

Such a test, however, seems of little value. It has descended in the law from a time when it was more nearly true than it now is, because impossibility was more rarely an excuse. Any kind of impossibility is more or less capable of anticipation. The question is one of degree, and if anticipated, any circumstance whatever may be guarded against by the draftsman of the contract.11

In Comment c, § 261 of the Restatement (Second) on Contracts the drafters follow this reasoning in the requirement of foreseeability in the application of the doctrine. They said:

If the supervening event was not reasonably foreseeable when the contract was made, the party claiming discharge can hardly be expected to have provided against its occurrence. However, if it was reasonably foreseeable, or even foreseen, the opposite conclusion does not necessarily follow. Factors such as the practical difficulty of reaching agreement on the myriad of conceivable terms of a complex agreement may excuse a failure to deal with improbable contingencies.

These statements of the Restatement and of Williston were accepted and repeated by Judge Wright in the decision in Transatlantic:

Foreseeability or even recognition of a risk does not necessarily prove its allocation. Compare Uniform Commercial Code § 2-615, Comment 1, Restatement, Contracts § 457 (1932). Parties to a contract are not always able to provide for all the possibilities of which they are aware, sometimes because they cannot agree, often simply because they are too busy. Moreover, that some abnormal .risk was contemplated is probative but does not necessarily establish an allocation of the risk of the contingency which . actually occurs.12

As the Court in Mishara Const. Co., Inc. v. Transit-Mixed Concrete Corp., supra, 310 N.E.2d at 367 remarked this question is much broader than mere foreseeability and is, “Was the contingency which developed one which the parties could reasonably be thought to have foreseen as a real possibility which could affect performance?”13 and this question is in turn what Judge Learned Hand in Companhia De Navegacao Lloyd Brasileiro v. C.G. Blake Co., 34 F.2d 616, 619 (2d Cir.1929) said was “in the end a question of how unexpected at the time [the contract was made] was the event which prevented performance.” After all, as Williston has said, practically any occurrence can be foreseen but whether the foreseeability is sufficient to render unacceptable the defense of impossibility is “one of degree” of the foreseeability and whether the non-occurrence of the event was sufficiently unlikely or unreasonable to constitute a reason for refusing to apply the doctrine. And that is the rule which we think accords with modem reasoning of the doctrine as an equitable doctrine and is the one we approve.14

The second fact to be determined in the proposed application of the doctrine is that the frustration of performance was substantial. To satisfy this requirement “[t]he frustration must be so severe that it is not fairly to be regarded as within the risks [the obligor] assumed under the contract.” Comment a, § 265 of Restatement (Second) of Contracts And, finally, the defendant asserting the defense must establish that performance was impossible as that term has been defined in the refinements of the doctrine.

In summary, then, a party relying on the defense of impossibility of performance must establish (1) the unexpected occurrence of an intervening act, (2) such occurrence was of such a character that its non-occurrence was a basic assumption of the agreement of the parties, and (3) that occurrence made performance impracticable. When all those facts are established the defense is made out.

IV.

Applying the law as above stated to the facts of this case, we conclude, as did the district judge, that the existence of electric power was necessary for the satisfactory performance by the Opera Company on the night of June 15. While he seems to conclude that public safety was the main consideration on which the cancellation was based, he found that the power outage was the reason assigned for cancellation, and in that connection he found it to be questionable that “a generator could [have been] set up to provide additional light for the theater itself (when power from the utility company became unavailable) and still provide adequate light for the people who had to move backstage.” Such findings meet the requirement of Restatement (Second) on Contracts § 263 for an event, the “non-occurrence of which was a basic assumption on which the contract was made” and accordingly satisfies the definition of an impracticability which will relieve the obligor of his duty to perform as declared in section 265 of such Restatement (which we have accepted as the proper present statement of the doctrine of impossibility of performance as a defense to a breach of contract suit). Moreover, the facts as found make out impracticability of performance under the phraseology of the doctrine of impossibility in the Virginia case of Housing Authority, supra. The district judge, however, refused to sustain the defense because he held that if the contingency that occurred was one that could have been foreseen reliance on the doctrine of impossibility as a defense to a breach of contract suit is absolutely barred. As we have said, this is not the modern rule and he found that the power outage was foreseeable. In this the district judge erred. Foreseeability, as we have said, is at best but one fact to be considered in resolving first how likely the occurrence of the event in question was and, second whether its occurrence, based on past experience, was of such reasonable likelihood that the obligor should not merely foresee the risk but, because of the degree of its likelihood, the obligor should have guarded against it or provided for non-liability against the risk. This is a question to be resolved by the trial judge after a careful scrutiny of all the facts in the case. The trial judge in this case made no such findings. The cause must be remanded for such findings. In connection with that remand, the parties may be permitted to offer additional evidence on the matters in issue.

