Weyand Law Firm and Alexander Michael Weyand,
for Plaintiffs and Appellants
Garthwohl, Rauch & Cohen, Garry K. Cohen, Gary Steven Garfinkle;
and Maria J. Garfinkle, for Defendants and Appellants
Wayson and Susanna Wong bought a hillside home in San Carlos (City) for $2.35 million from Ira and Toby Stoler. Several months after they moved in, the Wongs discovered that they and 12 of their neighbors were connected to a private sewer system and were not directly serviced by the City’s public system. Believing they had been deceived, they sued the Stolers and the real estate agents who brokered the sale alleging various causes of action, including rescission. After the Wongs settled their dispute with the real estate agents for $200, 000, a court trial was held on the rescission claim only. Although the court found that the Stolers, with reckless disregard, made negligent misrepresentations to the Wongs, it declined to effectuate a rescission of the contract. Instead, it ordered the Stolers to be, for a limited time, indemnifiers to the Wongs for sewer maintenance and repair costs exceeding the $200, 000 they obtained in their settlement with the agents.
On appeal, the Wongs contend that the trial court erred in denying rescission, ordering the alternative relief, and denying them attorney fees. The Stolers contend in a cross-appeal that the trial court erred in denying them attorney fees.
We reverse. We conclude that the trial court declined to effectuate a rescission of the contract based on incorrect justifications and that its alternative remedy failed to provide the Wongs with the complete relief to which they were entitled.
A. The Property
The home is located on Sudan Lane, a privately maintained road on the west side of San Carlos in the Los Vientos Highlands area. When the developers built the house and 12 others, they installed a private system to carry sewage from these properties to a connecting point with the City’s public sewer on a downhill street. Some of the homes on the private system are on a nearby street, Best Court. To meet the connecting point, the private system runs approximately 1, 000 feet down a steep, unstable hillside through a public open-space and watershed area. At the time the 13 homes were built, the City required the developers to form a homeowners’ association to maintain, repair, and replace the private sewer lines. No formally incorporated or registered entity was ever formed to provide these functions.
References to the system are contained in two recorded documents entitled “Declaration Conditions, Covenants and Restrictions for Sewer Easements, ” (CC&Rs) which were recorded against the property in December 1987. The obligations of the subservient downhill properties and the liabilities of the easement holders are included in a “Cross-Easement Agreement” recorded in April 1984, and a first amendment recorded in December 1987. The recorded instruments, however, do not clearly attach the easements to the titles of the 13 properties served by the private system.
B. The Purchase and the Improvements
The Wongs bought the property from the Stolers in May 2008 for $2.35 million. Before the close of escrow, the Stolers provided the Wongs with a transfer disclosure statement completed in 2002 by the prior owners, an updated 2008 transfer disclosure statement, and a supplemental sellers’ checklist. These combined documents represented to the Wongs that the property was connected to a public sewer system. And they failed to inform the Wongs about (1) any specifics related to “CC&Rs or other deed restrictions or obligations”; (2) any “Homeowners’ Association [having] authority over” the property; (3) any “abatement or citations against” the property; (4) any “past or present blockage, backup, overflow or other failure” of the sewer lines or that they had ever been “snaked/rooted”; or (5) “any toxic or hazardous material leakages or spills within a half-mile” of the property.
In a roadside conversation, the parties directly discussed that Sudan Lane is a privately maintained road, and in a follow-up e-mail Mr. Wong specifically asked “is there any homeowners’ association here?” Mr. Stoler replied, “no.”
After the close of escrow, the Wongs allowed the Stolers to rent the property back from them for a few months. The Wongs then took possession in July 2008. In mid-September 2008, the City sent a letter to the Stolers about a problem with the private sewer system, and it was forwarded by the postal service to their new address. The Stolers returned the letter to the City. They also received an e-mail from a former neighbor about the City’s letter. Neither of these pieces of correspondence was forwarded to the Wongs.
After they moved in, the Wongs commenced an extensive remodeling project. Mr. Wong did some of the initial demolition work himself, but professional demolition began in early October 2008. The Wongs signed a contract with a general contractor in December 2008. The remodeling cost about $300, 000, and it included reconfiguring the garage doors and remodeling the kitchen, a bathroom, and a bedroom closet.
