We are all aware of the stories of the man/woman/child wandering along a desolate beach who stumbles on a lamp. Rubbing the dust off the lamp results in the emergence of a genie, ready to grant several wishes. In the context of litigating commercial agreements in the United States, that genie is extrinsic evidence intended to explain what otherwise appear to be clear and unambiguous written agreements.
It is an unfortunate fact that, when confronting a party with a breach of its obligations under a commercial agreement and the consequent remedies available to the nonbreaching party, the breaching party will often attempt to assert its ignorance of the particulars of its obligations, or of the remedies afforded the other party, or both. Notwithstanding the apparent clarity of the language in the Restatement (Second) of Contracts addressing the parol evidence rule, courts have long grappled with issues involving the introduction or exclusion of extrinsic evidence (the terms “parol evidence” and “extrinsic evidence” are used interchangeably in this article) to explain, supplement, or contradict the written statement of the parties’ agreement. It has been stated that the “parol evidence rule is the most-litigated doctrine of contract law.” Lawrence A. Cunningham, Toward a Prudential and Credibility-Centered Parol Evidence Rule, 68 U. Cin. L. Rev. 269, 271 (2000).
As is noted below, the traditional and prevailing view in most jurisdictions is to exclude parol evidence to contradict or explain an otherwise clear and unambiguous contract, but to generally permit such evidence to support a claim of fraud. While California courts have generally been more willing to allow the introduction of parol evidence to facilitate contract interpretation than courts in other jurisdictions, until recently the same courts in California have been reluctant to permit such evidence to establish fraud. Recent decisions in California may provide guidance on when and under what circumstances extrinsic evidence should be admitted or excluded in contract interpretation.
In January 2013, the California Supreme Court overruled Bank of America v. Pendergrass, 48 P.2d 659 (Cal. 1935), a decision narrowly articulating the circumstances when extrinsic evidence can be introduced to establish 75-year-old fraud. Another long-standing California Supreme Court decision, Pacific Gas & Elec. Co. v. G.W. Thomas Drayage & Rigging Co., Inc., 442 P.2d 641 (Cal. 1968), which provided authority for courts reluctant to exclude extrinsic evidence, has been roundly criticized and recently narrowly construed by the Ninth Circuit Court of Appeals. In light of its decision to overrule Pendergrass, it is now time for the California Supreme Court to overrule Pacific Gas and bring case law on the parol evidence issue into conformity with the statutes.
This article addresses those judicial developments signaling greater clarity in the introduction or exclusion of extrinsic evidence and argues for the overruling of Pacific Gas. Although recent developments are welcome, however, it will continue to be incumbent on lenders and their counsel to carefully draft loan documents and supplemental agreements that are clear, consistent, and unambiguous both respecting the parties’ intentions and their specific agreements and confirming that borrowers understand those agreements.
Prof. Lawrence A. Cunningham provides a formula for contract interpretation: S represents the negotiations and conversations of the parties leading up to the agreement (which is to say, a lot is said); some of which is not agreed on, and the remainder, K, is what the parties want to have included in their agreement. For a variety of reasons the eventual written agreement, W, does not include all of K. Cunningham, supra, at 273. Prof. Cunningham notes that under such circumstances courts can err from a strict version of the parol evidence rule by enforcing only W, and excluding that portion of K omitted from W. Similarly, courts can err from a permissive application of the parol evidence rule by including evidence of the omitted K, as well as evidence of S that was not ultimately included in K. Reading Prof. Cunningham’s article, it is clear why contract interpretation is so heavily litigated, notwithstanding the clarity with which transactional lawyers reduce their clients’ agreements to writing.
The Restatement and the Traditional View
The Restatement (Second) of Contracts provides that a court must determine whether an agreement is completely or partially integrated before it applies the parol evidence rule. Restatement (Second) of Contracts § 210. Whether an agreement is completely integrated (in other words, a final expression of the parties’ agreements) or partially integrated is a question to be determined by the court. Id. § 209. If a court determines that an agreement is fully integrated, prior inconsistent agreements, as well as prior agreements within the scope of the integrated agreement, are discharged. Id. § 213.
