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    August 28, 2018 Contract Boilerplate Series

    Effective Use of Merger Clauses: Part III

    Effect and enforcement of merger clauses in the context of the parol evidence rule.

    By Jason R. Scheiderer and Michael Malone

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

    Enforcement of Merger Clauses
    While the concept of merger clauses is generally straightforward, the application and enforcement of such clauses is not always so.  Merger clauses can pose challenges to practitioners and courts as they wrestle with strict application of the parol evidence rule and various exceptions that might allow admission of parol evidence under certain circumstances, even where the agreement contains a merger clause.

    The general rule is that if a writing contains a merger clause indicating the writing is a full and final expression of the parties’ agreement, i.e. the writing is completely integrated, the trier of fact may not look outside the four corners of the written agreement; parol evidence is excluded from the inquiry.  On the other hand, if the writing is not totally integrated, parol evidence may be admissible to explain or expand on certain terms contained therein.  However, parol evidence is generally not admissible to contradict the terms of the writing, regardless of whether the writing is totally or partially integrated. In sum:

    • Explaining or expanding on written terms. If the writing is not totally integrated, parol evidence may be admissible to explain or expand on certain terms contained therein.
    • Contradicting written terms. Parol evidence is generally not admissible to contradict the terms of the writing, regardless of whether the writing is totally or partially integrated.

    Explaining and expanding on terms. While extrinsic evidence is generally not admissible to contradict a term of a completely or partially integrated written agreement, evidence of a consistent additional term is admissible to supplement an integrated agreement unless the court finds that the agreement was completely integrated.  But the agreement cannot be completely integrated if it omits a consistent additional agreed term which is (a) agreed to for separate consideration, or (b) such a term as in the circumstances might naturally be omitted from the writing.  Accordingly, if there is evidence of such a term, it could be admissible on the issue of complete integration and to supplement the agreement if it is not completely integrated.

    In addition to supplementing a written agreement, parol evidence is generally admissible to explain the terms of the parties’ written agreement.  However, even courts that admit parol evidence to explain a fully integrated written agreement might not permit such evidence if the agreement contains a merger clause expressly forbidding the use of extrinsic evidence.  For example, in Hot Rods, LLC v. Northrop Grumman Sys. Corp., 196 Cal. Rptr. 3d 53 (Ct. App. 2015), the merger clause provided as follows:

    This Agreement contains the entire understanding between the Parties and supersedes any prior understandings or written or oral agreements between them regarding representations, agreements, arrangements or understandings, oral or written, between the parties hereto relating to the subject matter of this Agreement which are not fully expressed in this Agreement. The Parties further intend that this Agreement constitutes the complete and exclusive statement of its terms and that no extrinsic evidence whatsoever may be introduced in any judicial proceedings involving this Agreement.

    196 Cal. Rptr. 3d at 58 (emphasis added).

    Based on the preclusive language in the last sentence of the merger clause, the court held that the trial court erred in admitting extrinsic evidence even to explain the terms of the contract.

    Contradicting written terms. Typically, parol evidence, often offered in the form of agreements or negotiations prior to or contemporaneous with execution, is not admissible to contradict a term of a totally or partially integrated written agreement. This rule is set forth in the Restatement:

    Except as stated in the preceding Section, where there is a binding agreement, either completely or partially integrated, evidence of prior or contemporaneous agreements or negotiations is not admissible in evidence to contradict a term of the writing.

    Restatement (Second) of Contracts § 215 (1981).

    There are, however, some exceptions to this general rule.   For example, agreements and negotiations prior to or contemporaneous with the adoption of a writing are admissible in evidence to establish that the writing is or is not an integrated agreement, or that the integrated agreement is completely or partially integrated.  Such evidence is also admissible to establish the meaning of the writing, whether or not integrated.  Notably, this exception applies to interpreting the plain meaning of the terms of, not the parties’ subjective intent.  Parol evidence is also admissible to establish illegality, fraud, duress, mistake, lack of consideration, or other invalidating cause, as well as grounds for granting or denying rescission, reformation, specific performance, or other remedy.  Each of these exceptions is set forth in the Restatement (Second) of Contracts § 214 (1981).

    Explanatory or contradictory? Distinguishing explanatory evidence from supplemental or contradictory evidence is often difficult. Skilled advocates on either side of a dispute may be able to take a term outside a written agreement and make equally convincing cases that the term is admissible to explain a term or terms of the agreement and that the evidence should be excluded as contradicting the terms.

    “The test of admissibility of extrinsic evidence to explain the meaning of a written instrument is not whether [the writing] appears to the court to be plain and unambiguous on its face, but whether the offered evidence is relevant to prove a meaning to which the language of the instrument is reasonably susceptible.”  Pacific Gas & Elec. Co. v. G.W. Thomas Drayage & Rigging Co., 442 P.2d 641, 644 (Cal. 1968) (emphasis added).  Cf. Trident Center v. Connecticut Gen. Life Ins. Co., 847 F.2d 564 (9th Cir. 1988) (criticizing but nevertheless applying this rule). In determining whether there is a contradiction, a court must decide whether the terms at issue are consistent or inconsistent. This question often cannot be answered from the face of the writing.

