Rescission Definition

Rescission is the cancelling of a contract so that it is no longer legally binding. A court can release parties from any obligations under the contract and revert them to their positions before the contract was executed.

How Rescission Works

In simple terms, rescission involves cancelling a contract as though it was never executed. The goal is to eliminate all elements of the contract and to return all participants to the state they were in prior to its original execution. This includes returning money or property that had been exchanged.

In order for a contract to be rescinded, one or more parties must prove that there was a material error in the contract. Such qualifying factors would include evidence of fraud, mutual errors of both parties, a lack of legal or mental capacity, duress or undue influence, or a party not fulfilling the contractual obligations.

Rescission is frequently used in the insurance industry. Life, health, and property-casualty insurers have the right of rescission for insurance policies, without court approval, if there is proof that an insurance application was submitted using falsified information or under false pretexts.

Rescission of business contracts is actually quite rare as companies typically resolve disputes through mediation or seek repayment through legal action. Most commercial contracts contain a clause preventing rescission and spelling out remedy through mediation or litigation.

Rescission in Consumer Contracts

The right of rescission in consumer contracts is often explicit, regulated, and can differ from state to state depending on the laws that govern consumer protection.

In California, for example, the law allows the right of rescission for over 30 different types of consumer contracts including funeral services contracts, automobile purchase contracts, and door-to-door sales contracts.

The period allowed for rescission can vary from 24 hours, 10 days, or even indefinitely.

Rescission is more difficult in lending contracts, such as mortgages. However, under the Truth In Lending Act, banks are required to give refinancing customers a three-day right of rescission that begins once the contract is signed.

Rescission Example

The most common example of rescission is the three-day right of rescission, in which a borrower refinancing a loan has extra time to reconsider the decision. The “clock” on the rescission process begins “ticking” the moment the contract is signed by the borrower. The borrower must affirm the decision to exercise the right of rescission by midnight of the third day after signing the contract.

If the borrower decides to cancel, she or he must inform the lender. Once the contract is rescinded, the lender must refund any fees associated with the contract that were paid by the borrower, such as closing costs, inspection fees, points, or origination fees. Once this is complete, the contract is then null and void.

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Rachel Siegel, CFA
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Rachel Siegel, CFA is one of the nation's leading experts at ensuring the accuracy of financial and economic text. Her prestigious background includes over 10 years creating professional financial certification exams and another 20 years of college-level teaching.

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