Furthermore, whether fully or partially integrated, terms of a written agreement cannot be contradicted by evidence of prior or contemporaneous agreements, id. § 215; however, an agreement that is not completely integrated can be supplemented with evidence of consistent terms. Id. § 216. The Restatement describes a contract not completely integrated as one that “omits a consistent additional agreed term,” which is either supported by separate consideration or “might naturally be omitted from the writing.” Id.
So what role does parol evidence play in determining whether a contract is completely integrated? At this point, the prevailing view appears to be that a court’s initial inquiry should be limited to the “four corners” of the written agreement. Ferdinand S. Tinio, Annotation, The Parol Evidence Rule and Admissibility of Extrinsic Evidence to Establish and Clarify Ambiguity in Written Contract, 40 A.L.R.3d 1384, at note 12 (2013). Once a contract is deemed to be fully integrated, the parol evidence rule precludes the admission of such evidence. Furthermore, an agreement that is deemed to be clear and lacking ambiguity cannot be explained, supplemented, or contradicted with extrinsic evidence. Id. at note 22. Although an ambiguity cannot be created by the consideration of parol evidence, courts are generally more receptive to allowing such evidence to explain an agreement otherwise incomplete or inconsistent on its face. Id. at notes 16, 17. Similarly, courts are generally amenable to admitting parol evidence to establish fraud. Gary D. Spivey, Annotation, Application of Parol Evidence Rule of UCC Section 2-202 where Fraud or Misrepresentation Is Claimed in Sale of Goods, 71 A.L.R.3d 1059, at note 4 (2013). Some courts, and in particular courts in California, have moved away from the traditional view and acknowledge the role parol evidence may have to establish an agreement as not being either fully integrated or unambiguous. Conversely, while seeming to embrace the possible utility of parol evidence in interpreting parties’ agreements, those same California courts have historically erected barriers to the admission of parol evidence to establish fraud.
The California Statute
It is an axiom in California jurisprudence that the written agreement, once executed and delivered, shall be considered as the final, complete, and exclusive statement of the parties’ agreement. This leads to the parol evidence rule, precluding the introduction of extrinsic evidence to interpret an integrated agreement. This rule is codified in Cal. Civ. Proc. Code § 1856 and Cal. Civ. Code § 1625, which expands on the Restatement. Cal. Civ. Proc. Code § 1856(a) provides 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.” Cal. Civ. Proc. Code § 1856(a).
The section continues, acknowledging that terms in a contract can be explained or supplemented by evidence of consistent terms, id. § 1856(b), or course of dealing or usage of trade or course of performance. Id. § 1856(c). The section also provides that parol evidence can be introduced when the validity of an agreement is in dispute, id. at § 1856(f), when necessary to explain an extrinsic ambiguity, to otherwise interpret the agreement, or to establish illegality or fraud. Id. § 1856(g). In addition, Cal. Civ. Code § 1625 provides that a written contract supersedes all negotiations and stipulations of the parties that preceded or accompanied the execution of the agreement. Cal. Civ. Code § 1625.
In summary, the statutory expressions of the rule confirm that parol or other extrinsic evidence cannot be used to contradict an agreement but can be offered to explain or supplement or to otherwise interpret the agreement, provided such parol evidence is consistent with the written agreement. Extrinsic evidence can be introduced, however, to support a challenge to the validity of an agreement or to establish fraud or illegality. Although the California statutory scheme tracks the traditional view of parol evidence, as will be noted herein, over the years the California Supreme Court has taken very nontraditional approaches to the consideration of such evidence.