Because of the dissent, we would review anew some of the other undisputed facts in this case, it should be noted in this connection that, while the lack of power may have interfered with the immediate commencement of the performance, that, as we have seen, was not the basic consideration which motivated the Park Service in pressing for the cancellation of the performance and it must be remembered that it was the Park Service which was the primary advocate of cancellation. There was, it is admitted, auxiliary power available for the stage and perhaps the dressing rooms furnished by the Park as a part of the Park’s service. But to have made this auxiliary service operable would have delayed the commencement of the performance until ten or eleven o’clock. The Park Service’s concern was for the safety of the thirty-five hundred people already in the Park and the additional three thousand who were due to come into the Park for the performance. The situation confronting the Park Service must be understood: Should the performance be delayed while the auxiliary services for the Pavillion were brought into operation? Even when the auxiliary service was brought into operation, it would not have provided lights for the roads and paths in the wooded park. To have sixty-five hundred people stranded in a wooded park during a lightning storm without any lights for a period of hours was a hazard to safety for which the Park Service was understandably unwilling to take the responsibility. All the parties at the conference— the Park Service, Wolf Trap, and Boston Opera — recognized the problem. After debating it, the agreement to cancel was reached, based, as we have said, primarily on “the Park Service’s view that a prompt cancellation was necessary to enable the parties to leave the Park safely and to prevent others from coming.” To this decision the Boston Opera’s representative did not, it is true, affirmatively agree but she did not dissent. It may be that this situation would not have arisen if the Park had had auxiliary power services which, in the event of a power shortage on the part of the public utility, would have provided ample lighting for the roads and paths in the Park. But can it fairly be said that this was the obligation of Wolf Trap, the lessee of merely the Pavillion area, whatever may have been its obligation for the stage and dressing rooms at the Pavillion itself, or that the failure of Wolf Trap to provide auxiliary lighting for all the roads and paths in the Park was such action on its part as would preclude it from asserting the defense of impossibility of performance on its part? We think not.

CONCLUSION

The judgment herein must, therefore, be vacated and the action remanded to the district court to make findings, based on a statement of reasons, whether the possible foreseeability of the power failure in this case was of that degree of reasonable likelihood as to make improper the assertion by Wolf Trap of the defense of impossibility of performance.

The judgment of the district court is reversed, and the action is remanded with instructions.

VACATED and REMANDED WITH INSTRUCTIONS.

1

Wolf Trap Park is a national park owned by the United States Government and operated under the jurisdiction of the National Park Services.

2

The contract included a number of other provisions but such provisions are irrelevant to the resolution of the issues posed by the action.

3

Wolf Trap has not argued on this appeal that its non-performance was excused because of an Act of God. For a statement of the rule in connection with the plea of Act of God, see Sanders v. Coleman, 97 Va. 690, 34 S.E. 621 (1899).

4

See Bruce, An Economic Analysis of the Impossibility Doctrine, XI, The Journal of Legal Studies 211, 324-25 (1982).

5

The Restatement (Second) on Contracts accepts this statement of the doctrine in its Introductory Note to Chapter 11 ('Impracticability of Performance and Frustration of Purpose") at pp. 310-11.

6

See Housing Authority Etc. v. East Tenn. L. & P. Co., supra, 31 S.E.2d at 276.

7

See U.C.C. § 2-615(a) (1978).

