RECENT UPDATES: EXPANDED RIGHT TO INTRODUCE FRAUD INTO EVIDENCE TO INVALIDATE WRITTEN CONTRACTS AUTHOR: HENRY R. STIEPEL

Known to lawyers as the “Parole Evidence Rule”, parties to an “integrated” written contract are generally prohibited from introducing evidence outside of a contract to alter or add to the terms of that contract. An “integrated” contract simply means that the parties intend the contact to be the entire, exclusive agreement between them. You’ll therefore generally find in contract “boilerplate” (the importance of which clients often overlook) an “integration” clause, which states in one form or another that it’s the parties intention that the terms of the contract are fully and exclusively expressed in the contract and that no extraneous agreements or representations may be introduced to vary the contract’s terms. The integration clause creates a presumption that the contract is “integrated.”

  The purpose of the Parole Evidence Rule is obvious: parties generally want the written contract to be controlling, with the words on paper establishing the sole terms and conditions of their agreement. However, as with all things legal, there are exceptions–and there are exceptions to those exceptions. 

For example, courts will allow evidence to prove that the contract itself is invalid, and courts will allow evidence to show fraud or illegality. In 1935, contrary to the law in most other states, the California Supreme Court, in a case entitled Bank of American Nat’l Trust & Savings Assoc. v. Pendergrass, managed to create an exception to the fraud exception. Pendergrass held that facts that would otherwise prove fraud are inadmissible if the evidence directly contradicts the express terms of the written, integrated contract. For example, in Pendergrass, the court would not allow into evidence statements by the lender to the farmer/borrower that the lender would not enforce the “payment on demand” note during the remainder of the year to permit the borrower’s farming operations to continue and allow the debt to be paid. The express terms of the note were directly contrary to the asserted statements by the lender, and the statements were therefore not admissible. Exceptions to exceptions are difficult to interpret and to enforce, and the Pendergrass rule was therefore no exception.

However, in a recent case entitled Riverisland Cold Storage, Inc. v. Fresno-Madera Production Credit Association, the California Supreme Court finally overruled Pendergrass. In Riverisland, the plaintiff/borrowers, who admited they did not read their loan restructure agreement before signing it, contended that the lender promised a 2-year extension and required only 2 parcels of additional collateral. In fact, the loan restructure agreement provided for only a 3-month extension and included 8 additional parcels of collateral. The borrowers sued, and the trial court refused to admit the lender’s statements based on the Pendergrass rule. In overruling Pendergrass, the Supreme Court admitted that there must be some “justifiable reliance” on the extraneous statements; however, whether or not that occurred will be a question of fact for the court. (Question: Should the failure to even read the contract as in Riverisland void any justifiable reliance argument?)

In case we were to assume that Riverisland only applies to a sophisticated lender taking advantage of an unsophisticated borrower, in a follow-up case this year entitled Julius Castle Restaurant, Inc. v. Payne, involving the sale of an historic Restaurant and alleged misstatements regarding the good working order of the equipment, a California Appellate Court stated that the relative sophistication of the parties has no bearing on whether or not evidence of fraud can be introduced.

How does all this apply to you? Without the Pendergrass rule, it will of course be easier for a party to introduce evidence of that it was fraudulently induced into entering the contract. Documentation of course will be critical, both as to the discussions between the parties before the contract is signed and the integration of the contract itself.