The Fraud Exception to the Parol Evidence Rule
Despite the legislative articulation and the prevailing view that parol evidence can be introduced to establish fraud or illegality, the California Supreme Court’s decision in Pendergrass held that parol evidence of fraud can be introduced only to establish an independent fact or representation, and not a “promise directly at variance with the promise of the writing.” 48 P.2d at 661. Pendergrass involved an action to recover judgment on a promissory note. At the trial court, the jury considered the plaintiff’s evidence of a note payable on demand and the defendant’s assertions that, among other things, the note was obtained by fraud. The defendant claimed that the plaintiff had promised that the defendant would have the right to extend or postpone payments for a year, notwithstanding the express language in the note that it was payable on demand.
The Supreme Court explained that the parol evidence rule permits the introduction of extrinsic evidence of fraud to invalidate an instrument if such evidence establishes “some independent fact or representation, some fraud in the procurement of the instrument, or some breach of confidence concerning its use,” id.; however, such evidence cannot be introduced to establish an agreement directly contrary to the written agreement. The court looked to common law, which “exclude[s] such oral testimony of the alleged agreement; and as it cannot be proved by legal evidence, the agreement itself in legal contemplation cannot be regarded as existing in fact.” Id. at 662. Furthermore, the court noted that, if a court allows a party to introduce oral testimony evidencing that, contemporaneously with the execution of the agreement, the other party promised not to enforce it, the court would “open the door to all evils that the parol evidence rule was designed to prevent.” Id. (citations omitted).
A chink in the Pendergrass armor appeared in Pacific State Bank v. Greene, 1 Cal. Rptr. 3d 739 (Ct. App. 2003), a court of appeals decision that addressed the question of “whether the parol evidence rule bars a party from offering evidence that her signature on an agreement was procured by a misrepresentation over the content” of the written agreement. Id. at 741. The defendant asserted that she had agreed to sign a guaranty applicable to a single loan and claimed that the bank’s representative assured her on the day the documents were executed that the guaranty was applicable only to one loan with a remaining balance of $27,000. Despite the defendant’s understanding and the bank representative’s assurances, the term “indebtedness” as used in the guaranty included “all of Borrower’s liabilities,” which included four loans totaling approximately $180,000. Id.
Acknowledging that Pendergrass had narrowed the statutory fraud exception to the parol evidence rule to exclude evidence of an agreement directly contrary to the written agreement, the Greene court refused to extend Pendergrass to exclude parol evidence of a misrepresentation of fact over the contents of an agreement made at the time of execution of the agreement. Id. at 742. The court’s refusal was based on its determination that to exclude such evidence “would conflict with the Legislature’s express and unqualified statutory exception for fraud—a policy judgment that we have no power to overrule.” Id.
The court acknowledged that permitting extrinsic evidence to contradict a written agreement, as prohibited by Pendergrass, “would swallow up the rule.” Id. The Greene court sought, however, to distinguish Pendergrass, holding that evidence of a misrepresentation of fact does not bear the same risks, as such misrepresentations are limited in time to execution of the documents, rather than during the course of negotiations, and must include evidence of reliance on such misrepresentations. Indeed, the Greene court took pains to craft a holding consistent with Pendergrass, acknowledging that the extrinsic evidence the defendant sought to include could not be used “to interpret the existing language” of the agreements, id. at 748, and distinguished Pendergrass and its progeny as excluding evidence of promissory fraud inducing an agreement, as distinct from a misrepresentation of fact over the content of the agreement on execution. Id. at 752.
Despite the effort of the Greene court to carefully distinguish the facts presented to it from those considered in Pendergrass, in a masterful understatement the court acknowledged: “To be sure, there can occasionally be a fine line between a promise that induces an agreement and a misrepresented fact concerning the physical content of the agreement at the time of signing.” Id. at 753. The court acknowledged that if the defendant had sought to introduce evidence that the bank officer had assured her that she would only be required to guaranty one loan, such evidence would have been excluded under the principle of promissory fraud articulated in Pendergrass. Id. This distinction is clearly one without a difference and is particularly confusing in the context of a body of law seeking to impose rules limiting introduction of extrinsic evidence to explain the otherwise clear and unambiguous meanings of words in an agreement.
