The California Supreme Court has overruled a longstanding limitation on extrinsic evidence that essentially precluded a borrower from alleging that the documents he or she signed were misrepresented by the lender.  The parol evidence rule provides that when parties enter an integrated written agreement, extrinsic evidence may not be relied upon to alter or add to the terms of the writing in the absence of fraud, mistake, undue influence, or illegality or other extraordinary factors.  (Code Civ. Proc. § 1856, Civ. Code § 1625). In Bank of America etc. Assn. v. Pendergrass, 4 Cal.2d 258, 263 (1935), the Court held that in order for the fraud exception to overcome the parol evidence rule, the evidence offered must have tended to establish fraud in the procurement of the instrument, or some breach of confidence concerning its use, instead of a promise directly at variance with the promise of the writing.  In Riverisland Cold Storage, Inc. v. Fresno-Madera Production Credit Assn., 2013 WL 141731 (2013), the Court overturned this venerable precedent.  By overturning Pendergrass, the Court now seems to have opened the door to a type of fraud claim that previously could gain little traction in litigation – “they told me what it said so I didn’t read it and it didn’t say what they told me it said”.

The Riverisland Decision

In the Riverisland case, the borrowers of an agricultural credit facility had defaulted on their loan payments in 2006.  Subsequently, in March 2007, they executed a written forbearance and modification agreement that confirmed delinquent payments totaling $776,380.  This agreement provided that the lender (Fresno-Madera Production Credit Association) would forbear from pursuing its remedies until July 31, 2007, as long as the borrowers made the required payments.  The borrowers also apparently executed a security instrument pledging eight parcels of land as additional collateral, and initialed each page of the legal descriptions on the modification and forbearance agreement.

Despite the terms of the written modification and forbearance agreement, the borrowers made no payments after signing it.  After waiting until July 31, 2007, and then waiting yet another nine months, the lender eventually filed a notice of default on March 21, 2008 and initiated foreclosure proceedings.  At that point, the borrowers paid off the loan in full and the foreclosure proceedings were dismissed.

The borrowers next filed suit against the lender for fraud and negligent misrepresentation.  In the lawsuit they claimed that two weeks before they signed the March 2007 modification and forbearance agreement, they had met with a vice president of the lender who allegedly had represented to them orally that the lender would extend the loan for two years in exchange for additional collateral consisting of only two of their ranches, not the eight ranches they eventually pledged.  They further alleged that in reliance on this oral representation, when the draft modification and restructure agreement was presented to them, they signed it without reading it because the vice president again told them it was a two-year extension and involved only two ranches as additional collateral.  Therefore, they claimed, they were misled into executing but not reading what they thought was an agreement for a two-year forbearance, when in fact it was only a short-term forbearance.  They also evidently claimed that they were misled into signing an agreement to provide a total of six additional ranches in addition to the two ranches they intended to pledge as additional security without reading that agreement either.

The lender moved for summary judgment, asserting that the fraud exception could not be relied upon because the borrowers’ claims contradicted the express terms of the written agreement that they had signed.  Relying on Pendergrass, the trial court granted the lender’s summary judgment motion. The court of appeal reversed, reasoning that Pendergrass was limited to cases of promissory fraud.  Choosing to accept the borrowers’ allegation that the lender’s loan officer had misrepresented the contents of the agreement, the court of appeal considered them to be factual representations beyond the scope of the Pendergrass exclusion. 

The California Supreme Court affirmed the court of appeal decision, but not on the basis that the lender’s oral representations about the contents of the agreement were outside Pendergrass.  The Court instead noted that the facts of Pendergrass were virtually identical to the facts in the current case.  Pendergrass involved an allegation that an agricultural borrower signed a new promissory note secured by additional collateral that contained a “due on demand” clause based on false representations by an agent for the creditor that it would not demand payment or foreclose until after the end of the current crop year.  Instead, the creditor exercised the demand clause and foreclosed immediately on the newly encumbered property.  The Pendergrass court had ruled that a party who claims it relied on fraudulent promises that are themselves at variance with the executed written agreement is essentially barred from alleging fraud under the parol evidence rule.  Rather than follow its 80-year old Pendergrass precedent, the Court overruled it, based on its conclusion that in 1937 it had misread the statute codifying the parol evidence rule and the exception for the evidence of fraud.  (Code Civ. Proc. § 1856.)  The Court summarized its reasons for overturning Pendergrass by noting that it was an “aberration”; not only was there no statutory support for it, but it diverged from the position of the Restatement of Contracts and the Restatement of Torts as well as the courts in a majority of other states, and most commentators. 

Now, the Court apparently has concluded that a representation of the anticipated contents of an agreement that would be prepared in the future, or a misrepresentation of the nature of the agreement the lender would agree to, is itself a form of fraud in the inducement that survives the execution of an integrated agreement.  According to the Court, the unqualified language of § 1856 broadly permits evidence “relevant to the validity of an agreement” and specifically allows evidence of “fraud”:

The fraud exception has been part of the parol evidence rule since the earliest days of our jurisprudence, and the Pendergrass opinion did not justify the abridgment it imposed. “[I]t was never intended that the parol evidence rule should be used as a shield to prevent the proof of fraud.”

Justifiable Reliance is Still an Issue

The creditor in Riverisland argued that, as a matter of law, there could be no justifiable reliance on the alleged oral representations, since the borrowers admittedly failed to read the documents they had signed.  While refusing to enunciate such a rule, the Court did emphasize that proof of promissory fraud entails more than proof of an unkept promise or mere failure of performance, or even a misstatement of intent to enter into an agreement.  Rather, it requires an intent to mislead as to the contents of the actual agreement intended by the parties, coupled with a showing of justifiable reliance.  However, noting that the lower courts had not directly addressed the issue of reliance (since they deemed the lender’s alleged oral representations inadmissible), the Court merely affirmed the court of appeal’s reversal of summary judgment in favor of the lender, and sent it back for further consideration.