C. Discovery of the Private Sewer System
The Wongs first learned of the private sewer system around November 6, 2008, when they received an e-mail from a neighbor discussing it. Unbeknownst to the Wongs, this neighbor had been the coordinator of an informal homeowners’ association since 2005. By this time, much of the home was down to the studs as a result of the demolition work.
The Wongs tried to resolve the problem without involving the Stolers. They and other neighbors met with the City and asked it to take possession of the sewer system. In April 2009, the City denied the request and instead proposed that the homeowners enter into a maintenance agreement. The Wongs also worked to no avail to establish a formal structure to oversee the system. When it became increasingly unlikely that their neighbors would come together to form a responsible entity or to enter into a maintenance agreement, the Wongs sought legal counsel.
D. Commencement of Litigation and Trial
The Wongs sued the Stolers for negligence, negligent misrepresentation, fraudulent concealment, fraudulent misrepresentation, breach of contract, and breach of fiduciary duty. They also sought rescission of the purchase agreement.
Immediately before trial, the parties argued whether the case should be tried to a jury. The Wongs argued it should, and the Stolers argued it should
not. The trial court ruled that it would try the case “as a bench trial [on] the rescission claim... and then depending upon what I decide on that, then we’ll see where we are as far as whether or not the remainder of the trial continue[s] on as a court trial or at that time whether we will need to empanel a jury and have a jury decide something.”
At the ensuing trial, the evidence showed that the property owners on the private system never agreed to formalize an association, establish an emergency repair fund, or create a long-term reserve for the system’s eventual replacement. It also showed that two sewage overflows occurred in 2008, and landslides damaged the pipes.
Experts for the Wongs testified that the 25-year old system has an expected useful life of 50 more years and is susceptible to damage from fire, erosion, landslides, and earthquakes. They testified that system failure is inevitable given the system’s steep hillside location and existing tension cracks. According to the experts, the cost to replace two of the lines would be between $592,000 and $740,000.
Mr. Wong testified that he reviewed all the transaction materials given to him by the sellers, including the preliminary title report. He stated that the combination of the 2002 and 2008 transfer disclosure statements, together with Mr. Stoler’s representation that there was no homeowners’ association, misled him about the property’s sewer service. He explained that he believed that the reference to a “CC& R/easement” in the preliminary title report pertained to a public sewer line running under the private road because he had been told that the property was on a public sewer and the 2002 transfer disclosure statement referenced CC&Rs solely in the context of the road and driveway.
The evidence established that the Stolers participated in forming an informal associationthe Los Vientos Highlands Sewer Associationto pay for sewer maintenance. The Stolers contributed money to the association, and Mrs. Stoler was an initial signator on the association’s bank account. Evidence was presented that the Stolers had, but failed to give the Wongs, a copy of the original cross-easement, which referenced the City’s requirement that a homeowners’ association be formed. Evidence was also presented that the Stolers failed to disclose they had received a letter from the City reminding them and the other owners about the obligation to form an association as “part of the privately owned and maintained sewage disposal system.” This letter was actually a notice of abatement, and the evidence therefore showed that the Stolers knew that the private sewer system had leaked.
Mr. Stoler testified that he had made improvements costing approximately $100, 000 to the new house he and his wife bought after selling the property to the Wongs. He believed that their new house had nonetheless decreased in value, but he did not specify an amount. He also testified that the property sold to the Wongs was “quite different” from its condition at the time of sale. He testified that “[a] whole lot of landscaping, mature landscaping had been removed [from] around the driveway and some mature acacia trees had been removed and the eucalyptus tree umbrella... over the driveway area had been topped, cut off, trimmed.” In addition, he testified that the garage had been “dramatically” changed, that some interior walls had been removed, various fixtures had been replaced, and that the kitchen configuration had been changed.
E. Statement of Decision
The court found that the Stolers acted with reckless disregard in negligently misrepresenting the material facts about the true nature of the sewer system and the existence of the informal association loosely established to maintain it. The court further found that the misrepresentations affected the property’s value and that the Wongs would not have bought the property if they had known about the private sewer system and the informal association.
