Cal App Allows Fraud Exception to Parol Evidence Rule in Loan Mod/Forbearance Case

The California Court of Appeals, Fifth Appellate District, recently held that the fraud exception to the parol evidence rule applies to fraudulent inducement claims, in connection with a loan forbearance and modification effort.


A copy of the opinion is available at http://www.courtinfo.ca.gov/opinions/documents/F058434.PDF

A number of commercial borrowers filed a complaint which alleged causes of action involving fraud, negligent misrepresentation, rescission, and reformation concerning a written forbearance agreement with Defendant Fresno-Madera Production Credit Association.

The borrowers alleged they were induced to enter into the forbearance agreement by “defendant’s oral misrepresentations of the terms contained in the written agreement.” These alleged misrepresentations included promises made prior to and at the execution of the written agreement, wherein the borrowers alleged that the lender stated the forbearance would be for two years, and the collateral property would consist of two orchards, not the borrowers’ residence or truck yard. The executed agreement provided only that the lender would forbear from collection until July 1, 2007, and included the borrowers’ residence and truck yard as collateral property. Following a failure to make the payments due under the agreement, the lender recorded a notice of default; however, the borrowers then repaid the loan.

The lender’s motion for summary judgment was granted by the lower court based on the borrowers’ failure to perform pursuant to the written forbearance agreement, and the parol evidence rule’s barring “any prior or contemporaneous oral agreement” which changes or adds to “the terms of an integrated written agreement.”

The Appellate Court stated that the only issue on appeal was “whether evidence of defendant’s oral statements, proffered by plaintiffs in opposition to the motion, was properly excluded by the trial court.”

The Court reviewed the policy basis of the parol evidence rule, noting that the rule stems from the concept of contract “integration” whereby “the parties to an agreement incorporate the complete and final terms of the agreement in a writing.” Extrinsic evidence is thus excluded “because it cannot serve to prove what the agreement was” as the writing itself determines this “as a matter of law.” However, the Court noted that there are exceptions to this rule, such as “to establish illegality or fraud.” (Emphasis added by the Court). However, the Court noted that this exception has been limited by the California Supreme Court decision in Bank of America etc. Assn v. Pendergrass (1935) 4 Cal.2d 258, which limits the fraud exception “making it inapplicable when the evidence is offered to show a promise contradicting the written agreement.”

In their appeal, the borrowers pointed to more recent California decisions, including Pacific State Bank v. Greene (2003) 110 Cal, App. 4th 373, which drew a distinction between parol evidence of a “prior promise made without any intention of performing it” which contradicts the terms of a written contract, and “parol evidence of a contemporaneous factual misrepresentation of the terms contained in a written agreement submitted for signing.” The Appellate Court held that in the latter case, extrinsic evidence would not be admitted to “alter, vary, or add to the provisions of an integrated agreement” but would be allowed to prove that the written contract was not in fact the integrated agreement intended by the parties.

Based on the above analysis, the Appellate Court held that the Pendergrass standard “did not intend its limitation on the fraud exception to the parol evidence rule to extend beyond evidence of promissory fraud.”

In the instant case, the Court found that the borrowers' “extrinsic evidence of the alleged misrepresentations made by defendant’s representative should have been admitted in opposition to defendant’s motion for summary judgment.” Accordingly, the Appellate Court reversed the judgment of the trial court, with directions to vacate the order granting summary judgment, and to enter a new order to denying summary judgment except as to select causes of action.