8

Impossibility or impracticability may not be “subjective” but must be "objective,” and the difference between the two concepts has been summarized in the phrases "the thing cannot be done" (this being objective impossibility or impracticability) and ‘7 cannot do it” (classified as subjective impossibility or impracticability). B’s Company, Inc. v. Barber & Associates, Inc., 391 F.2d 130, 137 (4th Cir.1968); Ballou v. Basic Construction Co., 407 F.2d 1137, 1140-41 (4th Cir.1969). It is often necessary in this connection to consider when the performance, as stipulated, is objectively impossible, whether there is an alternative form of performance and, if there ' is, if it is not "so excessive [in cost of performance] as to make performance extremely impracticable,” there is no objective impracticability so far as the obligor is concerned. See Waegemann v. Montgomery Ward & Co., Inc., 713 F.2d 452, 454 (9th Cir.1983).

9

See also Comment, Restatement (Second) on Contracts § 261: “Even though a party, in assuming a duty, has not qualified the language of his undertaking, a court may relieve him of that duty if performance has unexpectedly become impracticable as a result of a supervening event."

10

Restatement (Second) on Contracts § 263.

11

18 Williston on Contracts, § 1953, pp. 117-18.

12

Transatlantic, supra, 363 F.2d at 318.

13

Emphasis added.

14

We do not intend to suggest that there are not dicta — some even in the more recent decisions — which still adhere to the obsolete rule that foreseeability, whether reasonably likely or not, bars the application of the doctrine. There is in Eastern Air Lines, supra, 532 F.2d at 992 a dictum, which, though somewhat ambiguous, could be assumed to support this view. It finds warrant for its dictum in two authorities, Lloyd v. Murphy, 25 Cal.2d 48, 54, 153 P.2d 47, 50 (1944) and in Madeirense Do Brasil S/A v. Stulman-Emrick Lumber Co., 147 F.2d 399, 403 (2d Cir.1945). Madeirense may be quickly dismissed. The opinion in that case was written by Judge Clark who authored the subsequent case of L.N. Jackson, quoted supra. If his language in Madeirense could be considered to establish what Eastern Air Lines seems to assume (contrary to our reading of the decision) it is difficult to reconcile that construction with the strong contrary declaration of Judge Clark in L.N. Jackson. It is noteworthy that any construction of Lloyd v. Murphy as stating a rule that foreseeability was an absolute bar to the use of the doctrine as a defense in a breach of contract action was found to be improper by the Ninth Circuit (within whose jurisdiction federal appeals involving California law were reviewable) in West Las Angeles Institute for Cancer Research v. Mayer, 366 F.2d 220, 225 (9th Cir.1966).

McMILLAN, District Judge,

dissenting in part and concurring in part:

The majority opinion does an admirable job of analyzing and declaring the state of the court decisions on the doctrine of impossibility of performance.

However, I believe that the District Court takes that law into account and that although he did not fully articulate a classic statement of the law, he reached the right result for the right reasons and ought to be affirmed.

Evening opera on an indoor stage obviously requires power and lights. Supplying power and lights was a necessary part of Wolf Trap’s undertaking, a cost figured into their charges for the facility.

The financing and the preparation for the delivery of the essential power required nothing esoteric, inspirational, unforeseeable or expensive.

Mr. Craig Hankenson, a representative of Wolf Trap who apparently negotiated the contract, made a detailed statement about the situation immediately after the cancellation of the concert. On pertinent matters, his statement included the following:

From my experience in theatres with which I have been affiliated prior to Wolf Trap, I know it is possible to install at the main service panel for the theatre a switchover system so that within 10 minutes an external portable generator or an emergency stage lighting generator can provide emergency service for minimal theatrical lighting and sound. This is not a major investment.

Generally every region of the country has a civil defense program which has stationed somewhere in its region a large portable generator. Prior arrangement can be made with the Civil Defense so that in emergencies, such as ours, the generator, which is usually on a trailer, could be transported to the rear of the Theatre.

In my opinion a far better solution though it is a capital investment of some size is to have a generator of sufficient capacity to deliver power to our stage so that we can carry on a performance with minimal interruption, though we would certainly have to compromise with less than the full lighting and sound which was designed for that performance.

It is my feeling that a theater without this capacity is incomplete. I attach a memo to Claire which I wrote last summer voicing this opinion along with her response.

My memo addressed two equally critical issues: public safety and the ability to continue the performance. Her reply seems to be based solely on public safety and a very “let’s wait to see it if it ever happens and then maybe we’ll do something” attitude.

