Parol Evidence after Riverisland

Cindy Client signed a fully integrated purchase agreement requiring her to make 24 equal monthly installment payments, followed by a large balloon payment. A year into the contract she realizes, for the first time, that she has been misled by Flim Flam, the other party to the contract. He orally represented to Cindy Client that she would have 36 months before she had to make the balloon payment.

Flim Flam's oral representation directly contradicts the written agreement. Cindy Client admits that she failed to read the agreement before signing and never noticed that she was accepting terms that were materially at odds with what she had been told.

Now Cindy Client realizes that she will be unable to make the balloon payment at the 24-month mark. She comes to you seeking legal advice on her chances of prevailing if she sues Flim Flam to nullify the agreement.

Specifically, Cindy Client wants to know whether she can introduce evidence of Flim Flam's oral statements about the three-year payment schedule even though the contract states that it is the full and final agreement between the parties and clearly specifies a two-year time frame.

The key to this conundrum lies in a recent decision of the California Supreme Court.

Oral Promises
In Riverisland Cold Storage, Inc. v. Fresno-Madera Production Credit Association (55 Cal. 4th 1169 (2013)), the plaintiffs fell behind on loan payments and restructured their debt in an agreement with their lender. The plaintiffs alleged that two weeks before the modification agreement was signed, the lender told them it would extend the loan for two years and require two parcels of additional collateral. Under the new integrated agreement, the lender was to take no enforcement action until a specified date, so long as certain payments were made.

The plaintiffs admittedly did not read the agreement before signing it. As it turned out, the agreement provided for only a three-month forbearance and identified eight parcels of additional collateral.

When the borrowers failed to make the required payments, the lender recorded a notice of default. The loan was ultimately repaid without foreclosure, but the plaintiffs sued the lender for fraud and negligent misrepresentation. The trial court entered summary judgment in favor of the lender based on an old precedent limiting the use of parol evidence in cases where the written contract purports to be the full expression of the parties' agreement. (See Bank of America Nat'l Trust & Sav. Ass'n v. Pendergrass, 4 Cal. 2d 258 (1935).) The Riverisland case eventually reached the California Supreme Court.

Parol Evidence
The parol evidence rule is codified in two separate statutes. (See Cal. Code Civ. Proc. § 1856; and Cal. Civ. Code § 1625.) It is a rule of substantive law, not evidence, and provides that when parties enter into an integrated written agreement, extrinsic evidence generally may not be relied upon to alter or add to the terms of their writing. Integrated agreements are written agreements intended as a final expression of the agreed-upon terms (that is, the parties intend the written instrument to serve as the exclusive embodiment of their agreement). When an instrument includes a clause stating that the parties have no prior understandings or agreements concerning its subject matter or otherwise expresses the parties' intention to nullify any such prior understandings or agreements, such a clause is highly persuasive on the issue of integration. (See Banco Do Brasil, S.A. v. Latian, Inc., 234 Cal. App. 3d 973, 1001-1003 (1991).)

The purpose of the parol evidence rule is to ensure that the written final understanding of the parties is not subject to change. For example, under the rule, when an integrated written agreement provides that a loan shall mature on December 31, 2013, no party can subsequently seek to contradict the maturity date by introducing evidence to demonstrate that the parties actually intended the maturity date to be something different. Instead, the agreement is generally allowed to speak for itself on matters that are expressly set forth, without interference by the introduction of evidence of prior or contemporaneous understandings to the contrary.

However, the parol evidence rule is subject to certain exceptions. Thus, "[w]here the validity of the agreement is the fact in dispute, [the parol evidence rule] does not exclude evidence relevant to that issue." (Cal. Code Civ. Proc. § 1856(f).) Similarly, an exception exists to prove illegality or fraud in a given contract. (See Cal. Civ. Code § 1856(g).)

Pendergrass Rule
Until recently, the fraud exception to the parol evidence rule was subject to a major limitation imposed by the oft-cited Pendergrass decision.

In Pendergrass, borrowers fell behind on their farm loan payments and, at their bank's request, executed a new promissory note secured by additional collateral. The new note was payable on demand. Shortly thereafter the bank took enforcement action, including seizing the collateral. In challenging the bank's action, the borrowers asserted that the lender had promised it would not interfere with their farming operations for the remainder of the year, and would take the proceeds of those operations in payment. The Pendergrass court noted that the alleged promise was in direct contravention to the express terms of the new note, since the note expressly provided that it was payable on demand without any limitation on when demand could be made.

The Pendergrass decision has been cited repeatedly for the proposition that when an oral promise - made at or before the time of signing - directly contradicts the specific terms of an integrated agreement, the fraud exception to the parol evidence rule does not apply; the oral promise, therefore, is not admissible to prove fraud. Thus, under Pendergrass, when an integrated contract specifically addresses an issue such as the date of loan maturity, the stated contract terms are conclusive, regardless of any prior or contemporaneous statements to the contrary.

For example, when an integrated loan forbearance agreement provides that the forbearance will expire in one year, a defendant cannot offer evidence to demonstrate he was defrauded into executing the forbearance agreement by virtue of being told by the plaintiff, prior to execution of the agreement, that the forbearance would expire in two years. After Pendergrass, it became critical for parties to read instruments before signing them in order to make sure that the instrument does not contain any terms contradictory to the oral representations that induced the contract in the first place.

If Cindy Client had approached you in 2012 about her dilemma, Pendergrass would have been controlling law. Your advice would have been that the chance of prevailing against Flim Flam is severely hampered by the parol evidence rule; indeed, pursuant to Pendergrass, the court would not permit Cindy Client to introduce evidence of Flim Flam's prior representations that she would have 36 months before the balloon payment came due.