Attempting to re-insert reason into the role of extrinsic evidence to establish fraud, the California Supreme Court overruled Pendergrass in Riverisland Cold Storage, Inc. v. Fresno-Madera Production Credit Ass’n, 291 P.3d 316 (Cal. 2013), on facts very similar to those in Pendergrass. The plaintiffs were parties to certain loan agreements with a credit association, and, when the plaintiffs fell into default, the parties entered into agreements to restructure the debt. The restructured agreements provided that the creditor would take no enforcement action for three months, with the borrowers pledging eight additional parcels of real property as collateral.
Notwithstanding the language of the agreements, which were fully executed by borrowers, the borrowers asserted that two weeks before the agreements were executed the creditor’s representatives assured borrowers that the loans would be extended for two additional years in exchange for the pledge of two additional parcels of property. At the time the restructure agreements were being executed, the same creditor representatives made the same assurances to the borrowers, who signed and initialed the agreements without reading them. The trial court granted the credit association’s motion for summary judgment under the authority of Pendergrass, but the court of appeal reversed, characterizing the statements of the creditor representatives as factual misrepresentations, as distinguished from the promissory fraud addressed in Pendergrass. Riverisland Cold Storage, Inc. v. Fresno-Madera Prod. Credit Ass’n, 119 Cal. Rptr. 3d 380 (Ct. App. 2011).
The California Supreme Court concluded that the Pendergrass decision (1) was not supported by the codification of the parol evidence rule and the fraud exception in California, (2) is in conflict with the Restatement (Second) of Contracts and treatises, (3) can be used to shield fraudulent conduct, and (4) was “ill-considered, and should be overruled.” Riverisland Cold Storage, 291 P.3d at 317. The court articulated its concern that Pendergrass’s exclusion of evidence to prove fraud may support the perpetration of fraud, because “[t]o bar extrinsic evidence would be to make the parol evidence rule a shield to protect misconduct or mistake.” Id. at 320–21, citing 6 Corbin on Contracts § 25.20(A), at 280 (rev. ed. 2010). Furthermore, the court noted the difficulty of trying to distinguish false promises from misrepresentation of facts. Id. at 321. Ultimately, the Riverisland court concluded that Pendergrass was an aberration that “failed to account for the fundamental principle that fraud undermines the essential validity of the parties’ agreement.” Id. at 324.
The fraud exception was again addressed by a California Court of Appeal decision in early June 2013. Julius Castle Rest., Inc. v. James Frederick Payne, 157 Cal. Rptr. 3d 839 (Ct. App. 2013). The litigation involved the sale of certain restaurant assets and a lease of the restaurant facilities. In the lease, the tenant acknowledged that it had inspected the premises and improvements and found them to be in good order and repair, and further acknowledged that the lease was fully integrated and that any representations or warranties of any party not included in the lease were void. Notwithstanding such language in the lease, the tenant claimed that the seller/landlord had made oral assurances of the condition of the property, as well as assurances that if something was not working, the seller would fix it.
The court concluded that the tenant’s assertions were inconsistent with and directly contrary to the express terms of the lease. Nevertheless, the court concluded that, under the authority of Riverisland, such extrinsic evidence must be admitted to determine whether the tenant was fraudulently induced to enter into the lease. The landlord sought to exclude such evidence on the basis that the Riverisland decision seemed to imply that sophisticated parties can rarely invoke the fraud exception. The court rejected that implication, cautioning parties in the future to focus on the issue of whether the fraud sought to be established by extrinsic evidence was justifiably relied on.