The facts are that we have experienced power outages on several occasions. It is perhaps a matter of opinion as to how many occurrences can be called frequent. There have been many other occasions of power outage at Wolf Trap has been very lucky they did not occur during the evening when the performance would have been affected. It can perhaps be said that tonight, too we were lucky. What if the failure had occurred after 9:30 in the middle of the performance in darkness?

I recommend that this situation be addressed immediately. The cost to the Foundation, the Park Service and the Opera Company of Boston for the evening’s cancellation would go along way if not all the way toward providing emergency backup equipment to prevent such a recurrence.

[Emphasis. added.]

From this evidence, the trial court could rationally have concluded, and did obviously conclude, that performance of this contract was not “impossible”; that power failures were not only foreseeable in an abstract sense, but were, in fact, inevitable; that a theater without emergency capacity to carry on in case of a power outage is “incomplete”; that Hankenson had advised “Claire,” chairman of the theater board, of this opinion during the previous summer; that power outages had occurred on several previous occasions; that “Wolf Trap has been very lucky they did not occur during the evening when the performance would have been affected”; and that the “cost to the Foundation, the Park Service and the Opera Company of Boston for the evening’s cancellation would go along [sic] way if not all the way toward providing emergency backup equipment to prevent such a recurrence.”

It would have taken only a few seconds to write into the contract a sentence which said, in effect, “If the electric power fails, Wolf Trap will not be responsible for any losses caused by the power failure.”

If the parties had agreed to such a provision I would not raise my voice.

They did not so agree.

I do not think we should write for the defendant a defense it did not write for itself.

I would affirm the decision of the trial court.

[L. A. No. 18738.

In Bank.

Oct. 31, 1944.]

CAROLINE A. LLOYD et al., Respondents, v. WILLIAM J. MURPHY, Appellant.

Chas. W. Rollinson and Wm. Roy Ives for Appellant.

Albert W. Leeds for Respondents.

Schultheis & Laybourne and Clifford E. Royston as Amici Curiae on behalf of Respondents.

TRAYNOR, J.

August 4, 1941, plaintiffs leased to defendant for a five-year term beginning September 15, 1941, certain premises located at the corner of Almont Drive and Wilshire Boulevard in the city of Beverly Hills, Los Angeles County, “for the sole purpose of conducting thereon the business of displaying and selling new automobiles (including the servicing and repairing thereof and of selling the petroleum products of a major oil company) and for no other purpose whatsoever without the written consent of the lessor” except “to make an occasional sale of a used automobile.” Defendant agreed not to sublease or assign without plaintiffs’ written consent. On January 1,1942, the federal government ordered that the sale of new automobiles be discontinued. It modified this order on January 8, 1942, to permit sales to those engaged in military activities, and on January 20, 1942, it established a system of priorities restricting sales to persons having preferential ratings of A-l-j or higher. On March 10, 1942, defendant explained the effect of these restrictions on his business to one of the plaintiffs authorized to act for the others, who orally waived the restrictions in the lease as to use and subleasing and offered to reduce the rent if defendant should be unable to operate profitably. Nevertheless defendant vacated the premises on March 15, 1942, giving oral notice of repudiation of the lease to plaintiffs, which was followed by a written notice on March 24, 1942. Plaintiffs affirmed in writing on March 26th their oral waiver and, failing to persuade defendant to perform his obligations, they rented the property to other tenants pursuant to their powers under the lease in order to mitigate damages. On May 11, 1942, plaintiffs brought this action praying for declaratory relief to determine their rights under the lease, and for judgment for unpaid rent. Following a trial on the merits, the court found that the leased premises were located on one of the main traffic arteries of Los Angeles County; that they were equipped with gasoline pumps and in general adapted for the maintenance of an automobile service station; that they contained a one-story storeroom adapted to many commercial purposes; that plaintiffs had waived the restrictions in the lease and granted defendant the right to use the premises for any legitimate purpose and to sublease to any responsible party; that defendant continues to carry on the business of selling and servicing automobiles at two other places. Defendant testified that at one of these locations he sold new automobiles exclusively and when asked if he were aware that many new automobile dealers were continuing in business replied: “Sure. It is just the location that I couldn’t make a go, though, of automobiles.” Although there was no finding to that effect, defendant estimated in response to inquiry by his counsel, that 90 per cent of his gross volume of business was new car sales and 10 per cent gasoline sales. The trial court held that war conditions had not terminated defendant’s obligations under the lease and gave judgment for plaintiffs, declaring the lease as modified by plaintiffs’ waiver to be in full force and effect, and ordered defendant to pay the unpaid rent with interest, less amounts received by plaintiffs from re-renting. Defendant brought this appeal, contending that the purpose for which the premises were leased was frustrated by the restrictions placed on the sale of new automobiles by the federal government, thereby terminating his duties under the lease.