    To aid in this analysis, the court must apply the writing to its subject matter and place it in context. The court then must answer the question of contradiction as part of its interpretation of the agreement. The asserted meaning of the term at issue must be one to which the language of the writing, read in context, is reasonably susceptible. If no other meaning is reasonable, the court should rule as a matter of law that the meaning is established.

    Resolving ambiguity. Ambiguity is often regarded as a predicate to the admission of extrinsic evidence. Generally, extrinsic evidence of the parties’ intentions is admissible if the contract is ambiguous, and is not admissible if the contract is unambiguous. Eagle Indus., Inc. v. Devilibiss Health Care, Inc., 702 A.2d 1228, 1232 (Del. 1997); Louisiana Mun. Police v. J.P. Morgan Chase & Co., 2013 WL 3357173 (S.D.N.Y. July 3, 2013).  Whether a contract term is ambiguous is a threshold question of law for the court to decide.  Rhone-Poulenc Basic Chemicals Co. v. Am. Motorists. Ins. Co., 616 A.2d 1192, 1195 (Del. 1992); W.W.W. Assocs. v. Giancontieri, 566 N.E.2d 639 (N.Y. 1990); Duane Reade Inc. v. St. Paul Fire and Marine Ins. Co., 411 F.3d 384, 390 (2d Cir. 2005).  A party seeking to offer extrinsic evidence will almost always argue the contract term at issue is ambiguous.  But a provision is not ambiguous simply because the parties offer different readings of its language.  GMG Capital Inv., LLC v. Athenian Venture Partners I, LP, 36 A.3d 776 (Del. 2012); Mount Vernon Fire Ins. Co. v. Creative Hous., 668 N.E.2d 404 (N.Y. 1996).  Rather, a contract is ambiguous, so that extrinsic evidence may be offered as to its interpretation, only if the language is reasonably sus­ceptible of more than one meaning.  This is ascertained from the perspective of a reasonable person in the position of the parties, not the parties’ own subjective interpretations. GMG Capital,36 A.3d at 780; Lightfoot v. Union Carbide Corp., 110 F.3d 898, 906 (2d Cir.1997).

    An important aspect of the ambiguity inquiry is contextual evidence, such as the parties’ course of dealing to the trade usage of a certain term.  Lightfoot, 110 F.3d at 906; Nowak v. Ironworkers Local 6 Pension Fund, 81 F.3d 1182, 1192 (2d Cir. 1996).  To be sure, trade usage or other contextual evidence may not be admissible in every case. A court may treat such evidence as parol evidence and exclude it if the agreement at issue is integrated or, even if it is not, if the contextual evidence cannot be squared with the written terms of the agreement. However, a court could elect to admit the evidence.  Trade usage and other contextual evidence differs materially from other extrinsic evidence, such as the parties’ discussions leading up to their execution of the agreement.  Trade usage can be established by more reliable and objective evidence, and courts are more likely to admit it.

    Both the Restatement and the UCC give guidance on how trade usage is to be considered and applied and permit an integrated agreement to be supplemented by evidence of course of dealing and trade usage:

    Restatement (Second) of Contracts § 222: Usage of Trade
    (1) A usage of trade is a usage having such regularity of observance in a place, vocation, or trade as to justify an expectation that it will be observed with respect to a particular agreement. It may include a system of rules regularly observed even though particular rules are changed from time to time.

    (2) The existence and scope of a usage of trade are to be determined as questions of fact. If a usage is embodied in a written trade code or similar writing the interpretation of the writing is to be determined by the court as a question of law.

    (3) Unless otherwise agreed, a usage of trade in the vocation or trade in which the parties are engaged or a usage of trade of which they know or have reason to know gives meaning to or supplements or qualifies their agreement.

    Uniform Commercial Code § 2-202(a)
    Terms with respect to which the confirmatory memoranda of the parties agree or which are otherwise 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 but may be explained or supplemented

    (a) by course of dealing or usage of trade (Section 1-205) or by course of performance (Section 2-208)

    The UCC provision makes clear such evidence should be admitted even where the writing is integrated and represents the final expression of the parties’ agreement.  In other words, § 2-202(a) embodies a strong presumption that parties intend to contract in light of their own and the market’s customary practices.  Thus, the parties might reasonably assume the writing’s terms arise from these sources, and they may not refer to the sources expressly in the agreement.  This should compel parties to use clear, explicit language in the writing if they intend to exclude trade usage or similar contextual evidence from their contract.

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

    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