In contract disputes in California courts, the Parol Evidence Rule (codified in California Code of Civil Procedure section 1856) prohibits evidence of promises or representations that are contrary to the written terms of a contract that was intended to be a complete and final statement of the parties’ agreement. For decades (since the 1935 case of Bank of America v. Pendergrass), financial institutions relied on the Parol Evidence Rule to prohibit borrowers from making claims or defenses based on the lender’s alleged false promises or misrepresentations that contradict the terms of the loan documents.
In 2013 and the years that followed, the California Supreme Court and Courts of Appeal issued several decisions that have eroded the Parol Evidence Rule’s strict prohibition against evidence of alleged false promises that contradict the terms of a written contract.
In the seminal case on this issue, Riverisland Cold Storage, Inc. v. Fresno-Madera Production Credit Association (2013) 55 Cal.4th 1169, the plaintiffs made claims against their lender for fraud and negligent misrepresentation based on allegations that, contrary to the terms of a forbearance agreement in which the plaintiffs pledged eight parcels of property as collateral, the credit association’s vice president told the plaintiffs that they only needed to pledge two properties as additional collateral for the forbearance agreement. The trial court in that case granted summary judgment in favor of the defendant credit association based on the then longstanding rule stated in the Pendergrass case that prohibited evidence of a false promise that contradicted the terms of the parties’ contract. Both the California Court of Appeal and Supreme Court reversed the trial court’s ruling and labeled the Pendergrass case an “aberration.” The Supreme Court stated that, “although a written instrument may supersede prior negotiations and understandings leading up to it, fraud may always be shown to defeat the effect of an agreement,” and thus, “the parol evidence rule should not be used as a shield to prevent the proof of fraud.” The Court’s premise for its decision was the “fundamental principal” that the proof of fraud defeats the validity of the contract.
Although Riverisland is a relatively new opinion, the California Courts of Appeal have cited and applied its exception to the Parol Evidence Rule in numerous opinions, including Julius Castle Restaurant v. Payne (2013) 216 Cal.App.4th 1423 and Thrifty Payless, Inc. v. Americana at Brand, LLC (2013) 218 Cal.App.4th 1230. Thus, after Riverisland, the law in California is that evidence of promises or statements that are inconsistent with the terms of a written agreement is not necessarily barred by the Parol Evidence Rule, but rather, may be admitted to support a claim or defense of fraud.
The likely effect of the Riverisland decision is that contract-related fraud claims and defenses will be more difficult to defeat on legal grounds at the early stages of a lawsuit. Despite that, fraud remains difficult to plead and prove, and as such, fraud claims and defenses will remain vulnerable to legal and factual attacks in later court proceedings like motions for summary judgment. For instance, while a borrower now may be permitted to offer evidence of promises made that are contrary to the terms of the loan documents, that borrower’s fraud claim may still be subject to attack on the ground that he cannot prove “reasonable reliance” on the lender’s alleged false promise where the loan documents state that they are a complete and final recitation of the parties’ agreement and that all prior negotiations and promises are superseded by the final written documents.
In light of Riverisland, there are several measures that a financial institution should take to minimize the risk of a viable claim or defense of contract-related fraud being raised against it.
First, the institution’s legal counsel should draft a thorough integration clause to be included in all loan documents that states that (a) all parties have read and understand the contract; (b) all parties intend for the contract to be the final and complete recitation of the parties’ agreement; (c) none of the parties are relying on any representation, inducement, negotiation or discussion made prior to the execution of the contract and that all prior representations, inducements, negotiations or discussions between the parties are superseded by the written agreement; and, if applicable, (d) the parties jointly drafted the contract and have had the final version of the contract reviewed by their respective legal counsel. There should also be a space left immediately below the integration clause for the borrower and/or guarantors to initial and acknowledge that they read the integration clause. It is also a good practice to have all key contract terms initialed by the parties to the agreement. This should minimize the borrower’s ability to prove “reasonable reliance” on the lender’s alleged false promises.
Second, the institution should limit the number of officers or employees that discuss the loan terms with the borrower and guarantor. That way, it is less likely that there will be conflicting representations made by the lender’s representatives. If resources allow, the institution should also have an additional officer or employee present to witness all contract discussions and negotiations so that a “he said, she said” scenario in court can be limited, if not avoided.
Third, copies of the final loan documents should be given to the borrower and guarantor at least several days before the signing date so that there is sufficient time for the borrower to review the documents. For deals with less sophisticated borrowers, the institution may also want to include with the final loan documents a list that highlights the key terms of the loan documents in simple English. Doing this will make the borrower’s reliance on the lender’s oral representations and failure to read the loan documents unreasonable and insufficient to support a fraud claim or defense.
Finally, if the loan documents are ever modified, a release of the lender by the borrower should be included in the modification documents. The release should operate to eliminate any claim that a borrower may have had against the institution prior to the execution of the amendment, including claims of fraud related to the loan transaction.
These measures, if implemented, should help minimize the effect of Riverisland’s exception to the Parol Evidence Rule on a financial institution’s reliance on and enforcement of the terms stated in its loan documents.
Steven Casselberry is partner in the Firm’s Orange County office. A multi-faceted attorney, he combines his extensive deal making talents with litigation experience to counsel clients in the financial services, real estate and title insurance industries. His full bio and contact information can be found at http://www.musickpeeler.com/professional/Steven_Casselberry/
Stephen Isbell is an associate in the Firm’s Orange County office, where he handles litigation matters in state and federal court in the financial services, real estate, and title insurance industries for many of the Firm’s top clients, including national, regional, and community banks. His full bio and contact information can be found at http://www.musickpeeler.com/professional/Stephen_Isbell/
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