If recent trends of the California Supreme Court are anything to go by, commercial real estate agents may have to be more careful about what they say when entering into lease agreements. In January 2013, the California Supreme Court in Riverisland Cold Storage Inc. v. Fresno-Madera Production Credit Association (2013 WL 141731 (2013)) reversed an 80-year old rule limiting the admission of extrinsic evidence (including oral evidence) to show that a contract was tainted by fraud, essentially opening the floodgates of litigation to a bare claim that would have otherwise found little favour with the court – “I never read the contract before signing it; they told me it said something else and so I did.”

The parol evidence rule, as codified in Section 1856 of the Code of Civil Procedure, and Section 1625 of the Civil Code, precludes challenges to the validity of an “integrated contract,” or one which the parties expressly intend (by the inclusion of an integration clause) to be the final expression of their agreement, on the basis of prior written or oral agreements and contemporaneous oral agreements; this rule, however, is subject to a number of codified exceptions, one of which is fraud.

The prevailing law in California prior to Riverisland was laid down in 1935 in Bank of America v. Pendergrass (4 Cal.2d 258, 263 (1935)), where the Court rejected the claim advanced by borrowers who had restructured their debt after defaulting on payments, that the lending bank had made oral representations contrary to the terms of the written agreement, to the effect that the renegotiated agreement would extend the period of the loan, in order to fraudulently induce them to put up additional collateral. In doing so, the Court refined the fraud exception, expressly excluding facts evidencing “a promise directly at variance with the promise of the writing,” and upholding its application solely in instances where the evidence sought to be admitted was an independent fact or representation evidencing either a fraud in the procurement of the instrument or a breach of confidence with respect to its use.

Since then, California creditors and mortgagees have enjoyed the protection of this peculiar rule that has prevented debtors from relying on oral statements made prior to or at the time of their entering into the contract, placing the onus of due diligence squarely on the shoulders of the contracting parties. In Riverisland, which presented facts virtually identical to those of Pendergrass, the California Supreme Court seized opportunity to correct what was widely considered an 80-year old mistake, terming its decision in Pendergrass an “aberration” that ran contrary to the statutes, restatements, and prior case law, in addition to constituting bad policy.

In its attempt to bring California law in conformity with the laws of the majority of the other states, however, the language of the court’s decision creates no safe harbours that would preclude fraud claims even in cases where both parties have carefully read the clauses of the contract, in contrast to the case in Riverisland, where the parties relying on the oral representations were uneducated. This will undoubtedly have significant ramifications on the climate for contract formation in California, even if the various other elements of fraud (knowledge of falsity, intent to deceive, reasonable reliance, and resulting damage) are difficult to prove. Indeed, leasing agreements have become some of the first victims of newly-expanded fraud exception to the parol evidence rule, with the Court ruling in favour of tenants who alleged fraud despite having read and renegotiated lease agreements in both Julius Castle Restaurant v. Payne (157 Cal. Rptr. 3d 839, Cal. App. 1st Dist. (2013)), and Thrifty Payless, Inc. v. The Americana at Brand, LLC (2013 WL 3786374 (2013)), as recently as July 2013.

While the inclusion of more robust and conspicuous integration clauses that evidence clear intention on that part of the parties to supersede any oral promises, in addition to clauses that express that the agreement has been jointly drafted with recourse to legal representation, may afford some protection, it remains to be seen whether such contracts will survive judicial scrutiny, given that the court has gone so far as to distinguish such cases from precedent that precludes challenges to validity where the party alleging fraud was negligent in acquainting himself with the terms of the written agreement despite having had reasonable opportunity to do so, as applicable only to the execution of the contract rather than its formation (Rosenthal v. Great Western Financial Securities Corp. (14 Cal.4th 394, 419 (1996)).

Indeed, the decision in Riverisland appears to have heralded the return to a position of law which had been historically evolved in the 1800s to protect the interests of mortgagors at a time when mortgage agreements were drafted so as to convey title to the mortgagee immediately, subject to the timely payment of a consideration (Pierce v. Robinson (1859) 13 C 116). However, in light of changing circumstances and norms in contract formation, a legislative clarification of the law in a manner that reflects a balancing of the freedom of contract and its policy interests in protecting small parties, is essential to preserving California’s environment as conducive to contractual relations.