May 21, 2020

Effective Use of Merger Clauses: Part II

Jason R. Scheiderer and Michael Malone – June 13, 2018

Note: In the first installment of this series, we discussed the history of the parol evidence rule and the use of merger clauses. Here, we discuss the legal effect of merger clauses and various jurisdictions’ approaches to them.

Once parties write a merger clause into their agreement, what weight should that provision have? Should merger clauses be given more weight when they are negotiated between two sophisticated businesses, both represented by counsel? Should merger clauses be given less weight when they are “boilerplate” or “stock” clauses preprinted on contracts, particularly consumer contracts?  Conversely, why should merger clauses be given any less weight than any other term of the contract?

Posing these questions raises another important question.  What evidence should a court consider when evaluating how well or how thoroughly a contract was negotiated? What evidence should a court consider when evaluating the respective bargaining power of the parties?  All of this evidence is extrinsic to the contract.  When the parties have prepared and executed a merger clause, isn’t the mere consideration of these issues directly contrary to the express intent of the parties? Courts and scholars have taken different approaches to answering these types of questions. Since opinions continue to be written every day (and since related courts have shown some striking inconsistencies), the practitioner should carefully study the nuances in the authority governing the particular contract. But it is helpful to identify the three primary approaches courts currently take when considering the enforcement of a merger clause. We identify them as the “conclusive approach, the “highly persuasive” approach, and the “mere factor” approach.

Conclusive Approach
There is virtually universal agreement that where there is evidence of fraud or mutual mistake in the formation of a contract, a merger clause will not be conclusive. Restatement (Second) of Contracts § 209 cmt., b. Similarly, where a contract is invalid or illegal as a matter of law, a merger clause will not be conclusive.

But without such evidence, the traditional view has been that contracts should be enforced as written, including a contract’s merger clause, if the parties chose to include one. Early advocates of this view, both Professors Corbin and Williston argued that a merger clause should have conclusive effect in determining the integration of a contract. 4 Williston § 633; 3 Corbin on Contracts, § 578. Therefore, unless the writing was obviously incomplete or other clauses were inserted as the result of fraud or mistake, the merger clause should be conclusive evidence that the parties intended the contract to be integrated. (4 Williston § 633; 3 Corbin § 578).

Several states continue to hold this “traditional” view regarding the enforcement of merger clauses, including: New York, New Jersey, Connecticut, Florida, Colorado, Alabama, and Wisconsin. See, e.g., Tallmadge Bros, Inc. v. Iroquois Gas Transmission System, 746 A.2d 1277, 1287 (Conn. 2000); Nelson v. Elway, 908 P.2d 102 (Colo. 1995). New York has long enforced one of the strictest parol evidence rules among the states. See, e.g., W.W.W. Associates, Inc. v. Giancontieri, 566 N.E. 2d 639, 642 (N.Y. 1990); DiLorenzo v. Estate Motors, Inc., 802 N.Y.S. 2d 516 (N.Y. 2005). Summarizing New York’s strict enforcement of merger clauses, the Court of Appeals explained the purpose of a merger clause is to require the full application of the parol evidence rule in order to bar the introduction of extrinsic evidence to alter, vary, or contradict the terms of the writing. The merger clause accomplishes this purpose by evincing the parties’ intent that the agreement is to be considered a completely integrated writing. New York City Health and Hospital Corp. v. St. Barnabas Hospital, 782 N.Y.S. 2d 12 (2004).

One example of the occasional harshness of the strict rule appeared in Colafrancesco v. Crown Pontiac-GMC Inc., 485 So.2d 1131 (Ala. 1986). Joy Colafrancesco purchased a 1981 Datsun believing (apparently because she was told) that she had purchased the 1982 model. However, all of the paperwork associated with the purchase stated that it was 1981 model. The Alabama Supreme Court confirmed the exclusion of all parol evidence of her prior oral understanding. The court noted that the contract for sale had a merger clause, which stated “the above comprises the entire agreement pertaining to this purchase, and no other agreement of any kind, verbal understanding, or promise whatsoever, will be recognized.” Given this provision, the Alabama Supreme Court had little trouble excluding Ms. Colafrancesco’s parol evidence of an oral agreement.

