If you enter into a contract (including a lease, purchase agreement or any other written agreement), what happens if the other party later claims you promised something that's different from what’s in the contract?
In California, for over 78 years there’s been a rule that generally protected parties from these sorts of claims. The rule prevented one party to a contract from suing the other for fraud based on alleged promises or representations that were contradicted by the express terms of the contract. In other words, if the contract said I would do X, you couldn't sue me for fraud claiming that I really promised Y.
But this rule, called the Pendergrass rule based on a 1935 case with the same name, was thrown out in 2013 by a California Supreme Court in the Riverisland case discussed below. And while the Riverisland case was worrisome enough, a case that followed it, the Julius Castle case, also discussed below, shows how easy it has become for one party to successfully sue the other for fraud based on allegations that are directly contradicted by their written contract.
Why you should be worried:
The Riverisland and Julius Castle cases are discussed below in detail, but to keep you reading, here’s the short version of Julius Castle : A sophisticated landlord and tenant entered into a commercial lease for a restaurant property. In the lease the tenant accepted the premises "as is", and the landlord had no obligation to maintain or repair the restaurant equipment that had been left by the previous tenant. However, the tenant later sued the landlord for fraud and alleged that the landlord's agent promised *verbally* that the landlord would repair any faulty restaurant equipment. The result? After a jury trial, even though the written lease directly contradicted this alleged verbal promise, which the landlord continued to dispute was ever made, the tenant was awarded $205,800 in damages and $158,180 in attorney’s fees and costs.
How do you protect yourself from a similar result and avoid being sued for fraud based on an alleged promise you claim you never made that contradicts your written agreement? The linchpin to a party’s claim for fraud is that it must show it justifiably relied on the alleged promise or representation, and one way to significantly undercut a party’s ability to show its reliance was justifiable, and therefore defeat the party’s claim, is to include a specific waiver of reliance or “big boy” provision in the contract.
Given the change in California law, which again did away with 78 years of precedent, if you are entering into an agreement that's vulnerable to these sorts of claims (which would include any complex transaction with significant prior negotiation), you should consider including a waiver of reliance provision.
Below is a discussion of the Riverisland and Julius Castle cases and of waiver of reliance provisions in California and other states. It’s a long post, so feel free to jump around.
Two ranchers sign and initial a loan modification agreement and then claim they never read it.
In Riverisland, two ranchers, after signing and initialing a loan modification agreement, claimed they never read the agreement and that the lender's agent verbally promised terms that were different from those that were in the written agreement. The ranchers had fallen behind on loan payments to their lender. The lender agreed to restructure the loan and prepared a modification agreement in which the lender agreed to forbear for three months if the ranchers made reduced payments and pledged eight parcels of real property as additional collateral.
The ranchers/borrowers signed the modification agreement and even initialed the pages with the legal descriptions for the additional parcels. However, after entering into the agreement, the ranchers failed to make the reduced payments required. When the lender moved to foreclose, the ranchers sued the lender for fraud and claimed that even though they had signed the modification agreement and initialed all the pages, they never read the agreement and instead relied on the lender's representative's *alleged* promise that the loan would be would be extended for two years, not three months, and that they were only pledging two additional parcels of property, not eight.
How times have changed and why the Court overturned Pendergrass.
Based on the 78-year-old Pendergrass rule noted above, the ranchers' claim would have been denied because the alleged verbal statements of the lender's representative conflicted directly with the terms of the written agreement that the ranchers signed. But times have changed.
While in 1935, the California Supreme Court was concerned that plaintiffs like the ranchers in Riverisland would perjure themselves by making up claims to get out of their agreements, today the Court fears the opposite and now worries that barring these claims, no matter how implausible, would encourage parties to promise things they had no intention of doing (or documenting). And so in the Riverisland case, which you will likely seen referenced again and again in the coming years, the Court overruled Pendergrass and permitted the ranchers' claims to go forward, claims that essentially rewrote the modification agreement that the ranchers signed and initialed but claimed to have never read.
Why you shouldn’t dismiss Riverisland as being an insignificant change.
After the Riverisland case, legal commentators (and the Court itself) sought to soften the perceived impact of doing away with the old Pendergrass rule by reminding us that the new rule under Riverisland is followed by a majority of other states, and, more importantly, even if a plaintiff may now bring a claim for fraud that would have previously been barred, the plaintiff must still prove it justifiably relied on the alleged misrepresentation or false promise.
