Change In Parol Evidence Precedent Could Spell Greater Litigation Expense for Businesses

by McManis Faulkner

The California Supreme Court’s recent clarification of the fraud exception to the Parol Evidence Rule weakened the effect of contract integration clauses, and may mean lengthier, and more costly, litigation for businesses.  In Riverisland Cold Storage, Inc. v. Fresno-Madera Production Credit Assn. (2013) 55 Cal.4th 1169, the California Supreme Court overruled 78 years of precedent on the issue of whether parol evidence is admissible to show that a contract was procured by fraud.

Parol evidence is evidence of the terms of a contract outside of the written contract itself.  Under the Parol Evidence Rule, when a contract is fully integrated – meaning it was intended by the parties to contain the entire agreement – evidence of prior or contemporaneous negotiations or agreements is not admissible to vary, alter, or add terms to a written contract.  This rule is a powerful statement that the best evidence of a parties’ agreement is the contract itself.

To ensure the protections of the Parol Evidence Rule, most contracts contain an integration or merger clause.  This clause reinforces the notion that the written contract is intended to be the full and final expression of the agreement, and that the contract supersedes any prior negotiations or agreements.

An exception to the Parol Evidence Rule exists for evidence introduced to establish that a contract was procured by fraud.  In other words, extrinsic evidence, including evidence of prior negotiations and agreements, is admissible to support a claim that a party was induced to enter into a contract based on fraud or misrepresentation.

However, California has long recognized a limitation on the fraud exception, pursuant to the state Supreme Court’s 1935 holding in Bank of America v. Pendergrass.  Under Pendergrass, evidence of fraud was admissible “to establish some independent fact or representation, some fraud in the procurement of the instrument or some breach of confidence concerning its use, and not [to show] a promise directly at variance with the promise of the writing.”  In light of the Pendergrass limitation, motions for summary judgment were frequently granted in favor of defendants on fraudulent inducement claims because plaintiffs were, as a matter of law, prohibited from proving fraud by introducing evidence of alleged oral “promises” that contradicted the terms of the final, written contract.  This changed significantly with the California Supreme Court’s ruling in Riverisland.

California Supreme Court Decides Riverisland

The Riverisland plaintiffs were borrowers who sued a lender for fraud and misrepresentation, alleging they were induced to enter into a lending contract based on the lender’s oral promise about the agreement’s length and the collateral securing the loan.  The borrowers admittedly failed to read the subsequent written contract that contained different terms than the lender’s alleged prior oral promise.  The written contract also contained an integration clause stating that the contract constituted the parties’ entire agreement and superseded any prior negotiations. 

After defaulting on the loan under the terms of the written contract, the borrowers sued the lender for fraud and misrepresentation.  The trial court granted summary judgment in favor of the lender, excluding, as a matter of law, evidence of the lender’s alleged prior oral agreement under the Parol Evidence Rule, and Pendergrass.  The Court of Appeal reversed, narrowly distinguishing Riverisland from Pendergrass on the ground that the latter applied only to cases of fraudulent inducement to contract and not fraudulent misrepresentation of the terms of a written contract.  

The California Supreme Court went one step further and, in affirming the Court of Appeal, overruled Pendergrass entirely.  The court found that Pendergrass was contrary to the broad fraud exception to the Parol Evidence Rule as codified, and was inconsistent with the Restatement of Contracts, other legal treatises, and extrajurisdictional authority.  It held that “to bar extrinsic evidence [of fraud] would be to make the parol evidence rule a shield to protect misconduct and mistake.”  In response to the argument that overruling Pendergrass would open the flood gates to fraudulent inducement litigation, the court noted that the high pleading and proof standard for fraud requires a plaintiff to show more than a broken oral promise.  The court also emphasized that a plaintiff must prove reasonable reliance on the alleged oral promise, which may be difficult where, as in Riverisland, the plaintiffs admittedly failed to read the written contract before signing.

Potential Impact of Riverisland for Businesses  

Riverisland changes the landscape of fraudulent inducement claims by opening the door to extrinsic evidence that directly contradicts a written contract, including where a contract contains an integration clause.  This ruling will likely have important effects on the way businesses negotiate contracts and litigate fraud actions. 

Because Riverisland did away with the bar on evidence of prior oral agreements, contract negotiations will likely play a greater role in fraudulent inducement cases.  Businesses should put a greater emphasis on thoroughly and accurately documenting contract negotiations to be able to rebut evidence that the parties previously agreed to more favorable terms. While this is especially true when contracting with unsophisticated parties such as consumers, at least one California appellate court has held that Riverisland’s holding extends to contract negotiations between sophisticated parties for commercial contracts.

Additionally, in a post-Riverisland world, the cost of litigating cases of fraudulent inducement will likely increase because defendants will have a more difficult time disposing of such claims on demurrer or summary judgment.  Whereas these claims would previously have been dismissed or decided as a matter of law because plaintiffs were barred from introducing evidence to vary the terms of a written contract, the existence of prior agreements and their terms are now fact issues that will likely necessitate trial.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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