Although commercial frustration was first recognized as an excuse for nonperformance of a contractual duty by the courts of England (Krell v. Henry [1903] 2 K.B. 740 [C.A.]; Blakely v. Muller, 19 T.L.R. 186 [K.B.]; see MeElroy and Williams, The Coronation Cases, 4 Mod.L.Rev. 241) its soundness has been questioned by those courts (see Maritime National Fish, Ltd., v. Ocean Trawlers, Ltd. [1935] A.C. 524, 528-29, 56 L.Q.Rev. 324, arguing that Krell v. Henry, supra, was a misapplication of Taylor v. Caldwell, 3 B.&S 826 [1863], the leading case on impossibility as an excuse for nonperformance), and they have refused to apply the doctrine to leases on the ground that an estate is conveyed to the lessee, which carries with it all risks (Swift v. McBean, 166 L.T.Rep. 87 [1942] 1 K.B. 375; Whitehall Court v. Ettlinger, 122 L.T.Rep. 540, (1920) 1 KB. 680, [1919] 89 L.J. [KB.] N.S. 126; 137 A.L.R. 1199, 1224; see collection and discussion on English cases in Wood v. Bartolino,—N.M.—[146 P.2d 883, 886-87]). Many courts, therefore, in the United States have held that the tenant bears all risks as owner of the estate (Ctisack Co. v. Pratt, 78 Colo. 28 [239 P. 22, 44 A.L.R. 55] ; Yellow Cab Co. v. Stafford-Smith Cos., 320 111. 294 [150 N.E. 670, 43 A.L.R. 1173]), but the modern cases have recognized that the defense may be available in a proper ease, even in a lease. As the author declares in 6 Williston, Contracts (rev. ed. 1938), § 1955, pp. 5485-87, “The fact that lease is a conveyance and not simply a continuing contract and the numerous authorities enforcing liability to pay rent in spite of destruction of leased premises, however, have made it difficult to give relief. That the tenant has been relieved, nevertheless, in several cases indicates the gravitation of the law toward a recognition of the principle that fortuitous destruction of the value of performance wholly outside the contemplation of the parties may excuse a promisor even in a lease. . . .

“Even more clearly with respect to leases than in regard to ordinary contracts the applicability of the doctrine of frustration depends on the total or nearly total destruction of the purpose for which, in the contemplation of both parties, the transaction was entered into.”

The principles of frustration have been repeatedly applied to leases by the courts of this state (Brown v. Oshiro, 58 Cal.App.2d 190 [136 P.2d 29]; Davidson v. Goldstein, 58 CaLApp. 2d Supp. 909 [136 P.2d 665]; Grace v. Croninger, 12 Cal. App.2d 603 [55 P.2d 940]; Knoblaugh v. McKinney, 5 Cal.App.2d 339 [42 P.2d 332]; Industrial Development & Land Co. v. Goldschmidt, 56 Cal.App. 507 [206 P. 134] ; Burke v. San Francisco Breweries, Ltd., 21 Cal.App. 198 [131 P. 83]) and the question is whether the excuse for nonperformance is applicable under the facts of the present case.

