California Real Estate and Finance Alert: Riverisland Alters Legal Landscape

A precedent-setting case in California is changing the way lenders, developers and other parties involved in real estate and finance are handling contract negotiations. In Riverisland Cold Storage, Inc., et al. v. Fresno Madera Production Credit Assn. (decided January 2013), the California Supreme Court held that evidence of oral statements made prior to or at the time of entering into a written contract are admissible to show fraud even if the contract was "integrated." A contract is "integrated" if it states that it is the final and complete expression of the agreement between the parties. Before Riverisland, if a contract was integrated, one party could not show evidence that the other party told them the contract had different terms than what was written.

In Riverisland, the borrowers defaulted on a commercial real estate loan and tried to avoid liability by showing the lender had committed fraud. The borrowers said that before signing the loan documents, the lender told them it would extend the loan for two years if the borrowers provided additional collateral in the form of two parcels of land. The written loan documents gave the borrowers only a three-month extension and collateralized eight parcels of land. Even though the borrowers admitted they did not read the loan documents, the Court allowed the borrowers to admit the oral statements as evidence of fraud on the part of the lender even though the loan documents were integrated and the oral statements were contrary to the terms of the written documents.

Some view Riverisland as the harbinger of doom for integrated contracts. It is feared that now every defaulting borrower or tenant will say it was the victim of fraud and courts must allow it to put on evidence of the alleged fraud.

A number of cases have followed Riverisland and expanded it to other situations. In June 2013, the Court of Appeal, in Julius Castle Restaurant Inc. v. Payne, held that even heavily negotiated agreements between sophisticated parties are subject to Riverisland.

In Julius Castle, commercial tenants who were "very well qualified restaurateurs with well over 38 years of successful operations" tried to avoid liability under a restaurant lease and guaranty, which were the products of "extensive negotiations" between the parties, by alleging that their landlord induced them to enter into the lease by making fraudulent statements about the condition of the premises. The court held that, although the lease was integrated and contained several provisions directly in conflict with what the landlord allegedly said, the tenants were entitled to proceed with their case because of the holding in Riverisland.

In February, March, June, July and September of 2013, other Courts of Appeal have applied Riverisland in a variety of contexts, including defaulted promissory notes and other commercial real estate transactions, allowing parties to admit evidence of fraud despite an integrated agreement. The result is that Riverisland is likely here to stay, and lenders, developers and other parties involved in real estate and finance need to be very careful in negotiating transactions to avoid making oral promises, commitments or representations during the negotiation stage which are not ultimately reduced to writing.

Riverisland sets a precedent that will undoubtedly result in many more cases making it to trial that would not otherwise get that far, leading to a significant additional burden on the justice system. It is now clear that evidence of oral representations or promises that contradict the terms of the written agreement will be admissible in many more situations, and the parties must undertake contract negotiations with that in mind.

No single course of action will make an integrated agreement immune to a fraud claim or offer complete protection against liability for statements made prior to contract execution under Riverisland, but steps can be taken in the commercial lending and leasing context to minimize the risk to the party attempting to enforce the written agreement, including:

1. careful drafting of loan documents and leases, including explicit statements that each of the parties to the contract has read and understands the entire agreement after seeking the advice of independent legal counsel;
2. adding alternative dispute resolution clauses to the loan documents, such as judicial reference provisions, arbitration clauses or jury trial waivers (where enforceable), with the hopes of the case being argued before a judge who would be more likely to see through a meritless fraud claim than a jury;
3. inserting clauses in the written agreement that the parties acknowledge their respective obligations under the contract and there are no defenses to the enforceability of the contract;
4. carefully tailoring language in the written agreement in order to establish the document as fully integrated; or
5. obtaining a separate certificate executed by the borrower or tenant stating that it has read and understands the loan documents or lease and is not relying on any statements of the lender or landlord that are not included in the written agreement.

Although Riverisland and its companion cases do not provide a set of guidelines for contracting parties to follow, being very careful to memorialize key conversations in email format and taking precautions such as those listed above should mitigate the risks associated with a statement or promise being introduced as evidence to contradict the terms of the written agreement.