Nonetheless, the court denied rescission because of the “practicality of unwinding the transaction” and because of the undue burden it would place on the Stolers. The court reasoned that the Stolers had purchased a new home over four years ago and had spent $100, 000 in improving it, and the Wongs had spent $300, 000 improving the property and had removed a significant amount of the original landscaping. The court determined that, given the “burden that rescission would place on the Stolers, ” rescission was neither a fair nor appropriate remedy.
Instead of granting rescission, the court fashioned alternative equitable relief in the form of declaratory relief and an equitable decree of indemnity. As to the declaratory relief, the court found that there is an “unincorporated association in existence through which the 13 owners must carry out the terms and conditions of the equitable servitudes set out in the CC&Rs, ” and the Wongs, as one of the 13 owners, are members of it. The court declared that pending any quiet-title action or agreement to make the sewer easements appurtenant to the 13 affected lots, the Wongs and the other 12 owners had an equitable servitude that ran with the land. But, recognizing that the other 12 owners were not before the court, the court stated that it was only determining the rights and obligations as between the Wongs and the Stolers. Thus, the court declared that the Wongs “have only a 1/13th responsibility as to the Sudan Lane piece of the line.”
As to the equitable decree of indemnity, the court ordered the Stolers to indemnify the Wongs for any repairs, maintenance, or replacement needs for a reasonable time not to exceed the sale of the property or 10 years, whichever occurred sooner. This obligation was capped at $360, 000, which would be triggered only by the exhaustion of the $200, 000 reflecting the settlement the Stolers received from the real estate agent.
Finally, the court declined to award punitive damages and deemed all other causes of action dismissed. As a consequence of the court’s ruling, the non-rescission claims were never tried or resolved, much less by a jury as the Wongs had demanded.
F. Attorney Fees
Each side filed motions for attorney fees. Finding neither party qualified as the “prevailing party, ” the court denied both motions. It explained: “[E]ach side here has achieved discernible, and equally substantial, major objectives that each had in the eventual outcome that each respectively sought in this litigation. [The Wongs] have recovered [i]ndemnity protection against the negligently undisclosed repair, maintenance, third party liability risks, and environmental injury risks arising from the shared ownership of the private sewer line servicing their house. At the same time, [the Stolers] have defeated the intentional fraud and deceit claims and have thereby avoided a rescission of their sale of the house to the Wongs, a rescission that would have been extremely disruptive given the changes in position of both [p]arties over the several years since the house was sold.”
A. The Appeal: Rescission and Attorney Fees
a. Applicable Law and Standard of Review
A party to a contract has two different remedies when it has been injured by a breach of contract or fraud and lacks the ability or desire to keep the contract alive. (Akin v. Certain Underwriters at Lloyd’s London (2006) 140 Cal.App.4th 291, 296 [44 Cal.Rptr.3d 284] (Akin).) The party may disaffirm the contract, treating it as rescinded, and recover damages resulting from the rescission. (Ibid.) Alternatively, the party may affirm the contract, treating it as repudiated, and recover damages for breach of contract or fraud. (Ibid.)
Rescission and damages are alternative remedies. (Akin, supra, 140 Cal.App.4th at p. 296.) A party may seek rescission or damages for breach of contract or fraud “in the event rescission cannot be obtained” in the same action. (Williams v. Marshall (1951) 37 Cal.2d 445, 457 [235 P.2d 372] [defrauded vendee], citing Bancroft v. Woodward (1920) 183 Cal. 99 [190 P. 445]; Walters v. Marler (1978) 83 Cal.App.3d 1, 16 [147 Cal.Rptr. 655] [breach of contract], disapproved on another ground in Gray v. Don Miller & Associates, Inc. (1984) 35 Cal.3d 498, 505-507 [198 Cal.Rptr. 551, 674 P.2d 253].) But “[t]he election of one remedy bars recovery under the other.” (Akin, at p. 296, citing Alde v. Drudis (1947) 30 Cal.2d 372, 383 [182 P.2d 195].)
Before 1961, California recognized two methods by which a party to a contract could obtain rescissionary relief: (1) unilateral rescission, followed by an action to enforce the out-of-court rescission; or (2) an action for judicial rescission in which specific judicial relief is granted. (Runyan v. Pacific Air Industries, Inc. (1970) 2 Cal.3d 304, 311-312 [85 Cal.Rptr. 138, 466 P.2d 682] (Runyan).) In 1961, however, the Legislature abolished the action to obtain judicial rescission and left only an action to obtain relief based on a party effecting rescission. (Id. at p. 313;
seePaularena v. Superior Court (1965) 231 Cal.App.2d 906, 913 [42 Cal.Rptr. 366].)