Although the doctrine of frustration is akin to the doctrine of impossibility of performance (see Civ. Code, § 1511; 6 Cal.Jur. 435-450; 4 Cal.Jur Ten-year Supp. 187-192; Taylor V. Caldwell, supra) since both have developed from the commercial necessity of excusing performance in cases of extreme hardship, frustration is not a form of impossibility even under the modern definition of that term, which includes not only cases of physical impossibility but also cases of extreme impracticability of performance (see Mineral Park Land Co. v. Howard, 172 Cal. 289, 293 [156 P. 458, L.R.A. 1916F 1] ; Christin v. Superior Court, 9 Cal.2d 526, 533 [71 P.2d 205, 112 A.L.R 1153] ; 6 Williston, op. cit. supra, § 1935, p. 5419; Rest., Contracts, § 454, comment a., and Cal.Ann. p. 254). Performance remains possible but the expected value of performance to the party seeking to be excused has been destroyed by a fortuitous event, which supervenes to cause an actual but not literal failure of consideration (Krell v. Henry, supra; Blakely v. Muller, supra; Marks Realty Co. v. Hotel Hermitage Co., 170 App.Div. 484 [156 N.Y.S. 179] ; 6 Williston, op. cit. supra, §§1935, 1954, pp. 5477, 5480; Restatement, Contracts, § 288).

The question in cases involving frustration is whether the equities of the case, considered in the light of sound public policy, require placing the risk of a disruption or complete destruction of the contract equilibrium on defendant or plaintiff under the circumstances of a given case (Fibrosa Spolka Akcyjina v. Fairbairn Lawson Combe Barbour, Ltd. [1942], 167 L.T.R. [H.L.] 101, 112-113; see Smith, Some Practical Aspects of the Doctrine of Impossibility, 32 IlLL.Rev. 672, 675; Patterson, Constructive Conditions in Contracts, 42 Columb.L.Rev. 903, 949; 27 Cal.L.Rev. 461), and the answer depends on whether an unanticipated circumstance, the risk of which should not be fairly thrown on the promisor, has made performance vitally different from what was reasonably to be expected (6 Williston, op. cit. supra, § 1963, p. 5511; Restatement, Contracts, § 454). The purpose of a contract is to place the risks of performance upon the promisor, and the relation of the parties, terms of the contract, and circumstances surrounding its formation must be examined to determine whether it can be fairly inferred that the risk of the event that has supervened to cause the alleged frustration was not reasonably foreseeable. If it was foreseeable there should have been provision for it in the contract, and the absence of such a provision gives rise to the inference that the risk was assumed.

The doctrine of frustration has been limited to cases of extreme hardship so that businessmen, who must make their arrangements in advance, can rely with certainty on their contracts (Anglo-Northern Trading Co. v. Emlyn Jones and Williams, 2 K.B. 78; 137 A.L.R. 1199, 1216-1221). The courts have required a promisor seeking to excuse himself from performance of his obligations to prove that the risk of the frustrating event was not reasonably foreseeable and that the value of counterperformance is totally or nearly totally destroyed, for frustration is no defense if it was foreseeable or controllable by the promisor, or if counterperformance remains valuable. (La Cumbre Golf & Country Club v. Santa Barbara Hotel Co., 205 Cal. 422, 425 [271 P. 476] ; Johnson v. Atkins, 53 Cal.App.2d 430, 434 [127 P.2d 1027] ; Grace v. Croninger, 12 Cal.App.2d 603, 606-607 [55 P.2d 940] ; Industrial Development & Land Co. v. Goldschmidt, 56 Cal.App. 507, 511 [206 P. 134] ; Burke v. San Francisco Breweries, Ltd., 21 Cal.App. 198, 201 [131 P. 83] ; Megan v. Updike Grain Corp. (C.C.A. 8), 94 F.2d 551, 553; Herne Bay Steamboat Co. v. Hutton [1903], 2 K.B. 683; Leiston Gas Co. v. Leiston Cum Sizewell Urban District Council [1916], 2.K.B. 428; Raner v. Goldberg, 244 N.Y. 438 [155 N.E. 733] ; 6 Williston, op. cit. supra, §§ 1939, 1955, 1963; Restatement, Contracts, § 288.)

