Sometimes business deals or financial transactions end poorly for one or both parties. When these disputes are litigated, it is often under a theory of breach of contract. But not always. One party may go so far as to accuse the other of civil fraud or negligent misrepresentation. The presence of an integration clause in the underlying agreement or contract adds a layer of complexity to these claims. In this article, we discuss how an integration clause could affect such litigation.
Background: The Elements of Civil Fraud and Negligent Representation and Integration Clauses
The elements of a fraud claim, which is premised on a defendant’s false promise or false representation, are:
(1) that the defendant made a promise or represented that a fact was true;
(2) that the defendant did not intend to perform this promise, or the representation was false, when he made it;
(3) that the defendant intended that the plaintiff rely on the promise or the false representation;
(4) that the plaintiff reasonably relied on the promise or the false representation;
(5) that the defendant did not perform the promised act or the representation was false;
(6) that the plaintiff was harmed; and
(7) that the plaintiff’s reliance on the promise or representation was a substantial factor in causing its harm.
See CACI Nos. 1900 and 1902. The elements of negligent misrepresentation are similar, but do not require that the defendant knew the representation was false—negligence about its falsity is sufficient. CACI No. 1903.
Usually, the alleged fraud is a statement or promise made outside the agreement. Defendants may argue that this evidence is inadmissible, or should be given almost no weight, because of an integration clause in the underlying agreement. This is very likely in fraud cases stemming from a contract dispute because integration clauses are common in most agreements. The clauses are sometimes labeled “merger” or “entire agreement” clauses. While the title and precise language of the clause can vary, the basic purpose does not. Integration clauses are intended to reflect an agreement that the signed contract constitutes the final agreement between the parties, and the written agreement therefore supersedes any prior agreements—verbal or otherwise. Parties include this type of clause in the agreement to establish a final and controlling contract between the parties, and also to limit the future use of parol evidence (i.e., extrinsic evidence of the terms of the parties’ agreement) in a dispute about the meaning of the contract’s terms.
Generally, although not always, an integration clause will make it very difficult to introduce parol evidence if the meaning and scope of a contract is disputed in a breach of contract action. The same, however, is not true for disputes involving fraud and negligent misrepresentation claims.
In the fraud and negligent misrepresentation context, an integration clause should not be a per se bar against the introduction of agreements or statements outside of the four corners of the written final contract. Black letter law allows this introduction of extrinsic evidence of fraud. For example, in Riverisland, the California Supreme Court explicitly confirmed that parol evidence can be used in establishing fraud and negligent misrepresentation. Riverisland Cold Storage v. Fresno-Madera Production Credit Ass’n (2013) 55 Cal.4th 1169, 1182. Indeed, courts commonly conclude that no-representation clauses and integration clauses do not serve to shield parties from their own fraud. (Hinesley v. Oakshade Town Center (2005) 135 Cal. App. 4th 289, 301) (“[A] per se rule that an integration/no oral representations clause establishes, as a matter of law, that a party claiming fraud did not reasonably rely on representations not contained in the contract is inconsistent with California law.”). As a result, parties should contemplate this rule when drafting contracts, and defendants should be cautious about raising this defense.
Plaintiffs must also establish that they relied upon the misrepresentation or promise. It is not enough that one was merely made. As a result, many disputes will turn on this allegation rather than the mere fact of a misrepresentation or false promise. In testing whether the plaintiff’s allegations (or the evidence at trial) establishes reasonable reliance, courts will likely use a multifactor test. E.g., Julius Castle Restaurant v. Payne (2013) 216 Cal.App.4th 1423, 1442. Courts often analyze whether: (i) there is a plausible reason for a difference between an oral promise and the integrated agreement; (ii) whether the two different agreements/promises can be reconciled; and (iii) whether there is evidence that the parties read and considered the written agreement (as opposed to the oral promise).
It should also be noted that an agreement cannot “contract around” the question of whether there was justifiable reliance on an extrinsic promise or misrepresentation. For example, the presence of a clause in the written agreement that disclaims reliance on statements outside the contract is not dispositive. Orozco v. WPV San Jose, LLC (2019) 36 Cal.App.5th 375, 393-94 (“[I]t is well-established that the kind of disclaimers and exculpatory documents . . . that disavowed any representations . . . do not operate to insulate defrauding parties from liability or preclude [a plaintiff] from demonstrating justifiable reliance on misrepresentations.”). Rather, the existence of any disclaimers is just one factor for the trier of fact to consider. Id.
Because California allows parol evidence to support a claim of fraud or negligent representation, the merits of these claims are usually fact specific. Pleadings must be specific and establish these elements. If the case moves past challenges to the allegations, the parties are well served by diligently seeking discovery into the basis of the claims and testing the allegations early in the litigation process. Finally, in evaluating any settlement and the potential risks and benefits of going to trial, the parties should remember that the addition of these claims often changes the case from one of only involving compensatory damages to one that may also include punitive damages.
As former Assistant U.S. Attorneys, Patrick Delahunty and Will Edelman are well-equipped with the perspective and skill of prosecutors who have prosecuted and obtained convictions in countless cases in California. With this background, we have successfully defended clients in criminal and civil courts. For more information, please contact us today for a confidential consultation at (415) 891-6210.
Patrick Delahunty is a former federal prosecutor with deep experience in resolving disputes. He advises individuals and companies in complex criminal, regulatory, and commercial litigation.
