California Supreme Court Overrules Bank of America v. Pendergrass: Allowing Broad Use of Parol Evidence to Show Contracts are Tainted by Fraud

January 16, 2013

In a decision with important ramifications for financial institutions and other businesses, the California Supreme Court held in Riverisland Cold Storage v. Fresno-Madera Production Credit Ass’n that parol evidence, such as an alleged oral promise directly at variance with the terms of a written contract, may be admissible to show that a written contract was procured by fraud. With this January 14, 2013 decision, the Court has expressly rejected the 75-year-old Pendergrass rule, which precluded the admissibility of an oral promise directly at variance with the promise of the writing. (Bank of America etc. Ass’n. v. Pendergrass (1935) 4 Cal.2d 258, 263.) Considering Pendergrass to have been poorly reasoned, the Court overruled it, finding that: (1) it contradicts the terms of Code of Civil Procedure section 1856, subdivisions (f) and (g), which broadly allows parol evidence of fraud to show the invalidity of a contract; (2) it contradicts earlier California Supreme Court rulings, which held parol evidence to always be admissible to prove fraud; and (3) it constitutes bad policy, as Pendergrass allows the use of the parol evidence rule to conceal acts of fraud.

Pendergrass Background

In Pendergrass, the Court considered whether oral testimony would be admissible for the purpose of establishing fraud as a defense to the bank’s action to enforce a note. The borrowers had fallen behind on their payments and executed a new promissory note with their bank, secured by additional collateral and payable on demand. The bank quickly seized the encumbered ranch property and sued to enforce the note. As a defense, the borrowers alleged that the bank had fraudulently induced them into signing the new note by purportedly promising not to interfere with their ranching operations for the rest of the year and to accept the proceeds of those operations as payment. This alleged oral promise directly contradicted the “payable on demand” term of the written agreement. The Court held that parol evidence of this oral promise could not be admitted as evidence because allowing such easily falsified oral testimony would risk having the party seeking to enforce the written agreement found guilty of fraud every time. (Pendergrass, supra, 4 Cal.2d at pp. 263-64.) The Pendergrass rule thus limited the fraud exception to allow only parol evidence of “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.” (Id. at p. 263.)
Riverisland Facts and Procedural History

The facts in Riverisland are similar in certain respects to those in Pendergrass. In Riverisland, plaintiffs, a married couple, fell behind on their loan payments to the defendant Fresno-Madera Production Credit Association and restructured their debt of $776,380.24 in a 2007 agreement. The 2007 agreement provided three months of forbearance and identified eight parcels of real property as additional collateral. Plaintiffs allegedly did not read the agreement, but signed and initialed it at the locations tabbed.  

The plaintiffs did not make their required payments under the agreement, and defendant recorded a notice of default on March 21, 2008. Though the plaintiffs eventually repaid their loan and avoided foreclosure, they filed suit for fraud and negligent misrepresentation, alleging that the defendant’s vice president met with them two weeks before the agreement was signed and orally promised to extend the loan for two years in exchange for additional collateral of two ranches — a promise that directly contradicts the terms of the written agreement.

Relying on Pendergrass, the trial court granted summary judgment to the credit association, ruling that the fraud exception does not allow parol evidence of promises at odds with the terms of the written agreement. The Court of Appeal reversed, holding that Pendergrass only applied to cases of promissory fraud and that false statements about the contents of an agreement are factual misrepresentations beyond the scope of the Pendergrass rule.

The Court’s Analysis of the Pendergrass Rule

In overruling Pendergrass, the Court discussed how, for 75 years, appellate courts generally followed Pendergrass, but with resistance. Courts have stated that the distinction between promises that are “consistent” or “inconsistent” with a writing is “tenuous.” Attempting to “detour” around Pendergrass, some courts have distinguished false promises at variance with the terms of a contract from factual misrepresentations about the contents of a writing — the approach taken by the Court of Appeal in Riverisland. Such fine distinctions have resulted in uncertainty in the case law.

The Court further noted that, in 1977, the California Law Revision Commission ignored the Pendergrass rule when it advised the Legislature on case law to guide its revision of the parol evidence rule as codified in Code of Civil Procedure section 1856. Section 1856, subdivision (f) states, “Where the validity of the agreement is the fact in dispute, this section does not exclude evidence relevant to that issue.” Subdivision (g) states, “This section does not exclude other evidence…to establish…fraud.” Thus, the Pendergrass rule is not reflected in the statutory language. The Court also found Pendergrass to be at odds with the majority rule on the fraud exception as reflected in the Restatements.

After noting the historic difficulties posed by the application of the Pendergrass rule and its outlier status, the Court evaluated the reasoning of the Pendergrass decision. The Court found that though the law allowing the unconditional use of parol evidence in proving fraud was well-settled at the time Pendergrass was decided, the Pendergrass court failed to address this contrary authority. Furthermore, the cases relied upon in Pendergrass did not involve allegations of fraud nor did they discuss the fraud exception to the parol evidence rule. The Court therefore concluded that the Pendergrass opinion “did not justify the abridgement it imposed” on the fraud exception, which “has been part of the parol evidence rule since the earliest days of our jurisprudence.” The Court in Riverisland reaffirmed, “‘[I]t was never intended that the parol evidence rule should be used as a shield to prevent the proof of fraud.’”

Implications of Riverisland

Both Riverisland and Pendergrass concerned borrowers who sought to introduce evidence of oral promises at odds with the terms of their written loan agreements in order to prove claims of fraud against financial institutions. By overruling Pendergrass, the Court has greatly expanded the use of the fraud exception to the parol evidence rule. Nevertheless, plaintiffs still face many hurdles to prevail on claims of fraud. Plaintiffs must still satisfy the heightened pleading standard for fraud actions, which requires that facts constituting each element of fraud be alleged with particularity. (Committee on Children’s Television, Inc. v. General Foods Corp. (1983) 35 Cal.3d 197, 216.) Riverisland only gives plaintiffs alleging the existence of an oral promise that contradicts the terms of a written contract more latitude to allege the first element of a cause of action for fraud — that a false representation was made. That element, like all the others, must still be alleged with particularity.

The elimination of the Pendergrass rule, however, may result in fewer successful motions for summary judgment. Ultimately, the existence of the oral promise will become a factual issue that may need to be resolved by a trial on the merits. At such a trial, the plaintiff may be hard-pressed to prove that her reliance on an oral promise at odds with the written agreement was justifiable. Furthermore, a defaulting borrower’s testimony that a bank made her an oral promise at odds with the terms of the loan agreement would face credibility issues. The standard jury instructions advise jurors to consider the questions: “Did the witness have any reason to say something that was not true? Did the witness show any bias or prejudice? Does the witness have a personal stake in how this case is decided?” (California Civil Jury Instructions § 107.). Without additional evidence to corroborate the existence of the oral promise, the testimony of a defaulting borrower alone may be insufficient to sway a jury absent compelling circumstances.

Given that integration clauses in written agreements are not a “silver bullet” to defeat allegations of fraud, financial institutions should consider utilizing recorded phone interviews of borrowers as part of the loan process. The borrower should consent to the recording and confirm that no contradictory oral promises were made in connection with the loan. This audio recording would be effective evidence to counter testimony from a borrower that she was orally promised something at odds with the terms of the written loan agreement.

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This article was originally published by Bingham McCutchen LLP.