Thus laws or other governmental acts that make performance unprofitable or more difficult or expensive do not excuse the duty to perform a contractual obligation (Sample v. Fresno Flume etc. Co., 129 Cal. 222, 228 [61 P. 1085] ; Klauber v. San Diego St. Car Co., 95 Cal. 353, 358 [30 P. 555] ; Texas Co. v. Hogarth Shipping Co., 256 U.S. 619, 630 [41 S.Ct. 612, 65 L.Ed. 1123] ; Columbus Ry. Power & Light Co. v. Columbus, 249 U.S. 399, 414 [39 S.Ct. 349, 63 L.Ed. 669] ; Thomson v. Thomson, 315 Ill. 521, 527 [146 N.E. 451] ; Commonwealth v. Bader, 271 Pa. 308, 312 [114 A. 266] ; Commonwealth v. Neff, 271 Pa. 312, 314 [114 A. 267]; London & Lancashire Ind. Co. v. Columbiana County, 107 OhioSt. 51, 64 [140 N.E. 672] ; see 6 Williston, op. cit. supra, §§ 1955, 1963, pp. 5507-09). It is settled that if parties have contracted with reference to a state of war or have contemplated the risks arising from it, they may not invoke the doctrine of frustration to escape their obligations (Northern Pac. Ry. Co. v. American Trading Co., 195 U.S. 439, 467-68 [25 S.Ct. 84, 49 L.Ed. 269] ; Primos Chemical Co. v. Fulton Steel Corp. (D.C.N.Y.), 266 F. 945, 948; Krulewitch v. National Importing & Trading Co., 195 App.Div. 544 [186 N.Y.S. 838, 840] ; Smith v. Morse, 20 La.Ann. 220, 222; Lithflux Mineral & Chem. Works v. Jordan, 217 Ill.App. 64, 68; Mederios v. Hill, 8 Bing. 231, 131 Eng.Rep. 390, 392; Bolckow V. & Co. v. Compania Minera de Sierra Minera, 115 L.T.R. [K.B.] 745, 747).

At the time the lease in the present case was executed the National Defense Act (Public Act No. 671 of the 76th Congress [54 Stats. 601], §2A), approved June 28, 1940, authorizing the President to allocate materials and mobilize industry for national defense, had been law for more than a year. The automotive industry was in the process of conversion to supply the needs of our growing mechanized army and to meet lend-lease commitments. Iceland and Greenland had been occupied by the army. Automobile sales were soaring because the public anticipated that production would soon be restricted. These facts were commonly known and it cannot be said that the risk of war and its consequences necessitating restriction of the production and sale of automobiles was so remote a contingency that its risk could not be foreseen by defendant, an experienced automobile dealer. Indeed, the conditions prevailing at the time the lease was executed, and the absence of any provision in the lease contracting against the effect of war, gives rise to the inference that the risk was assumed. Defendant has therefore failed to prove that the possibility of war and its consequences on the production and sale of new automobiles was an unanticipated circumstance wholly outside the contemplation of the parties.

Nor has defendant sustained the burden of proving that the value of the lease has been destroyed. The sale of automobiles was not made impossible or illegal but merely restricted and if governmental regulation does not entirely prohibit the business to be carried on in the leased premises but only limits or restricts it, thereby making it less profitable and more difficult to continue, the lease is not terminated or the lessee excused from further performance (Brown v. Oshiro, supra, p. 194; Davidson v. Goldstein, supra, p. 918; Grace v. Croninger, supra, p. 607; Industrial Development & Land Co. v. Goldschmidt, supra; Burke v. San Francisco Brewing Co., supra, p. 202; First National Bank of New Rochelle v. Fairchester Oil Co., 267 App.Div. 281 [45 N.Y.S.2d 532, 533] ; Robitzek Inv. Co., Inc. v. Colonial Beacon Oil Co., 265 App.Div. 749 [40 N.Y.S.2d 819, 824] ; Colonial Operating Corp. v. Hannon Sales & Service, Inc., 265 App. Div. 411 [39 N.Y.S.2d 217, 220] ; Byrnes v. Balcolm, 265 App.Div. 268 [38 N.Y.S.2d 801, 803]; Deibler v. Bernard Bros. Inc., 385 Ill. 610 [53 N.E.2d 450, 453] ; Wood v. Bartolino, —N.M.— [146 P.2d 883, 886, 888, 890]). Defendant may use the premises for the purpose for which they were leased. New automobiles and gasoline continue to be sold. Indeed, defendant testified that he continued to sell new automobiles exclusively at another location in the same county.

