Riverisland Ruling Gives Calif. Fraud Victims Fairer Shake

Law360, New York (January 23, 2013, 3:08 PM ET) ‐‐
In a decision that will have a dramatic effect on
contract and lender liability litigation, the California
Supreme Court decided in Riverisland Cold Storage
Inc. v. Fresno‐Madera Production Credit Association,
Case No. S190581, that the parol evidence rule does not bar the introduction of evidence of fraud, even
if the misrepresentations directly contradict the terms of a written contract. In so ruling, the Court
directly overturned its decision in Bank of America etc. Assn. v. Pendergrass, which has been the law in
California, albeit reluctantly, for over 75 years.[1]

Importantly, the court left open the question of whether the borrower could establish justifiable
reliance of the misrepresentations at issue, given the fact that the borrowers admitted to not reading
the document. This will certainly be an issue on which future litigation will focus.

By way of background, Civil Code Section 1625 establishes that a contract in writing “supersedes all the
negotiations or stipulations concerning its matter which preceded or accompanied the execution of the
instrument.”[2] Similarly, the parol evidence rule in California is codified at Code of Civil Procedure
Section 1856. It states that “[t]erms set forth in a writing intended by the parties as a final expression of
their agreement with respect to such terms as are included therein may not be contradicted by evidence
of any prior agreement or of a contemporaneous oral agreement.”[3] While extrinsic evidence may
explain or supplement the terms of the writing, it may not alter or contradict the agreement’s terms.
However, Section 1856 subsection (f) provides an explicit exception to this rule, allowing extrinsic
evidence “where the validity of the agreement is in fact in dispute.” Similarly, subsection (g) provides
that “this section does not exclude other evidence of the circumstances under which the agreement was
made or to which it relates … or to explain an extrinsic ambiguity or otherwise interpret the terms of the
agreement, or to establish illegality or fraud.” Thus, for example, if the borrower contends that he was
fraudulently induced to enter into the contract or the contract is illegal, and the contract is therefore
voidable, evidence of the fraud is permissible. Pendergrass went one step further. In Pendergrass, the
court held that such extrinsic evidence of fraud was still impermissible if it directly contradicted a terms
of the agreement.

In Riverisland, borrowers Lance and Pamela Workman, together with affiliated companies that served as
borrowers and guarantors of the loan, went into default on a loan owed to lender Fresno‐Madera
Production Credit Association. They reached an agreement with the Association on March 26, 2007, to
restructure their debt and a written agreement was entered into, supposedly to memorialize that
Christopher Reeder Mark Madnick Andrew Howard agreement.

It was the Workmans’ understanding that the Association was extending their loan for two
additional years and receiving an additional two parcels of property as collateral.
The Workmans also contended that, at the time they signed the agreement, which they admittedly did
not read, the Association’s loan officer confirmed that the loan was being extended for two years and
only being secured by two additional pieces of property. Notwithstanding these representations, the
agreement only extended the loan for three months and the Workmans pledged eight additional pieces
of property as collateral. After the Workmans failed to pay off the loan, the Association attempted to
initiate foreclosure proceedings by recording a notice of default. The Workmans then paid off the loan
by selling properties in a soft market and initiated litigation against the Association, alleging fraud,
negligent misrepresentation, rescission and reformation of the contract.

As expected, the Association moved for summary judgment in the litigation contending that the
Workmans’ claims were barred by the parol evidence rule, as articulated in Pendergrass. Specifically, the
Association argued that the Workmans were prohibited from introducing any evidence of
representations that contradicted the terms of the written agreement. The trial court agreed and
granted summary judgment. However, on appeal, the Court of Appeal reversed, holding that
Pendergrass was limited to instances of promissory fraud — where a promise is made with no intention
of actual performance.[4]

The Supreme Court granted the petition for review, specifically to reconsider the Pendergrass decision.
The court determined that the Pendergrass decision was founded on poor analysis, led to inconsistent
and unpredictable results, and was contrary to legal principles applied in California and elsewhere. The
court detailed the extensive criticism of the decision and the fact that it was not even followed in
drafting treatises or recent revisions to the Civil Code on the subject of parol evidence. Numerous
exceptions to Pendergrass were developed in order to circumvent its holding. For instance, parol
evidence is permissible to admit a “misrepresentation of fact over the content of the physical document
at the time of signing” as opposed to a false promise.[5] Indeed, Pendergrass was not even in line with
decisions at the time it was decided, and in several instances, cases immediately following the decision
declined to apply its holding.

The court thus concluded that “Pendergrass was an aberration” and parol evidence is permitted to
demonstrate fraud, even if the representations are contrary to the terms of the writing. “[I]ts restriction
on the fraud exception was inconsistent with the terms of the statute, and with settled case law as
well.” In so holding, the court explained that, “Pendergrass failed to account for the fundamental
principal that fraud undermines the essential validity of the parties’ agreement.”

