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.

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