In sum, to this day, when the parties have agreed to include a merger clause, a number of states will strictly enforce the parol evidence rule and will bar extrinsic evidence from the courts’ consideration of the contract’s terms.

Highly Persuasive Approach
Reflecting the reasoning of many of the courts in the United States, the Restatement (Second) of Contracts has moved beyond the traditional understanding and enforcement of merger clauses. Instead, the Restatement flatly rejects the idea that a writing can “prove its own completeness.” Instead, the Restatement holds that “wide latitude must be allowed for inquiry into circumstances bearing on the intention of the parties.” Restatement (Second) of Contracts § 210 cmt., b. Thus, the Restatement does not give conclusive effect to a merger clause, but says that such a clause is “likely to conclude” the question of integration. Restatement (Second) of Contracts § 216 cmt., e. The Restatement maintains that “[w]here the parties reduce an agreement to a writing which in view of its completeness and specificity reasonably appears to be a complete agreement, it is taken to be an integrated agreement unless it is established by other evidence that the writing did not constitute a final expression.” Restatement (Second) of Contracts § 209. Importantly, however, the Restatement allows for robust consideration of evidence on the topic:

§214:  Evidence of Prior or Contemporaneous Agreements and Negotiations

Agreements and negotiations prior to or contemporaneous with the adoption of a writing are admissible in evidence to establish:

a.         that the writing is or is not an integrated agreement;

b.         that the integrated agreement, if any, is completely or partially integrated;

c.         the meaning of the writing, whether or not integrated;

d.         illegality, fraud, duress, mistake, lack of consideration, or other invalidating cause;

e.         ground for granting or denying rescission, reformation, specific performance, or other remedy.

Similarly, the Uniform Commercial Code (UCC) states that partial integration is the norm such that the court should bar evidence of consistent additional terms only when it “finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement.” U.C.C. § 2-202(b). The UCC thus allows the parties to explain or supplement their agreement with parol evidence of: (a) “course of dealing or usage of trade (§1-205) or by course of performance (§2-208)”; and (b) “by evidence of consistent additional terms…” U.C.C. § 2-202.

Whether a majority or only a plurality at this time, the common law of many states now allows parties to rebut the presumption created by merger clauses. See, e.g., Extra Equipamentos e Exportacao, Ltda. v. Case Corp., 541 F.3d 719, 722–23 (7th Cir. 2008). Two examples of states that consider merger clauses to be only persuasive evidence of integration are North Carolina and Washington. Black v. Evergreen Land Developers, Inc. is an early illustration of the movement away from the “conclusive” approach. In the Black v. Evergreen case, the Washington Supreme Court considered the importance and effect of “boilerplate” merger clauses. Black v. Evergreen Land Developers, Inc., 450 P.2d 470 (Wash. 1969). The court allowed parol evidence of a prior oral agreement that a particular view of the lake would not be impaired by subsequent construction in the subdivision. The contract at issue, for the receipt of plaintiffs’ earnest money, did not include this promise. Instead, the contract had integration clause that said “there are no verbal or other agreements which modify or affect this agreement.”  The clause was in fine print and at the end of the parties’ contract.  The deed itself did not specify any restrictions on construction.

The plaintiffs’ view of the lake had been impaired by subsequent construction, prompting their lawsuit.  At trial, there was available significant extrinsic evidence, both verbal and in an advertising brochure, that the developer had guaranteed the view would not be impaired. The Washington Supreme Court reversed the trial court and allowed the admission of evidence of the prior and extrinsic promises.  The high court explained that the integration clause “strengthens, and it may go beyond, the presumption of integration upon which the parol evidence rule proceeds; but it is not invariably conclusive and its coverage is a matter of interpretation.” Id. at 476. The court went on to explain that a party to a contract should not be bound by a false recital, and parol evidence should be admitted to show the true facts and circumstances surrounding the agreement.  The Washington court concluded “to now hold that the boilerplate at the conclusion of the earnest money agreement would vitiate the manifest understanding of the parties as evidenced by this record would amount to a constructive fraud practiced by the defendants upon the plaintiffs.” Id.