Consequently, any post-1961 rescission must necessarily be accomplished by a party to the contract. The court does not rescind contracts but only affords relief based on a party’s rescission. Both the grounds for rescission and the means by which parties may rescind their contract are governed by statute. (See Civ. Code § 1688, et seq.) Section 1689, subdivision (b)(1) permits rescission when “the consent [to the contract] of the party rescinding... was given by mistake or obtained through... fraud or undue influence exercised by... the party as to whom he rescinds.”
The steps to rescind a contract are set forth in section 1691, which provides in part: “Subject to Section 1693,  to effect a rescission a party to the contract must, promptly upon discovering the facts which entitle him to rescind.... [¶] (a) Give notice of rescission to the party as to whom he rescinds; and [¶] (b) Restore to the other party everything of value which he has received from him under the contract or offer to restore the same upon condition that the other party do likewise, unless the latter is unable or positively refuses to do so. [¶] When notice of rescission has not otherwise
been given or an offer to restore the benefits received under the contract has not otherwise been made, the service of a pleading in an action or proceeding that seeks relief based on rescission shall be deemed to be such notice or offer or both.” (Italics added.) Once a contract has been rescinded, any party to the disaffirmed contract may seek relief either by “bringing an action to recover any money or thing owing to him by any other party to the contract as a consequence of such rescission or for any other relief to which he may be entitled under the circumstances, ” or by asserting the rescission as a defense, counterclaim, or cross complaint. (§ 1692.)
Under section 1692, a trial court’s obligation is not over once it has determined whether the section’s substantive and procedural requirements have been satisfied. If the court finds that the contract was rescinded, “[t]he aggrieved party shall be awarded complete relief, including restitution of benefits, if any, conferred by him as a result of the transaction and any consequential damages to which he is entitled.” (Sharabianlou v. Karp (2010) 181 Cal.App.4th 1133, 1144-1145 [105 Cal.Rptr.3d 300]), italics added (Sharabianlou).) If the trial court finds that “the contract has not been rescinded, [it] may grant any party to the action any other relief to which he may be entitled under the circumstances.” (Runyan, supra, 2 Cal.3d at p. 311, fn. 10.)
Thus, section 1692 “ ‘restates the equity jurisprudence applicable in the rescission context.’ [Citation.] The fundamental principle underlying that jurisprudence ‘is that “in such actions the court should do complete equity between the parties” and to that end “may grant any monetary relief necessary” to do so. [Citation.]’ (Runyan[, supra,] 2 Cal.3d [at p.] 316.) Rescission is intended to restore the parties as nearly as possible to their former positions and ‘ “to bring about substantial justice by adjusting the equities between the parties” despite the fact that “the status quo cannot be exactly reproduced.” ’ [Citations.]” (Sharabianlou, supra, 181 Cal.App.4th at p. 1144-1145.) “Rescission extinguishes the contract (... § 1688), terminates further liability, and restores the parties to their former positions by requiring them to return whatever consideration they have received. [Citation.] Thus, the ‘[r]elief given in rescission casesrestitution and in some cases consequential damagesputs the rescinding party in the status quo ante, returning him to his economic position before he entered the contract.’ ” (Id. at p. 1145.)
In rescission cases involving a real estate purchase, “the seller must refund all payments received in connection with the sale. [Citation.] If the buyer has taken possession of the property, the buyer must restore possession to the seller. [Citation.] Such recovery of the consideration exchanged is part of restitution. [Citations.] As consequential damages, rescinding buyers or
sellers may recover such items as real estate commissions paid in connection with the sale [citation], escrow expenses [citation], interest on specific sums of money paid to the other party [citation], and attorney fees in appropriate cases [citation].” (Sharabianlou, supra, 181 Cal.App.4th at pp. 1145-1146, citing Kent v. Clark (1942) 20 Cal.2d 779, 784 [128 P.2d 868].) In some cases, the value of improvements may also be recovered. (Runyan, supra, 2 Cal.3d at p. 315; Lobdell v. Miller (1952) 114 Cal.App.2d 328, 344 [250 P.2d 357].)