However, both of these points mean very little in practice. With regard to the first point, that other states follow a similar rule, the rule is still new in California and leaves 78 years of precedent in question with little clear direction from the courts on what the limits of a plaintiff's potential claims will be. Simply put, in 2012 a party could not claim that it relied on a statement that conflicted with a written contract. Today, the party can. This change exposes contracting parties to a new risk, especially with regard to the type of alleged verbal statements at issue in the Riverisland and Julius Castle cases, and while parties in other states, can look to their state's precedent to gauge and manage that risk, parties in California cannot.
With regard to the second point, that a plaintiff must nevertheless show it justifiably relied on an alleged promise, a few more facts from the Julius Castle case below will show how low that standard actually is, especially when a jury is deciding the issue.
The Julius Castle case shows how easy it can be for a party to prevail when claiming the other party made a promise or representation that wasn't documented. The case involved two experienced restaurant operators who entered into a long-term lease for a historic restaurant property. After operating for just six months, the tenants closed their business. Instead of walking away, they sued their landlord for damages for the lost business opportunity of selling the restaurant. The tenants claimed that their six-month old business was profitable every month (even though they failed to pay sales taxes, began withholding payments to the landlord, and stopped paying their vendors and lender).
The tenants' primary claim was that the landlord, through his agent, promised during lease negotiations to repair any faulty restaurant equipment. The landlord had inherited the equipment from the previous restaurant tenant. The landlord denied ever promising to repair the equipment or fix anything else on the premises, and the lease did not include such an obligation. Instead, the lease provided that the tenants were taking the property "as-is".
What's more, before the tenants signed the lease, they were fully aware that the lease did not require the landlord to repair the equipment. As the court noted, the parties "went through every page of the Lease together to ensure they were all satisfied with the document." Over several weeks of negotiating and drafting the lease, the tenants "asked many questions so that they would feel confident and satisfied with the final version" and testified that they "did not feel rushed."
Despite weeks of reviewing, negotiating and apparently revising the lease on other issues, when it came to the landlord's alleged promise to repair the restaurant equipment, the tenants testified that they did not require the lease to be modified to reflect that point because "the obligation was already implied and [the landlord] had already promised to make any needed repairs."
Remember that in Riverisland, one of the justifications for allowing these sorts of claims to go through was that even if a party could now base its fraud claim on an alleged statement that was contradicted by the parties' written agreement, the party would still have to show that it justifiably relied on the statement. But as Julius Castle shows, in practice "justifiable reliance" does not mean much.
In Julius Castle, the tenants were sophisticated, negotiated and reviewed the lease at length, and knew what was and was not in the lease. The tenants requested multiple other revisions to the lease, but when it came to the condition of the restaurant equipment, which the tenants testified was critical to their business, they allegedly decided there was no need to incorporate the landlord's promise because it was already implied . . . and the jury agreed that this was justified.
But when would a party ever be justified in relying on a verbal statement about a material, even critical issue, when the written agreement says the opposite, and the party knows the written agreement says the opposite and has the power to revise the agreement?
The answer is never, and the fact that the jury didn't get that is why you shouldn't find much comfort in the idea that if a party sues you for fraud, the party won't be able to show justifiable reliance. If the tenants in Julius Castle were able to show justifiable reliance, it's hard to imagine what sort of plaintiff could not.
Waivers of Reliance -- Undercutting a party's justifiable reliance on extra-contractual promises and representations.
What should you do to protect yourself from the type of claims the lender and landlord were faced with in the cases above?
First, remember that the issue not whether a plaintiff can claim you promised or represented something that didn’t make its way into the contract. (There are almost always promises or representations that don't make it into the final agreement -- that's called negotiation.) The issue is whether a plaintiff can justifiably rely on promises or representations that were not ultimately documented as part of the parties’ final deal. Accordingly, anything you can do to chip away at the justifiableness of a party’s reliance will help.
As a preliminary matter, take the time to ensure your contract is clear on material points. In Julius Castle, if the restaurant equipment was discussed and an important issue, beyond the "as is" clause, the landlord would have been helped immensely if the lease affirmatively required the tenant to maintain and repair the equipment. Additionally, whenever there’s an opportunity to put something in writing, even if simply an informal email confirming a point or denying a request, do it.
Beyond that, the best way to build a certain amount of protection into your contracts, even if not 100%, is to include a waiver of reliance or “big boy” provision that expressly states that each party is not relying on any promises or representations not incorporated in the final contract. As discussed below, although most contracts do include an “integration clause” stating that the parties' contract is the final agreement and that there are no other promises or representations, there is difference between saying “there are no other representations” and saying “I am not relying on any other representations.”