The court’s reasoning is consistent with the Restatement’s acknowledgment that a trier of fact is responsible for interpreting an integrated agreement if it depends on the credibility of the extrinsic evidence, or on a choice of reasonable inferences from such extrinsic evidence. Restatement (Second) of Contracts § 212. Conversely, the Restatement provides that in the absence of evaluating the credibility of extrinsic evidence or inferences to be drawn from such evidence in contract interpretation, the interpretation of a contract is a question of law. Id.
Is Any Contract in California Proof to Parol Evidence?
Although important in bringing case law into line with the statutory fraud exceptions to the parol evidence rule included in Cal. Civ. Proc. Code § 1856, the Riverisland decision reaffirms the substantive legal principle “that when the parties put all the terms of their agreement in writing, the writing itself becomes the agreement.” 291 P.3d at 318–19. That principle, however, has not been applied consistently to exclude parol evidence from contradicting otherwise clear and unambiguous agreements.
Almost 25 years ago, in Trident Center v. Connecticut Gen. Life Ins. Co., 847 F.2d. 564 (9th Cir. 1988), a case pitting highly sophisticated parties dealing at arm’s length in a dispute involving detailed and heavily negotiated loan documents, Judge Kozinski stated the question before the court as “whether parties in California can ever draft a contract that is proof to parol evidence.” Id. at 565. In equal measures of frustration and incredulity, Judge Kozinski concluded the answer is no, reading Pacific Gas to stand for the proposition that, under California law, a contract cannot ever be interpreted by a court without considering extrinsic evidence, even when negotiated with the active involvement of highly competent counsel, when the parties are sophisticated, the transaction sizeable, and the contract language unambiguous.
In Pacific Gas, the parties entered into a contract involving the repair of a steam turbine. The defendant agreed to perform the work and indemnify plaintiff from certain claims arising in connection with the performance of the agreement. During the course of the work, a piece of the turbine became dislodged and damaged the turbine rotor. The plaintiff brought suit for damages under the indemnity provision of the agreement. The defendant asserted that the indemnity provision was meant to cover injury to the property of third parties, and not the plaintiff’s own property. Although determining that the indemnity language in the agreement was “the classic language for a third party indemnity provision” and a reasonable conclusion could be reached that it was intended to apply to damages suffered by third parties, the trial court determined that the agreement clearly required the defendant to indemnify the plaintiff for damages to the plaintiff’s property and therefore excluded extrinsic evidence “that would contradict” the language of the agreement. Pacific Gas, 442 P.2d at 643.
The California Supreme Court challenged the “judicial belief in the possibility of perfect verbal expression,” which it characterized as “a remnant of a primitive faith in the inherent potency and inherent meaning of words.” Id. at 643–44. The court continued, asserting that limiting the inquiry to the meaning of a written agreement to the writing on the basis of a determination that such writing is clear and unambiguous “would either deny the relevance of the intention of the parties or presuppose a degree of verbal precision and stability our language has not attained.” Id. at 644. Holding that words “do not have absolute and constant referents,” id., and acknowledging that extrinsic evidence cannot “add to, detract from, or vary the terms of a written contract,” the court concluded that it is a court’s duty to consider “all credible evidence offered to prove the intention of the parties.” Id. at 645.
Focusing on provisions in loan documents negotiated by highly sophisticated parties represented by highly sophisticated and experienced counsel, when it “is difficult to imagine language” more clear and unambiguous, 847 F.2d at 566 and 567, Judge Kozinski read Pacific Gas to stand for the proposition that “it matters not how clearly a contract is written, nor how completely it is integrated, nor how carefully it is negotiated, nor how squarely it addresses the issue before the court[;] the contract cannot be rendered impervious to attack by parol evidence.” Id. at 569.
