United States: California Supreme Court Allows Parol Evidence To Prove Fraud

A recent California Supreme Court case, Riverisland Cold Storage v. Fresno-Madera Production Credit Ass'n, is causing some anxiety among financial institutions and other businesses in California. 151 Cal. Rptr. 3d 93 (2013). Riverisland overturns prior California case law that prevented the use of parol evidence (such as oral or written statements) to contradict the terms of a written contract in fraud suits. In doing so, Riverisland conforms California law to the law in the majority of other states by allowing a plaintiff to rely upon statements that directly contradict the written terms of their agreement to support a case for fraud.

Riverisland is likely to make it more difficult for businesses to dismiss fraud cases at the early stages of litigation by allowing evidence of fraud that previously was prohibited. Although significant for its possible impact on litigation costs and settlement, the decision may have limited effect on ultimate litigation outcomes because fraud remains difficult to plead and prove. Indeed, although the rule adopted by Riverisland is new in California, reported activity in other jurisdictions that have long followed this approach to parol evidence does not indicate significantly different outcomes on fraud claims.

This Commentary will explain the decision and its likely impact, and discuss strategies at contract origination to mitigate the risk of Riverisland, especially for lenders.

Summary of Riverisland

Facts. The plaintiffs in Riverisland, the Workmans, sued their credit union for fraud and negligent misrepresentation related to a renegotiated loan agreement. They claimed a loan officer told them that as long as they pledged two additional pieces of real property as collateral, the new agreement would extend their loan for two years. This was inconsistent with the written terms of their renegotiated agreement, which provided for three months of forbearance and provided for a lien in eight parcels of real property. The Workmans signed the agreement, which was integrated (i.e., the contract contained an integration clause that recited that the written contract "integrated" and superseded all prior discussions, negotiations, and agreements), and the Workmans also initialed multiple pages of the contract. They later argued, however, that they never read the agreement.

Holding. The Court in Riverisland held that the Workmans could admit evidence of the oral representations made by their lender's loan officer as part of their fraud claim. This ruling overturned longstanding precedent in California that prevented admitting parol evidence (extrinsic evidence that contradicts or adds to the written terms of an integrated contract) directly contradicting the terms of a written agreement, even to prove fraud.

Rationale. Riverisland brings California law in line with the majority rule. The Court cited difficulty of administration of the prior distinction and lack of support in the parol evidence statute as reasons for its holding. It also noted that the prior rule's limitation on introducing evidence of fraud could further fraudulent practices because it effectively excluded evidence of fraud.

What Riverisland Means

Some commentators in California have expressed concern about the Riverisland decision. The new rule is likely to make it more difficult to dismiss fraud claims at early stages of litigation. However, the effect of the decision on case outcomes may be relatively limited for these reasons:

• Fraud remains difficult to prove. It requires proof of (i) a misrepresentation, (ii) knowledge of falsity, (iii) intent to defraud, (iv) justifiable reliance on the misrepresentation, and (v) resulting damage. Each element needs to be pled with specificity and proven by competent evidence, which remains difficult even with parol evidence. Riverisland addresses only the first element.
• The Court declined to address the issue of reasonable reliance. Existing law holds that contracting parties are responsible for acquainting themselves with a contract. Thus, courts may still decide to dismiss fraud claims at the early stages of litigation if they find there is no triable issue of fact on the reasonable reliance prong of fraud.
• The majority of states already follow the Riverisland rule, and courts generally have applied it reasonably. For example, some courts hold that if a party (including borrowers) has been performing under the contract, he/she was on constructive notice of any alleged misrepresentation and has waived any fraud claims by failing to raise them earlier.

Lessons Learned from Riverisland

The importance of clear and consistent communications in negotiation and drafting is the primary takeaway from Riverisland. Particular attention to unsophisticated borrowers or contracting parties is warranted, as they are less likely to be represented by counsel or to negotiate any significant changes to standard contracts, which increases the risk that the contracts will be considered contracts of adhesion.

Practically, banks and other businesses may want to consider the following ideas at origination:

• A robust (and perhaps separately initialed) integration clause that specifically recites that (i) the parties have read the contract and understand that the contract terms may differ from prior negotiations or discussions, (ii) the parties intentionally and expressly intend for the written contract to supersede and take precedence over prior documents, negotiations, and discussion, and (iii) all parties have been represented by counsel, if applicable. Such a clause could go a long way toward challenging the "reasonable reliance" of a borrower on a promise made outside of and prior to execution of the contract.
• Provide drafts of documents in advance, with time for review, as opposed to presenting complicated loan documents or other contracts for the first time at signing. The longer a party has with documents, the less reasonable it becomes to have not read them.

When faced with fraud claims based on representations inconsistent with a contract's terms, after Riverisland, it likely is increasingly important to challenge the specificity of fraud allegations at the pleading stage and to aggressively pursue early discovery regarding each element of fraud, with specific attention to reliance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.