Defendant contends that the lease is restrictive and that the government orders therefore destroyed its value and frustrated its purpose. Provisions that prohibit subleasing or other uses than those specified affect the value of a lease and are to be considered in determining whether its purpose has been frustrated or its value destroyed (see Owens, The Effect of the War Upon the Rights and Liabilities of Parties to a Contract, 19 California State Bar Journal 132, 143). It must not be forgotten, however, that “The landlord has not covenanted that the tenant shall have the right to carry on the contemplated business or that the business to which the premises are by their nature or by the terms of the lease restricted shall be profitable enough to enable the tenant to pay the rent but has imposed a condition for his own benefit; and, certainly, unless and until he chooses to take advantage of it, the tenant is not deprived of the use of the premises.” (6 Williston, Contracts, op. cit. supra, § 1955, p. 5485; see, also, People v. Klopstock, 24 Cal.2d 897, 901 [151 P.2d 641].) In the present lease plaintiffs reserved the rights that defendant should not use the premises for other purposes than those specified in the lease or sublease without plaintiffs’ written consent. Far from preventing other uses or subleasing they waived these rights, enabling defendant to use the premises for any legitimate purpose and to sublease them to any responsible tenant. This waiver is significant in view of the location of the premises on a main traffic artery in Los Angeles County and their adaptability for many commercial purposes. The value of these rights is attested by the fact that the premises were rented soon after defendants vacated them. It is therefore clear that the governmental restrictions on the sale of new cars have not destroyed the value of the lease. Furthermore, plaintiffs offered to lower the rent if defendant should be unable to operate profitably, and their conduct was at all times fair and cooperative.

The consequences of applying the doctrine of frustration to a leasehold involving less than a total or nearly total destruction of the value of the leased premises would be undesirable. Confusion would result from different decisions purporting to define “substantial” frustration. Litigation would be encouraged by the repudiation of leases when lessees found their businesses less profitable because of the regulations attendant upon a national emergency. Many leases have been affected in varying degrees by the widespread governmental regulations necessitated by war conditions.

The cases that defendant relies upon are consistent with the conclusion reached herein. In Industrial Development & Land Co. v. Goldschmidt, supra, the lease provided that the premises should not be used other than as a saloon. When national prohibition made the sale of alcoholic beverages illegal, the court excused the tenant from further performance on the theory of illegality or impossibility by a change in domestic law. The doctrine of frustration might have been applied, since the purpose for which the property was leased was totally destroyed and there was nothing to show that the value of the lease was not thereby totally destroyed. In the present case the purpose was not destroyed but only restricted, and plaintiffs proved that the lease was valuable to defendant. In Grace v. Croninger, supra, the lease was for the purpose of conducting a “saloon and cigar store and for no other purpose” with provision for subleasing a portion of the premises for bootblack purposes. The monthly rental was $650. It was clear that prohibition destroyed the main purpose of the lease, but Since the premises could be used for bootblack and cigar store purposes, the lessee was not excused from his duty to pay the rent. In the present case new automobiles and gasoline may be sold under the lease as executed and any legitimate business may be conducted or the premises may be subleased under the lease as modified by plaintiff’s waiver. Colonial Operating Corp. v. Hannon Sales & Service, Inc., 34 N.Y.S.2d 116, was reversed in 265 App.Div. 411 [39 N.Y.S. 2d 217], and Signal Land Corp. v. Loecher, 35 N.Y.S.2d 25; Schantz v. American Auto Supply Co., Inc., 178 Misc. 909 [36 N.Y.S.2d 747]; and Canrock Realty Corp. v. Vim Electric Co., Inc., 37 N.Y.S.2d 139, involved government orders that totally destroyed the possibility of selling the products for which the premises were leased. No case has been cited by defendant or disclosed by research in which an appellate court has excused a lessee from performance of his duty to pay rent when the purpose of the lease has not been totally destroyed or its accomplishment rendered extremely impracticable or where it has been shown that the lease remains valuable to the lessee.

The judgment is affirmed.

Gibson, C. J., Shenk, J., Curtis, J., Edmonds, J., Carter, J., and Schauer, J., concurred.

Appellant’s petition for a rehearing was denied November 28, 1944.