Judge Kozinski further observed that Pacific Gas “casts a long shadow of uncertainty over all transactions negotiated and executed under the law of California” and will lead “only to frustration and delay” for litigants and exacerbate “already overburdened courts.” Id. Heating up his rhetoric attacking the reasoning in Pacific Gas, Kozinski concluded that the decision “undermines the basic principle that language provides a meaningful constraint on public and private conduct” and explained the rational consequences of such a determination:
If we are unwilling to say that parties, dealing face to face, can come up with language that binds them, how can we send anyone to jail for violating statutes consisting of mere words lacking “absolute and constant referents”? How can courts ever enforce decrees, not written in language understandable to all, but encoded in a dialect reflecting only the “linguistic background of the judge”? Can lower courts ever be faulted for failing to carry out the mandate of higher courts when “perfect verbal expression” is impossible? Are all attempts to develop the law in a reasoned and principled fashion doomed to failure as “remnant[s] of a primitive faith in the inherent potency and inherent meaning of words”?
Two months after the Trident Center case was filed, another Ninth Circuit panel sought to “clarify” that decision, as well as Pacific Gas. In A. Kemp Fisheries, Inc. v. Castle & Cooke, Inc., 852 F.2d 493 (9th Cir. 1988), the court considered extrinsic evidence sought to be introduced by a party to a fishing vessel charter agreement that contradicted certain express waivers of warranties contained in the agreement. Confronted with admittedly ambiguous and contradictory provisions in the agreement, the trial court permitted the introduction and consideration of the extrinsic evidence offered by the plaintiff, and then ruled for the plaintiff. Id. at 496.
The court of appeals reversed. Although acknowledging that both Trident Center and Pacific Gas require the court to consider extrinsic evidence, the Kemp Fisheries court tried to narrow the holdings of those cases to permit the court to reject such evidence: “If, after considering the evidence, the court determines that the contract is not reasonably susceptible to the interpretation advanced, the parol evidence rule operates to exclude the evidence.” Id. at 496 n.2. Interestingly, the Kemp Fisheries court assumed the responsibility for evaluating the effect of the extrinsic evidence, despite the fact that it is unclear whether the consideration of such evidence in contract interpretation is a matter for the court or a jury. HSBC Bank USA v. Dara Petroleum, Inc., No. 2:09-2356 WBS EFB, 2010 WL 2197525, at *5 n.3 (E.D. Cal., May 28, 2010) (citing Loree v. Robert F. Driver Co., 151 Cal. Rptr. 557, 561–62 (Ct. App. 1978); Walsh v. Walsh, 116 P.2d 62, 63–64 (Cal. 1941); and Wolf v. Superior Court, 8 Cal. Rptr. 3d 649, 655 (Ct. App. 2004)). Although perhaps a valiant effort to narrow the holdings in Pacific Gas and Trident Center, Kemp Fisheries does nothing to alleviate the frustration and delay acknowledged by Judge Kozinski.
Nonetheless, the California Supreme Court reaffirmed the importance of the parol evidence rule in Casa Herrera, Inc. v. Beydoun, 83 P.3d 497 (Cal. 2004). The decision is instructive regarding the limits imposed on the introduction of parol evidence. In Casa Herrera, a manufacturer sold tortilla-making equipment to the defendant, with the contract providing certain production specifications and affording the purchaser 10 days to operate and return the equipment if dissatisfied. The 10-day period was extended while the manufacturer effected certain repairs and provided additional instructions, and approximately one month after delivery the equipment was accepted by the purchaser. When the purchaser began to experience financial difficulties, its lenders obtained a receiver to operate its business and the purchaser sued the manufacturer alleging breach of contract and fraud, claiming that, notwithstanding the contract specifications, the manufacturer claimed the equipment could perform at a greater capacity.
The trial court dismissed the action for lack of standing. The court of appeal affirmed, however, on the basis that there was no evidence to support the contract claim or the fraud claim, ruling that the parol evidence rule precluded the introduction of such evidence. Id. at 499–500.