Waivers of Reliance in Other States
In other states which never had the benefit of the Pendergrass rule and seem to have more precedent on these types of issues, commercial contracts often (and apparently increasingly) include waiver of reliance or "big boy" provisions. A New York case, Danann Realty Corp. v. Harris, 5 N.Y.2d 317 (1959), illustrates nicely how this sort of provision can destroy a plaintiff’s ability to claim it relied on promises or representations made outside of the contract.
In the case, a purchaser of commercial property claimed the seller misrepresented the property’s profitability; however, in the purchase agreement, the purchaser agreed as follows:
"The Seller has not made and does not make any representations as to the physical condition, rents, leases, expenses, operation or any other matter or thing affecting or related to the aforesaid premises, except as herein specifically set forth, and the Purchaser hereby expressly acknowledges that no such representations have been made, and the Purchaser further acknowledges that it has inspected the premises and agrees to take the premises `as is' * * * It is understood and agreed that all understandings and agreements heretofore had between the parties hereto are merged in this contract, which alone fully and completely expresses their agreement, and that the same is entered into after full investigation, neither party relying upon any statement or representation, not embodied in this contract, made by the other."
The court focused in on the language above, particularly the last line stating that neither party was relying on any statement or representation not embodied in the contract. The court determined that the plaintiff had no cause of action for fraud because “[s]uch a specific disclaimer destroys the allegations in plaintiff’s complaint that the agreement was executed in reliance upon these contrary oral representations.”
And in a rather nice twist of logic, the court reasoned that the plaintiff itself, by bringing a claim for fraud that contradicted its disclaimer, was committing a sort of fraud:
"[P]laintiff made a representation in the contract that it was not relying on specific representations not embodied in the contract, while, it now asserts, it was in fact relying on such oral representations. Plaintiff admits then that it is guilty of deliberately misrepresenting to the seller its true intention. To condone this fraud would place the purchaser in a favored position."
For an excellent review of these sorts of provisions and their enforceability in other states, see this article.
Waivers of Reliance in California
In California, provisions waiving reliance on statements made outside of the contract do not provide 100% protection, but they can be very helpful.
First, note again that it’s not enough to simply state that there are no other promises or representations except as provided in the agreement. The lease in Julius Castle had an integration clause that stated just that and read: “Any agreement or representations respecting the Premises or their leasing by Landlord to Tenant not expressly set forth in this instrument are void.” But this sort of statement is not a waiver of reliance and does not prevent a party from claiming that there were other statements made outside of the contract that it relied on. See Ron Greenspan Volkswagen, Inc. v. Ford Motor Land Dev. Corp., 32 Cal. App. 4th 985 (1995) (finding a similar clause stating "[n]o express or implied representations, warranties, or inducements have been made by any party to any other party except as set forth in this Agreement" could not prevent a claim for fraud).*
To get any sort of protection, the parties must actually agree that they are not relying on any extract-contractual promises or representations. Several courts applying California law have found that this sort of clause -- a true waiver of reliance -- limits a plaintiff's ability to show that its reliance on statements not documented in the contract was justifiable.
In a 2005 leasing case, Hinesley v. Oakshade Town Center, involving a retail lease in a shopping center, a tenant sued its landlord for fraud and rescission of the lease claiming that the landlord's agent told the tenant during negotiations that a regional restaurant chain Dos Coyotes, a Starbucks, and a Baskin-Robbins ice cream shop would all be opening near the premises the tenant was leasing. (Side note: Do you see the pattern? The alleged fraudulent statement is always made by the landlord's agent and is always verbal.) The lease, however, expressly disclaimed the tenant's reliance on such statements:
"Lessee does not rely on the fact nor does Lessor represent that any specific Lessee of [sic] type or number of Lessees shall during the term of this Lease occupy any space in the Shopping Center."
Relying in large part on the language above, the court held that the tenant could not have, as a matter of law, justifiably relied on the alleged statements by the landlord's agent. Again, distinguishing between a common integration clause and a waiver of reliance, the court noted that this language "was not merely a generic integration/no oral representations clause. The language specifically stated, "Lessee does not rely on the fact nor does Lessor represent . . ." and "such express language should have conveyed the implication [to the tenant] that the lease did not come with a guarantee that any particular businesses would be or stay cotenants . . .. The clause should have put [the tenant] on notice to ask further questions. The clause is certainly a factor to consider in determining whether [the tenant] justifiably relied . . .." Hinesley v. Oakshade Town Center , 135 Cal. App. 4th 289 (2005).
