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January 2013

California Supreme Court Lifts Long-Standing LimitationOn Fraud Exception to the Parol Evidence Rule

In a unanimous Jan. 14 decision, the California Supreme Court held in Riverisland Cold Storage v. Fresno-Madera Production Credit Association that evidence of the parties’ oral statements would be admissible under the fraud exception to the Parol Evidence Rule where the alleged statements contradict the terms of the written agreement.

The Parol Evidence Rule, codified in California Code of Civil Procedure §1856 and Civil Code §1625, prohibits the introduction of extrinsic evidence to alter or add to the terms of an integrated written contract. Section 1856, subdivision (f), establishes a fraud exception to the rule, which provides that evidence to establish fraud, illegality, mistake or ambiguity will be admissible. In 1935, however, the California Supreme Court substantially limited the scope of this exception in Bank of America etc. Assn. v. Pendergrass, 4 Cal. 2d 258, 263 (1935), holding that the exception to the Parol Evidence Rule does not allow the admission of parol evidence of promises “at odds with the terms of the written agreement.” The so-called Pendergrass rule – long criticized as being inconsistent with the statute and previous case law – held that evidence offered to prove fraud “must tend 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 a promise directly at variance with the promise of the writing.” Pendergrass essentially excluded any evidence of fraud when the fraud is directly contrary to the terms of a written agreement.

After falling behind on their loan payments, the plaintiffs in Riverisland, Lance and Pamela Workman, agreed to restructure their debt, secured by real property. In the new agreement, the credit association promised that it would not take any enforcement action for three months if the plaintiffs agreed to make specified payments. As additional collateral, the Workmans pledged eight separate parcels of real property. When the Workmans failed to make their payments as agreed, the credit association recorded a default notice and initiated foreclosure proceedings. Eventually, the loan was repaid and the association dismissed the foreclosure proceedings. The Workmans then sued the association, seeking damages for fraud and negligent misrepresentation and including causes of action for rescission and reformation of the restructuring agreement. The Workmans alleged that the association’s vice president had met with them two weeks before the agreement was signed, and told them that the association would extend the loan for two years in exchange for additional collateral consisting of two ranches. The Workmans further claimed that the association assured them that the ranches would be the only additional security. The Workmans did not read the contract, but simply signed at the locations tabbed for signature.

In granting summary judgment in favor of the lender, the trial court relied on Pendergrass, reasoning that because the credit association’s alleged oral promises contradicted the terms of the written agreement, they were therefore inadmissible. The Court of Appeal reversed and instead opted to apply the Pendergrass rule narrowly, stating that it should only be applied to cases of promissory fraud. The California Supreme Court unanimously affirmed the Court of Appeals decision and determined that the time had come for Pendergrass to be reconsidered.  In overruling Pendergrass, the Court called the rule “an aberration,” stating that it often leads to conflicting and unpredictable results.  The Court cited various reasons behind its decision, including that the Pendergrass rule has been criticized as bad policy and that it is inconsistent with the governing statute.  The Court did note, however, that allegations of fraud still require a showing of justifiable reliance on the defendant’s misrepresentation.

The Riverisland decision affirms that the fraud exception is applicable to all forms of fraud and brings California law in line with the Restatement of Contracts and the majority of other states.  It will also significantly affect breach of contract cases involving parol evidence.  Although it provides further protection for victims of fraud and misrepresentation, the ruling potentially opens the door to increased liability exposure for commercial entities.  As a result of this decision, contract drafters must be sure to avoid statements in negotiations that have the potential to be misconstrued or that contradict the terms of the written agreement.  It is also advisable for lenders to ensure that borrowers and other parties to a contract have sufficient time to read and understand any contracts before they are signed. 

 

Commercial Litigation

Allison J. Fernandez



Commercial Litigation

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