Following the court of appeal decision, the manufacturer brought an action against the purchaser for malicious prosecution. In this second action, the trial court dismissed the complaint with prejudice on the basis that a resolution of a case on the basis of the application of the parol evidence rule is not a favorable termination that supports a claim for malicious prosecution. The court of appeal reversed, asserting: “the parol evidence rule is not an evidentiary rule but is instead a rule that fixes duties and establishes rights and responsibilities among persons by declaring that the law will hold parties to their written agreements rather than to prior representations or promises inconsistent with the written agreement.” Id. at 500. The California Supreme Court affirmed.
The Casa Herrera court acknowledged that to prevail on a malicious prosecution case the plaintiff must establish that the prior action terminated in favor of the plaintiff, noting that “a ‘technical or procedural [termination] . . . ’ is not favorable for purposes of a malicious prosecution claim.” Id. at 501. The defendants had asserted that the judgment in favor of the plaintiff in the prior action was based on the absence of evidence to support defendants’ position because of the application of the parol evidence rule and therefore was a procedural or technical termination, not a substantive termination. The court noted that the parol evidence rule is not a rule of evidence, but is substantive law, id. at 501–02, and “therefore establishes that the terms contained in an integrated written agreement may not be contradicted by prior or contemporaneous agreements.” Id. at 502–03. Rejecting the defendants’ efforts to analogize termination of a case as a result of application of the parol evidence rule with termination of a case on statute of limitations grounds, under a settlement, or on the grounds of laches, the court determined that the parol evidence rule “determines the enforceable and incontrovertible terms of an integrated agreement,” to be interpreted without resort to extrinsic evidence to interpret or explain the agreement, absent fraud or mistake. Id at 503–04.
Pacific Gas again reared its head in Dore v. Arnold Worldwide, Inc., 139 P.3d 56 (Cal. 2006), an employment case before the California Supreme Court. An employee interviewed for a new job that necessitated a transfer to Los Angeles from Colorado. After interviews he was offered the job and orally accepted. He subsequently received and signed a written letter confirming the offer, the details of compensation and benefits, including an express provision indicating that the employment was “at will” and that either the employee or employer had the right to terminate the employment “at any time.” Id. at 58. Approximately two and one-half years later his employment was terminated and the employee brought suit claiming, among other things, breach of contract, negligent misrepresentation, and fraud. The trial court granted the employer’s motion for summary judgment, and the court of appeal affirmed in part but reversed as to the claims other than negligent misrepresentation, concluding that the employment letter was not “clear and unambiguous with respect to cause for termination.” Id. at 59.
The California Supreme Court noted that California courts have recognized that ambiguity in contract language arises when the contract can reasonably be “susceptible of more than one application to material facts” and that even when language does not appear to be ambiguous, extrinsic evidence can be introduced to reveal more than one possible reasonable interpretation. Id at 60. The court somewhat narrowly construed Pacific Gas to explain that the test of the admissibility of extrinsic evidence is whether the proposed evidence “is relevant to prove a meaning to which the language of the instrument is reasonably susceptible.” Id.
Ultimately, the court determined that the employment letter was clear and unambiguous on the nature of the employment as being “at-will.” The court rejected the employee’s attempt to introduce extrinsic evidence to create an ambiguity and asserted: “When a dispute arises over the meaning of contract language, the first question to be decided is whether the language is ‘reasonably susceptible’ to the interpretation urged by the party. If it is not, the case is over.” Id. at 61 (citing Southern Cal. Edison Co. v. Superior Court, 37 Cal. App. 4th 839, 847 (Ct. App. 1995).
In his concurring opinion Justice Baxter took the opportunity to criticize the majority’s “general endorsement” of Pacific Gas. Id. at 62. Baxter criticized Pacific Gas for its abrogation of traditional rules limiting the admissibility of parol evidence on the basis that such a decision “stretched the unremarkable principle that extrinsic evidence is admissible to resolve a contractual ambiguity into a rule that parol evidence is always admissible to demonstrate ambiguity despite facial clarity.” Id. Noting that Justice Mosk had expressed his own misgivings in participating in the Pacific Gas opinion as it contributed “toward emasculation of the parol evidence rule,” id. at 63 n.1, Justice Baxter expressed a willingness to consider “a comprehensive reexamination” of Pacific Gas. Id. at 63.