Other cases have reached similar results: Paracor Finance, Inc. v. General Electric Capital Corp., 96 F.3d 1151, 1159 (9th Cir. 1996) (court concluded that plaintiffs' “contractual representation that they did not rely on any other person goes far to defeat their present claims that they did precisely the opposite and relied on [defendant].”); Bank of the West v. Valley National Bank of Arizona, 41 F.3d 471, 478 (9th Cir. 1994) (court held that "the contract could and did control whether . . . reliance would be 'justifiable' for purposes of a fraud claim" and given the plaintiff's promise in the contract to act "independently and without reliance" on the defendant, it had no right to then do the opposite); Lancer Offshore, Inc. v. Dominion Income Mgmt. Corp., 01 CIV. 4860 (LMM), 2002 WL 441309 (S.D.N.Y. Mar. 20, 2002) (court held in the context of a settlement agreement that a plaintiff could not sustain a claim for fraudulent inducement where the parties agreed they did not rely on any representations made by the other party and assumed the risk of any unknown or concealed facts or information).
Final thoughts on crafting your own waiver of reliance provision.
It’s clear that at least in California, post Riverisland, there is an increased risk of litigation from a party claiming that it relied on alleged promises or representations that were never documented. Including a waiver of reliance provision may prevent a party from claiming it justifiably relied on any undocumented promises or representations, and even if such a provision is not ironclad, it's still worth adding. If you doubt that, remember the Julius Castle landlord who paid hundreds of thousands of dollars to a tenant that occupied for his property for just a few months because of an alleged verbal statement by the landlord's agent.
So if you are going to include a waiver of reliance provision, what should it say? As the discussion above makes clear, it's not enough to say there are no other promises or representations. At minimum the parties need to clearly agree they are not relying on any other promises or representations not included in the contract. Beyond this fundamental statement, what else should be covered?
A good place to start is to think about what's implied when you sign a contract (meaning as a sophisticated party entering into a commercial contract, not as a consumer signing whatever's put in front of you). At a minimum, you are agreeing to be bound by the terms of the contract. And it follows from that, that you are also indicating that you've read and understood the terms you'll be bound by, and to the extent you haven't, that you are nevertheless assuming the risk of complying with such terms. In addition, there's an implication that if a term is material to you and is not in the contract or is not correct or clear, you will speak up and ask for the contract to be revised .
A waiver of reliance provision might make these implications express agreements by the parties by covering the following points and clarifying that each is a material part of the consideration:
- each party has read the entire agreement;
- understands all of the provisions in the agreement and has requested modifications to the extent necessary to ensure this agreement clearly and completely reflects the party’s understanding;
- is not relying on any statement, representation, warranty, agreement or promise made by the other party, or any of the other party’s employees, agents, or contractors, that is not set forth in the agreement; and
- assumes the risk of any such statement, representation, warranty, agreement or promise not being set forth in this agreement.
Given the tendency of plaintiffs to claim they didn't read the agreement (or at least the part about waiving reliance), it's also a good idea to require the parties to initial a provision like this.
In addition to these basics, consider the proper scope of a waiver of reliance. Such a provision could be a double-edged sword, and courts are generally less willing to enforce provisions that seem overly broad or generic. So narrowing the scope could help on both fronts. The Hinesley cases has a good example of a very narrow waiver -- it applied only to cotenants. As another example, if you are only concerned with the type of claims brought by the plaintiffs in the Riverisland and Julius Castle cases, you might limit the waiver to verbal statements that conflict with the terms of the written agreement.
Finally, for specific types of transactions, another way of making a waiver of reliance provision more specific (and thus more likely to be enforced) and at the same time adding a sort of checklist for the parties would be to list out specific issues that the wavier applies to, for example, specifying that a tenant is not relying on any representations or promises regarding other tenants, the size of the space, the condition of the property, operating expenses, maintenance and repair obligations, etc. As shown in Hinesley (and out of state cases referenced by the article cited above) this sort of specificity can make it even harder for a plaintiff to overcome the waiver.
*As a side note, another case often cited, McClain v. Octagon Plaza, LLC , 159 Cal.App.4th 784 (2008), regarding a landlord’s misrepresentation of the size of a premises, held that a disclaimer in the lease did not prevent the plaintiff from showing justifiable reliance; however, that case is different from the cases discussed above in that the representation regarding the size of the premises was in the lease itself. This article is concerned with limiting questionable claims like those in Riverisland and Julius Castle which are based on alleged statements outside of the agreement, particularly alleged verbal statements contradicted by the agreement itself.
Photo credit: Photo of Julius Castle by ario_ (https://www.flickr.com/photos/ario/)