In Riverisland, the borrowers’ entire claim seemed to stand or fall on the basis of the borrowers’ alleged failure even to read the documents for a workout of a substantial credit transaction even though they had to know they were substantially in arrears of making the required payments and facing potential loss of substantial properties if they failed to perform.  The $776,380 delinquency amount reflects a multi-million dollar loan transaction, and the borrowers, owners of at least two or as many as eight “ranches” in addition to the initial collateral for the loan, clearly are well-heeled if not highly sophisticated borrowers who in fact had the means to protect themselves by paying off the loan to avoid foreclosure.  While allowing these parties to allege they were misled, the Court’s opinion is devoid of detail regarding the transaction or the circumstances in which the alleged “oral representations” were made, or of the exact nature and content of the alleged statements by the lender’s officers.  The Court’s opinion is almost entirely focused on a legalistic analysis of the Pendergrass rule, not its application to the facts of the case as adduced in the summary judgment motion at issue.  The Court also did not address the nature of the damages claimed by the borrowers, which were not yet at issue at this point in the proceedings.

Although the Court chose not to adopt a rule that an admitted failure to read the documents precludes justifiable reliance on the alleged oral misrepresentations, the Court did provide a limited amount of guidance in this regard:

  1. The Court acknowledged that negligent failure to acquaint oneself with the contents of a written agreement precludes a finding that a contract is void for fraud in the execution, as long as the second party “had reasonable opportunity to know of the character or essential terms of the proposed contract.”  (Rosenthal v. Great Western Financial Securities Corp., 14 Cal.4th 394, 419 (1996).  However, the Court went on to say that Rosenthal expressed no view on the “validity” and “exact parameters” of a more lenient rule that has been applied when equitable relief is sought for fraud in the inducement of a contract and “we need not explore the degree to which failure to read the contract affects the viability of a claim of fraud in the inducement.”  However, the Court did stress that the intent element of promissory fraud (although apparently not the reliance element) requires “more than proof of a unkept promise or failure of performance.” 
  2. The Court also went out of its way in a footnote to criticize efforts to draw “a line between false promises at variance with the terms of the contract and misrepresentations of fact about the contents of the documents”, claiming that this merely adds another layer of complexity and depends on an artificial distinction.  In doing so, the Court implicitly criticized the decision in Pacific State Bank v. Greene, 110 Cal.App.4th 375, 382-383 (3rd Dist. 2003), which would conclude that evidence of a false promise is inadmissible unless made at the time the contract was executed.  In doing so, the Court is apparently confirming that since the Pendergrass rule has been overturned, oral “promises” made well before the agreement is prepared or presented for signature may now be used as a basis for a claim of promissory fraud whether or not they are repeated at the signing table. 
  3. Unfortunately, the Court did not explicitly set forth its underlying of the relationship between preliminary negotiations or prior offers not accepted, and false representations of contractual intent, which may have been the primary focus of the Pendergrass court.  See, 4 Cal.2d at 264 (disallowing testimony as to inconsistent promises made at or before the contract is signed under circumstances where the party complaining “has it in his power to guard an advance against any and all consequences of a change in conduct by the person with whom he is dealing”).  The subtle difference between “fraud” and “negotiations” or “preliminary discussions” leading to a written agreement is not a part of the Court’s analysis. 

Precautionary Issues for Lenders

Previously, it would be anticipated that a claim that contradicted the terms of the integrated written agreement based solely on oral representations of contractual intent or claims of fraud as to the contents of documents that were signed would fail to get past summary judgment, but now there is a potential that any such claims will survive until trial, which will affect the settlement dynamics as well as the prospects for avoiding a jury trial in the event the borrowers are willing to testify to oral conversations without regard to whether they happened or when they were part of an ongoing negotiation that culminated in a different written agreement. 

As a result, at a minimum, it will be extremely important for lenders to carefully document all communications, oral or written, with borrowers and their representatives, in order to be in a position to defend subsequent claims about oral representations and the context in which they are made.  Riverisland does not address whether the lender disputed the borrower’s characterization of the claimed misrepresentations, and merely reverses summary judgment based on the lower court’s evident conclusion that the content of the alleged misrepresentations was irrelevant as a matter of law.  Therefore, it is difficult to know how much evidence is necessary to support such a claim. 

A number of other mechanisms can be considered in order to protect against false claims of oral misrepresentations or reliance, although none of them is without risk.

  1. Having the borrower execute every page of the documents, although in this case having the borrower initial the legal descriptions apparently clearly did not satisfy the requirements of the California Supreme Court as a method of protection;
  2. Having the borrower execute under the penalty of perjury a statement that they have read the documents and that they conform to the agreement (and having it verified under penalty of perjury with a notary public), although such a declaration may well be avoided on the theory that the contents were misrepresented to the signatory;
  3. Use all capital letters, italics or bolding to highlight key terms and clauses, although this simply creates the potential for a claim that those terms, alone, are the material terms and other terms of the document may be disregarded;
  4. Include a summary of the terms of the document in simple language at the beginning, although that again creates the potential for singling out “material” versus “nonmaterial” terms and may not achieve the desired purpose, and in fact may lead to further claims that the full contents of the document were fraudulently misrepresented by the lender who prepared the summary.

None of these approaches are foolproof, and the reversal of the Pendergrass rule may portend an increase in a form of lender liability litigation that usually has failed where the parties actually executed documentation reflecting a meeting of the minds in an integrated writing.