However, the situation changed dramatically in January when the California Supreme Court handed down its unanimous decision in Riverisland, overruling the 78-year-old Pendergrass precedent.

Shifting Tides
In the process of overruling Pendergrass, the justices reflected on several issues, reasoning that the statutes codifying the parol evidence rule do not include any limitation on the scope of the fraud exception. The court also observed that most other states do not limit the fraud exception. It noted that the Restatements of Contracts and Torts deem evidence admissible for the purpose of proving fraud without restriction. The court explained that Pendergrass potentially renders the parol evidence rule as a shield to protect misconduct or mistake, and "its limitation on evidence of fraud may itself further fraudulent practices." (Riverisland, 55 Cal. 4th at 1177.)

The state Supreme Court further expressed concern that courts were having difficulty applying Pendergrass and its progeny, resulting in uncertainty in case law. The opinion took note that judges were creating ever more exotic distinctions of fact in furtherance of applying the fraud exception to the parol evidence rule. For example, in one instance, a court of appeal distinguished between promises at variance with the terms of the contract and misrepresentations of fact about the contents of the document, adding further complexity and confusion to the legal analysis. (See Pacific State Bank v. Greene, 110 Cal. App. 4th 375 (2003).)

Moreover, doubts surrounded the Pendergrass rule almost from the date it was issued. For example, just two years after the decision, the California Supreme Court declared in no uncertain terms that "fraud may always be shown to defeat the effect of an agreement." (See Fleury v. Ramacciotti, 8 Cal. 2d 660 (1937) (emphasis added).)

In overruling its prior decision, the Riverisland court stated that Pendergrass was plainly out of step with established California law, adding that, "the authorities to which it referred, upon examination, provide little support for the rule it declared." Accordingly, the court concluded that Pendergrass itself was an aberration. The case "failed to account for the fundamental principle that fraud undermines the essential validity of the parties' agreement. When fraud is proven, it cannot be maintained that the parties freely entered into an agreement reflecting a meeting of the minds." (Riverisland, 55 Cal. 4th at 1182.)

A New Rule
The Riverisland opinion recognizes that "the intent element of promissory fraud entails more than proof of an unkept promise or mere failure of performance." (55 Cal. 4th at 1183.) Justifiable reliance is a necessary element of fraud - and that element is hard to prove if a party never read the contract in the first place. The state Supreme Court, however, declined to address this issue, stating that "we need not explore the degree to which failure to read the contract affects the viability of a claim of fraud in the inducement." (55 Cal. 4th at 1183 & n. 11.)

Given the Riverisland ruling, what will happen in future cases where a borrower or guarantor claims that a bank fraudulently induced them to sign a written agreement? Unless the trial court accepts an argument - at the pleading stage or on summary judgment - that the borrower or guarantor could not have reasonably relied on the allegedly fraudulent oral promise, the matter will presumably proceed to trial.

The Riverisland decision dramatically changes the litigation landscape for contractual disputes - potentially dragging things out. In many cases, there is now little hope of resolving an action via a pretrial motion; litigants can defeat summary judgment by submitting declarations alleging that prior oral promises made were at odds with the written instrument. The only way to adjudicate such a dispute is by trial on the merits. This is true even when the oral representations contradict the terms of a fully integrated writing, notwithstanding that the party asserting fraud admits he did not read the agreement prior to execution. As such, Riverisland does away with the certainty that has always been the primary purpose of utilizing a written agreement in the first place.

Moreover, decisions issued in the months since Riverisland indicate that the ruling is not restricted to unsophisticated parties. It appears to apply across the board. (See Julius Castle Restaurant Inc. v. Payne, 216 Cal. App. 4th 1423 (2013).)

Practically speaking, this means there will likely be an exponential increase in cases that must be tried, and a judge or jury will be tasked with weighing the evidence of fraud to determine whether the agreement is enforceable. This rise in litigation, combined with the many courtroom closures forced by California's budget cuts, means that such cases will take longer to resolve. As a result, alternative dispute resolution, compromise, and settlement will become more attractive than ever as a negotiated solution will remove the uncertainty and doubt associated with a "he-said, she-said" swearing contest before the trier of fact.

Practical Suggestions
To soften the impact of Riverisland, parties should make sure to include arbitration and judicial reference clauses in all written agreements. Such clauses, when enforced, will preclude trial by jury.

Moreover, whenever lender clients extend or renew any credit to their customers, the agreements should include recitals acknowledging the debt, the amounts owed, and the fact that there are no defenses to the obligation. This step is important, because such recitals are conclusively presumed to be true as between the parties or their successors in interest. (See Cal. Evid. Code § 622.) A well-written recital will therefore block evidence of any alleged promises prior to or contemporaneous with the original loan or any prior amendment to it.

However, this approach will not protect against any prior or contemporaneous promises allegedly made by the client concerning inducement to enter into the extension or renewal agreement itself.

Finally, lender clients should be advised to obtain releases from their customers at the time of extension or renewal of credit.

So as her lawyer, how should you respond to Cindy Client's predicament? Assuming she asked for advice after Riverisland came down, it would appear that a lawsuit against Flim Flam has a good chance of surviving a demurrer as well as his summary judgment motion. Pendergrass would no longer interfere with Cindy Client's ability to introduce evidence that, prior to her execution of the agreement, Flim Flam represented to her that she would have a total of 36 months before the balloon payment became due - she can now make that claim even though she didn't read the agreement before signing it.

To the extent that Cindy Client can convince the court that she reasonably relied on Flim Flam's prior oral promise, tell her that she has a reasonable chance of prevailing at trial.

Bob Benjy is a litigator with Frandzel Robins Bloom & Csato in Los Angeles, where he specializes in commercial and creditor rights litigation.

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