Whether to grant relief based on rescission “generally rests upon the sound discretion of the trial court exercised in accord with the facts and circumstances of the case [citations].” (Hicks v. Clayton (1977) 67 Cal.App.3d 251, 265 [136 Cal.Rptr. 512];
seeFairchild v. Raines (1944) 24 Cal.2d 818, 826 [151 P.2d 260] ["the granting or withholding of equitable relief involves the exercise of judicial discretion”].) “However, that discretion is not an arbitrary one, but should be exercised in accord with the principles and precedents of equity jurisprudence.” (Hicks, at p. 265.)
(1) The Purchase Agreement Was Rescinded
A straightforward application of the rescission statutes compels the conclusion that the purchase agreement was unilaterally rescinded by the Wongs. Their complaint expressly alleged numerous grounds entitling them to rescind the purchase agreement, including fraud and negligent misrepresentation, and it specifically sought relief based on rescission. By serving this complaint on the Stolers, the Wongs satisfied the procedural requirements of section 1691, i.e., they gave notice of rescission to the Stolers, and they subsequently offered to restore “everything of value” which they had received under the contract. (§ 1691, subd. (b).) At that point, the Wongs declared a unilateral rescission of the real estate contract under the clear language of the rescission statutes. “ ‘ “[I]f facts exist that justify a rescission by one party, and he declares a rescission in some effectual manner, he terminates the contract.” ’ ” (Wilson v. Lewis (1980) 106 Cal.App.3d 802, 809 [165 Cal.Rptr. 396], italics omitted, quoting Holmes v. Steele (1969) 269 Cal.App.2d 675, 677 [75 Cal.Rptr. 216];
seeC. Norman Peterson Co. v. Container Corp. of America (1985) 172 Cal.App.3d 628, 642-643 [218 Cal.Rptr. 592] ["In rescission cases the Civil Code now prescribes the method by which one party may unilaterally rescind the contract on explicit notice to the other. (See...§ 1691.)”]; Harrison v. Connecticut Mutual Life Ins. Co. (N.D. Cal. 1991) 771 F.Supp. 1053, 1056 [“Where the procedural prerequisites of section 1691 are met, and there is a valid substantive ground for rescission, unilateral rescission occurs”].)
(2) The Trial Court Abused Its Discretion
In deciding whether to effectuate the Wongs’ rescission, the trial court’s first task under section 1689 was to determine whether the Wongs
consent to the contract was given by mistake. . . or obtained through. . .
fraud. . . or undue influence, exercised by. . . the party as to whom he rescinds.” (§ 1689, subd. (b)(1)) If it was, the court’s duty was to effectuate the rescission and to otherwise award “complete relief.” (§ 1692.) The Wongs argue that the trial court was required as a matter of law to have found their rescission effective because it found that they were the victims of misrepresentations, and they contend the court erred in awarding the alternative equitable relief. For their part, the Stolers argue that section 1692, together with principles of equity, allowed the court to reject rescission and to award the alternative equitable relief.
We conclude that the trial court erred in declining to effectuate the Wongs’ rescission and in basing its decision on the prejudice to the Stolers. We further conclude that the trial court’s alternative award was inadequate because it failed to satisfy section 1692’s requirement that the relief be “complete.”
We begin by rejecting the argument advanced by the Stolers that the Wongs’ rescission could not have been effectuated by the trial court under section 1692 because the court did not find that the Stolers had engaged in actual fraud. Under California law, negligent misrepresentation is a species of actual fraud and a form of deceit. (SeeVentura County Nat. Bank v. Macker (1996) 49 Cal.App.4th 1528, 1530 [57 Cal.Rptr.2d 418];
see also Furla v. Jon Douglas Co. (1998) 65 Cal.App.4th 1069, 1077 [76 Cal.Rptr.2d 911] ["Negligent misrepresentation is a form of ‘actual fraud, ’ consisting of ‘[t]he positive assertion, in a manner not warranted by the information of the person making it, of that which is not true, though he believes it to be true, ’ ” citing § 1572, subd. 2]; Continental Airlines, Inc. v. McDonnell Douglas Corp. (1989) 216 Cal.App.3d 388, 403 [264 Cal.Rptr. 779] ['The case law, however, is clear that in California negligent misrepresentation is a form of fraud ...