Time to Overrule Pacific Gas
In February 2012, in Skilstaf, Inc. v. CVS Caremark Corp., 669 F.3d 1005 (9th Cir. 2012), another Ninth Circuit panel considered the application of extrinsic evidence to the interpretation of a settlement agreement in a prior Massachusetts class action case. A class member in the original case, who appeared as a limited objector through counsel, filed a similar case in California seeking to represent a nationwide class. Defendants sought to dismiss the California case under the covenant not to sue included in the settlement agreement approved in the Massachusetts case. The trial court dismissed and the plaintiff appealed, asserting, among other claims, that the trial court erred in dismissing the case on the pleadings because California law “mandates discovery when a party claims that extrinsic evidence makes a contract ambiguous.” Id. at 1014.
Defendants sought to establish that the covenant not to sue included in the settlement agreement was incorporated in the final decision entered in the Massachusetts case and should be interpreted under the law governing consent decrees rather than the law applicable to contract interpretation. The Skilstaf court acknowledged that “[i]f the plain language of a consent decree is clear, we need not evaluate any extrinsic evidence to ascertain the true intent of the parties.” Id. at 1014 n.7 (quoting Nehmer v. U.S. Dep’t of Veterans Affairs, 494 F.3d 846, 861 (9th Cir. 2007)). On the contrary, citing Trident Center, the court determined that “if a party claims that extrinsic evidence renders a contract ambiguous,” California law requires the consideration of such extrinsic evidence “no matter ‘how clearly a contract is written.’” Id. (quoting Trident Center, 847 F.2d at 568–69).
The court then provided a brief summary of the legal principles of California contract interpretation, purporting to conclude from reading, among others, Brooke Dore, Pacific Gas, and Kemp Fisheries, that extrinsic evidence must be considered even when the contract language appears clear and unambiguous. If the court determines that the contract is not reasonably susceptible to the interpretation advanced by the extrinsic evidence, it can be disregarded, and ultimately “[w]hether the contract is reasonably susceptible to a party’s interpretation can be determined from the language of the contract itself or from extrinsic evidence of the parties intent.” Id. at 1015 (quoting Cedars-Sinai Med. Ctr. v. Shewry, 41 Cal. Rptr. 3d 48, 60 (Ct. App. 2006)).
The foregoing seems a bit circular to this author, but it does ultimately focus the inquiry on the credibility of the extrinsic evidence to support the interpretation asserted. Such a focus on credibility, however, might open the door more widely to the admission of such extrinsic evidence.
In closing his decision in the Trident Center case, Judge Kozinski observed that the California Supreme Court might wish to revisit its decision in Pacific Gas. 847 F.2d at 570. As noted above, Justice Baxter seconded that motion in Brook Dore. After almost 45 years of discussion, it is now time to call the question and return to the California Legislature’s guidance set forth in the Code of Civil Procedure.
In the context of an integrated agreement, extrinsic evidence cannot contradict the clear language of the agreement. Such evidence can explain or supplement to the extent consistent with the agreement, explain or interpret to the extent the language in the agreement is ambiguous, and can be considered to establish illegality or fraud. But it is the role of the lawyers drafting and negotiating commercial agreements, including loan documents and other real estate contracts, to draft carefully to both clearly express the parties’ agreements and to clearly and unambiguously articulate the intentions of the parties in entering into the agreement. And, particularly with a court system already overburdened by a catastrophic loss of resources, it is incumbent on the courts to limit consideration of extrinsic evidence to avoid a party’s efforts to take advantage of the inefficiencies of the court system to seek to renegotiate its agreements in the context of litigation.