Evidence of Fraud That Runs Contrary to the Written Terms of a Contract No Longer Precluded in California

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Evidence of Fraud That Runs Contrary to the Written Terms of a Contract No Longer Precluded in California

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The California Supreme Court has overruled one of its own decisions from more than 75-years ago that adopted a limitation on the fraud exception to the parol evidence rule.   In a decision issued on January 14, 2013 (RiverIsland Cold Storage, Inc. v. Fresno-Madera Production Credit Association, California Supreme Court case number S190581), the Supreme Court concluded that its prior decision in Bank of America etc. Assn. v. Pendergrass (1935) 4 Cal.2d 258 was “ill-considered’ and an “aberration.”

The parol evidence rule protects the integrity of written contracts by making their terms the exclusive evidence of the parties agreement.  In accordance with California Code of Civil Procedure section 1856 and Civil Code section 1625, when parties enter into an integrated written agreement, extrinsic evidence may not be relied upon to alter or add to the terms of the writing.  Code of Civil Procedure section 1856, subdivision (f), establishes a broad exception to the operation of the parol evidence rule: “Where the validity of the agreement is the fact in dispute, this section does not exclude evidence relevant to that issue.”  Subdivision (f) is known as the “fraud exception” to the parol evidence rule.  Subdivision (f) allows a party to present extrinsic evidence to show that the agreement was tainted by fraud.

In 1935, the California Supreme Court in Pendergrass, however, adopted a limitation on the fraud exception to the parol evidence rule.  The Pendergrass Court held that the 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.”  In the case of RiverIsland Cold Storage, Inc., the California Supreme Court decided to revisit the limitation on the fraud exception created by Pendergrass.

In RiverIsland Cold Storage, Inc., the plaintiffs fell behind on their loan payments to the lienholder.  The parties agreed to restructure the debt and the new written agreement that was fully integrated and signed by the parties stated that the lienholder would take no enforcement action for three months if the plaintiffs made specified payments.  The required payments were not made and, therefore, the lienholder recorded a notice of default.  Eventually, the plaintiffs repaid the loan and the foreclosure proceeding was dismissed.  The plaintiffs then filed an action against the lienholder seeking damages for fraud and negligent misrepresentation.  The plaintiffs also sought rescission and reformation, alleging, inter alia, that the lienholder’s vice president orally agreed and represented that the forbearance period would be two years, not three months.  Plaintiffs signed the new agreement and initialed all of the pages but admitted they did not actually read the new forbearance agreement or the provision that provided for a three month forbearance period.  Instead, they relied on the oral representation from the vice president that the forbearance period would be two years, a contention that was disputed by the lienholder.

Relying on Pendergrass, the trial court granted summary judgment in favor of the lienholder, ruling the fraud exception to the parol evidence rule does not allow extrinsic evidence of promises at odds with the terms of the written agreement.  The Fifth District Court of Appeal reversed, reasoning that Pendergrass is limited to cases of promissory fraud and that false statements about the contents of the agreement itself are factual misrepresentations beyond the scope of the Pendergrass rule.  The California Supreme Court granted the lienholder’s petition for review to revisit the scope of the fraud exception to the parol evidence rule.

After noting that Pendergrass has survived for over 75 years and has been followed by Courts of Appeal to varying degrees, the Supreme Court decided it was time to overrule Pendergrass, concluding Pendergrass “was an aberration” and wrongly decided at the outset.  The Court held that,  “[Pendergrass] purported to follow section 1856 . . . , but its restriction on the fraud exception was inconsistent with the terms of the statute, and with settled case law as well.  Pendergrass failed to account for the fundamental principle that fraud undermines the essential validity of the parties’ agreement.  When fraud is proven, it cannot be maintained that the parties freely entered into an agreement reflecting a meeting of the minds.  Moreover, Pendergrass has led to instability in the law, as courts have strained to avoid abuses of the parol evidence rule.  The Pendergrass court sought to “ ‘prevent frauds and perjuries’ “ . . . , but ignored California law protecting against promissory 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 abridgement it imposed.  For these reasons, we overrule Pendergrass and its progeny, and reaffirm the venerable maxim stated in Fergusen v. Koch, supra, 204 Cal. at page 347:  ‘[I]t was never intended that the parol evidence rule should be used as a shield to prevent the proof of fraud.’ ”  In rendering its decision, the California Supreme Court declined to address the impact of the plaintiffs’ failure to read the contract on the required element of justifiable reliance, stating that because the element was not addressed by the trial court or the Court of Appeal, it declined to decide the question in the first instance.

The impact of the Supreme Court’s decision in the RiverIsland case is that there is no longer a distinction between “promissory fraud” and “misrepresentations of fact.”  Where the validity of the agreement is at issue, evidence of fraud is admissible.

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