The court also recognized important policy considerations. While the Pendergrass decision was intended
to protect against fraud, its preclusion of parol evidence contrary to the terms of the agreement
unintentionally serves to shield one’s fraudulent conduct. “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
court stated, “[I]t was never intended that the parol evidence rule should be used as a shield to prevent
the proof of fraud.”[6]

For the Workmans, they will live to fight another day. The court remanded the case to the trial court
where they will now have to demonstrate justifiable reliance on the defendant’s misrepresentation.
Under California law, “[o]ne party's misrepresentations as to the nature or character of the writing do
not negate the other party's apparent manifestation of assent, if the second party had ‘reasonable
opportunity to know of the character or essential terms of the proposed contract. If a party, with such
reasonable opportunity, fails to learn the nature of the document he or she signs, such “negligence”
precludes a finding the contract is void for fraud in the execution.”[7]

However, a much more lenient rule is applied when equitable relief is sought for fraud in the
inducement. “Where failure to read an instrument is induced by fraud of the other party, the fraud is a
defense …”[8] On the other hand, justifiable reliance is a highly factual issue that will often have to be
resolved by the trier of fact at a trial on the merits. “Whether reliance is justified is a question of fact for
the determination of the trial court; the issue is whether the person who claims reliance was justified in
believing the representation in the light of his own knowledge and experience.”[9]
For those who find themselves the victims of misrepresentations at the time they entered into a
contract, where the maker of such misrepresentations expected to be protected by the shield of the
parol evidence rule, Riverisland drastically changes the landscape.

As anyone who has ever purchased real estate can tell you, the terms of a loan are usually set forth
somewhere in the midst of stacks and stacks of paperwork, which often goes unread. Borrowers who
were truly told that their loan contained one set of terms, only to later find out that the written
agreement varied from the lender’s promises, have a new opportunity to seek redress in the courts. The
Riverisland court expressly recognized that lenders can and should be held accountable for their
representations to borrowers about the terms of their loan. No longer can they be shielded from facing
liability for their fraudulent conduct by relying on the “aberrant” opinion in Pendergrass.

With regard to lenders, and those drafting the contracts, it is important to properly document
representations leading up to the final document and ensure that the loan terms are accurately
represented to borrowers. Great care must be taken to avoid representations in negotiations that can
be misconstrued by the borrowers. In addition, lenders will want to review their reservation of rights
clauses in all of their documents to ensure they clearly indicate that the borrower cannot rely on terms
discussed before the final loan documentation. In light of this recent opinion, lenders may want to
immediately institute training programs to avoid this significant pitfall that could absolutely prevent the
enforcement of their loans.

On the other hand, counsel representing borrowers in this situation should be careful to screen their
cases with this opinion in mind. While the ability to admit certain additional evidence surrounding the
misrepresentations may be useful in precluding a demurrer, summary judgment or motion to dismiss,
counsel must still be able to demonstrate at trial that the alleged misrepresentation was made and their
client justifiably relied on the lender’s misrepresentations. If the court’s decision opens the floodgates
and brings a wave of non‐meritorious claims, further judicial or legislative action could be undertaken to
limit borrowers’ and other contracting parties’ ability to seek redress for these misrepresentations, thus
depriving true victims of fraud of their just remedies.

Those in the business of purchasing distressed debt should also take note. While the laws governing a
holder in due course will provide some insulation from misrepresentations by their predecessors, they
may arguably be on notice of the misrepresentations through the loan file.[10] Moreover, in many
instances, the same loan officers who made the misrepresentations may continue to be employed by
the entity acquiring the debt.

The California Supreme Court’s decision holds liable one who actively engages in fraudulent conduct. At
the same time, any such claim must be supported by the actual proof required in fraud cases, including
justifiable reliance. The import of this ruling is that the California Supreme Court has decided that
victims of fraud should have a remedy and more cases should be decided on their merits, instead of
disposed of by rigid legal rules that may or may not reflect commercial realities.
‐‐By Christopher S. Reeder, H. Mark Madnick and Andrew. L. Howard, Robins Kaplan Miller & Ciresi LLP
Christopher Reeder is a partner in the Los Angeles office of Robins Kaplan Miller & Ciresi. He is a lead trial
lawyer in complex commercial litigation cases including real estate, partnership and private equity
disputes, as well as lender liability matters.

Mark Madnick and Andrew Howard are associates in the Los Angeles office of Robins Kaplan Miller &
Ciresi and practice in business and real estate litigation.

The opinions expressed are those of the authors and do not necessarily reflect the views of the firm, its
clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general
information purposes and is not intended to be and should not be taken as legal advice.

[1] 4 Cal. 2d 258, 263 (Cal. 1935).
[2] Cal. Civil Code § 1625.
[3] Cal. Code Civ. Proc. § 1856.
[4] Cal. Civil Code § 1572(4).
[5] Pacific State Bank v. Greene, 110 Cal. App. 4th 375, 379 (2003).
[6] Citing Ferguson v. Koch, 204 Cal. 342, 347 (1928).
[7] Rosenthal v. Great Western Fin. Securities Corp., 14 Cal. 4th 394, 423 (1996) (internal citations omitted).
[8] Fleury v. Ramacciotti 8 Cal. 2d 660, 662 (Cal. 1937)
[9] Gray v. Don Miller & Associates, Inc., 35 Cal. 3d 498, 503 (1984).
[10] Roy Supply, Inc. v. Wells Fargo Bank, 39 Cal. App. 4th 1051, 1061 (1995) (“The holder in due course
does not take the instrument free of defenses of persons with whom the holder has dealt or of what
might be termed "real defenses," such as incapacity and certain types of misrepresentation.”)

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