by: Leslie A. Baxter
On January 14, 2013 the California Supreme Court overturned 78 years of precedent and expanded the fraud exception to the parol evidence rule.
In Riverisland Cold Storage v. Fresno-Madera Production Credit Association (2013) 55 C4th 1169, reported on p 42, plaintiffs sued their lender, seeking damages for fraud and negligent misrepresentation, rescission and reformation of a loan. Plaintiffs (the Workmans,) alleged that the lender’s vice president had told them that they would extend their loan for two years, in exchange for adding two more properties as collateral. The written contract, however, recited only three months forbearance on the loan (then in arrears) and identified an additional eight properties as collateral. The Workmans sued after the lender attempted to foreclose under the loan agreement. The trial court granted the lender’s motion for summary judgment, relying on Bank of America N.T. & S.A. v. Pendergrass (1935) 4 C.2d 258, 263.
The Pendergrass Rule
The Pendergrass rule is that parol evidence is admissible to establish fraud in the procurement of a contract by an independent fact or representation, but not by a promise that directly varies with the promise in the writing. 4 C2d at 263. The Court in Pendergrass explained that it would be “reasoning in a circle” to argue by oral testimony that a written agreement is fraudulent. 4 C2d at 263. The court left open the opportunity to prove that the agreement is invalid due to promissory fraud, through proof that there was no meeting of the minds on the terms of the agreement because one party fraudulently induced the other to enter into a contract. See, Riverisland, 55 C4th at 1173, n.3, citing 5 Witkin, Summary of California Law, Torts §781 (10th ed 2005).
California Case Law After Pendergrass
In California, pleading promissory fraud has been a low-yield proposition for plaintiffs attempting to invalidate an integrated, written contract. Two years ago, with Riverisland already on appeal to the supreme court, the court in Duncan v. McCaffrey Group, Inc. (2011) 200 CA4th 346, 373, overruled in Riverisland, 55 C4th at 1182 (reported at 35 CEB RPLR 57 (Mar. 2012)), ruled that plaintiff homeowners could not proceed on claims of promissory fraud against the developer. The Duncan plaintiffs had claimed that the developer promised them that the development would contain only custom homes. The purchase agreements, however, reserved to the developer the right to build other types of homes. The allegedly fraudulent representations were directly at odds with the written agreement. The court sustained the demurrer on the fraud claims, allowing plaintiffs to proceed on claims of unfair competition, false advertising, breach of fiduciary duty and constructive fraud. The court explained that (200 CA4th at 373, quoting Alling v Universal Mfg. Corp. (1992) 5 CA4th 1412, 1436):
“’Promissory fraud’ is a promise made without any intention of performing it. [Citations.] The fraud exception to the parol evidence rule does not apply to such promissory fraud if the evidence in question is offered to show a promise which contradicts an integrated written agreement. Unless the false promise is either independent of or consistent with the written instrument, evidence thereof is inadmissible.”
Before Riverisland, there was often little factual difference between a case which was allowed to go forward on a fraudulent inducement theory and a case terminated by the Pendergrass rule because the oral representations were at variance with the written contract. In Pacific State Bank v. Greene (2003) 110 CA4th 375, the court held that Greene, a guarantor for her husband’s debt, could introduce evidence that a bank employee had told her that the scope of her guaranty was limited to less than her husband’s entire debt, even though that verbal assurance contradicted the terms of the written guaranty. The court reasoned that Greene could allege that there was a misrepresentation of fact over the contents of the document at the time of its execution — the type of ‘independent fact or representation” that fit within the Pendergrass rule and the theory of fraudulent inducement. The court did not characterize this verbal assurance as a promise at variance with the integrated, written agreement. 110 CA4th at 390. In contrast, the homeowners in Duncan were not allowed to go forward on their fraud claim (that the developer misrepresented to them that only custom homes would be developed in their tract) because of contradictory language in their purchase agreements. The facts in Duncan and Greene are quite similar, yet their disparate holdings highlight the inconsistency that compelled the supreme court to accept Riverisland for review.
Criticism of Pendergrass
The Pendergrass rule has been roundly criticized. As the Duncan and Greene cases show, resistance to the rule by some lower courts has led to inconsistent case law. As the court discussed in Riverisland, the Pendergrass rule is inconsistent with the terms of the parol evidence rule (CCP § 1856), which allows evidence of whether the writing is intended as a final expression of the agreement, exclusive of other terms outside the writing. CCP § 1856(d). The statute also allows evidence of a mistake or imperfection of the writing. CCP §1856(e). Without the Pendergrass rule, an oral promise that is inconsistent with the written agreement would likely be admissible to show the writing was mistaken, imperfect, or contrary to the parties’ agreement.
Practical Implications for Real Property Lawyers
What is the real property lawyer to do in the face of Riverisland? To guard against claims of fraud after the contract is signed, parties will want to document (in writing) that the other side has read the contract and understands the deal. This will safeguard against a claim that the party reasonably relied on an oral statement at variance with the written contract Representations and warranties in the contract should recite that
- The parties have read and understood the contract;
- All of the terms are correct;
- The parties have had the opportunity to seek legal counsel or other expert advice regarding the contract terms; and
- All of their questions regarding the terms have been answered.
If there are language barriers, steps to provide translation should be documented as well.
Businesses that typically contract with less sophisticated parties may want to implement pre-contract procedures designed to educate the other party or give them the opportunity to seek independent help and enough time to think about the contract terms. Of course, integration clauses and representations and warranties will never provide an ironclad guarantee of the enforceability and integrity of the contract. Whether the reliance on an oral statement was reasonable will usually be a question of fact. The stronger the contract terms are, the more counterweight they will provide to the reliance element of a fraud claim.
An unintended consequence of Riverisland may be to squelch communication and negotiation leading up to the deal. Loan officers or real estate agents may be discouraged from ‘thinking out loud” about possible deal terms, lest the other party interpret them as the deal itself. Stated in a more positive way, the parties will be more careful to communicate deal points with clarity.
What’s Next? The Future After Riverisland
Will Riverisland trigger a flood of litigation by parties seeking to invalidate written contracts by claiming fraud? It depends. Many of the cases decided under the Pendergrass rule were decided at the demurrer stage, in favor of the defendant. Now that the fraud exception has been expanded to include oral evidence at variance with written contract, the analysis will likely shift to the trier of fact, at summary judgment or trial, to determine whether there were pre-contract misrepresentations and whether they were reasonably relied on.
Even though they triggered a sea change in California’s common law regarding parol evidence, the plaintiffs in Riverisland have not yet prevailed. The Riverisland action is now remanded to the trial court. The Workmans admitted that they did not read the contract they signed — a fact the lender is expected to use to show their lack of reliance on the oral assurances. Attorneys for borrowers and others looking to challenge written contracts through parol evidence should carefully analyze all of the facts in the client’s situation to determine the viability of an action to invalidate the contract. If there is an attorney fee provision, the economics of a legal attack on the contract must be weighed against the expense of an unfavorable outcome. This should temper the collective impulse of contracting parties and their counsel to run to California courts to undo their written contracts.