In Zinn v. Walker, the North Carolina Appellate Court noted that the merger clause created the presumption of complete integration, but the court considered evidence to rebut the presumption. Zinn v. Walker, 361 S.E. 2d 314 (N.C. Ct. App. 1987).  In Zinn, a real estate developer had provided money to a real estate broker to purchase real estate. Contemporaneously with the contract for sale, the parties executed a “Resale Profits Agreement.” The Resale Profits Agreement said that the net sale proceeds on lots will be shared with 80% going to the broker and 20% going to the developer.

The developer later sued to recover her share of the profits from the sale. The developer argued that the sale contract did not include a division of net sale proceeds, and contained a merger clause. The Appellate Court found that contemporaneously signed writings can be incorporated together to determine the intent and purpose of parties in the entirety of their contractual relationship. Thus, even though the sale contract had a merger clause, that did not preclude consideration of the Resale Profits Agreement. The court announced reasoning that is now widely adopted in the United States: “where giving effect to the merger clause would frustrate and distort the parties’ true intentions and understanding regarding the contract, the clause will not be enforced.” Id. at 333.

Mere Factor Approach
Several states (including such western states as California, Nevada, Oregon, and Alaska) have moved even further away from the “conclusive” view—nearly refusing to give merger clauses any presumption of integration. See, e.g., Riverisland Cold Storage, Inc. v. Fresno-Madera Prod. Credit Assoc., 291 P.3d 316 (Cal. 2013); Seibel v. Layne & Bowler, Inc., 641 P.2d 668 (Or. Ct. App.), rev. den. 648 P.2d 852 (Or. 1982) (Oregon Supreme Court refusing to enforce a merger clause that was not conspicuous); Sierra Diesel Injection Service Inc. v. Burroughs Corp., 656 F. Supp. 426, 428 (D. Nev. 1987) (applying Nevada law, refusing to enforce a merger clause where the party submitted evidence he did not understand the clause’s effect). Instead, courts will entertain extrinsic evidence to determine if a contract was intended to be fully integrated—even if the writing itself has an unambiguous merger clause stating the parties’ such intent. California Code of Civil Procedure, § 1856; Pacific Gas & Elec. Co. v. G.W. Thomas Drayage & Rigging Co., 442 P.2d 641, 645 (Cal. 1968). In an early explanation for its broad look to extrinsic evidence, the California Supreme Court asserted that “rational interpretation requires at least a preliminary consideration of all credible evidence offered to prove the intention of the parties. Id.

The Alaska Supreme Court expounded on this “flexible” approach towards parol evidence.  In Municipality of Anchorage v. Gentile, the Court explained that “the goal of the court is to enforce the reasonable expectations of the parties,” and that to do so the Court should look to both the written contract and to extrinsic evidence. Mun. of Anchorage v. Gentile, 922 P.2d 248, 255-256 (Alaska 1996). To do so, the courts of Alaska apply a three-step test once the parol evidence rule has been invoked. First, the court must determine whether the contract appears to be integrated. Second, courts must decide what the contract means on its face. Finally, a court needs to rule whether the asserted prior agreement actually conflicts with the integrated writing. Importantly, however, in Alaska, the trial court considers extrinsic evidence to resolve the first two inquiries. Froines v. Valdez Fisheries Dev. Ass’n, 75 P.3d 83, 87 (Alaska 2003).

Thus, typically the “mere factor” approach will broadly allow the presentation of extrinsic evidence—both as to particular terms and as to the parties’ intent to have an integrated agreement in the first place. This is true even where the parties have written an unambiguous merger clause into their agreement. See, e.g., Masterson v. Sine, 436 P.2d 561, 564 (Cal. 1968). In these jurisdictions, litigants are likely to see a variety of extrinsic evidence inserted into the dispute whenever such evidence supports the party’s contractual theory.

 

Jason R. Scheiderer is a partner with Dentons US LLP, in Kansas City, Missouri. Michael Malone is an associate with Polsinelli in Nashville, Tennessee.

Jason R. Scheiderer and Michael Malone – June 13, 2018