Recent Expansion of Lender and Servicer Risk of Adverse Misrepresentation Claims and Lawsuits.

Written By: Eric D. Dean and Christine E. Howson

As a matter of case law, statute and contract interpretation it has long been the established and accepted law in California that a party to a written agreement, including a borrower or guarantor, could not successfully introduce a prior agreement or contemporaneous oral agreement or promise that contradicted the express written terms of an unambiguous provision in an integrated loan agreement or security instrument.  (An integrated agreement is a writing or writings constituting a final expression of one or more terms of an agreement.)   This long standing rule of law which existed for nearly 75 years had been found applicable to promissory fraud claims despite the fraud exception to California’s Parol Evidence Rule. However, the California Supreme Court in the case of Riverisland Cold Storage, Inc. v. Fresno- Madera Production Credit Association (“Riverisland”) 2013 Cal. LEXIS 253 determined that reasoning and logic behind the long standing prohibition were faulty and unsupportable. 

In Riverisland, the Fresno-Madera Production Credit Association (“the Credit Association”) entered into a written loan restructuring agreement with the Borrowers.  The Borrowers contended that they did not read the agreement and simply signed it where it was tabbed for their signatures based on their understanding of the document derived from purported verbal representations of the lending officer .  After the loan modification was signed, the Borrowers failed to make the required payments, and the Credit Association filed a Notice of Default and commenced foreclosure proceedings with respect to the collateral.  Ultimately, the loan was repaid; however, the Borrowers and the guarantors of the loan sued the Credit Association alleging fraud, negligent misrepresentation, rescission and reformation of contract.

In their lawsuit, the Borrowers contended that prior to entering into the loan restructuring agreement, the Credit Association’s vice president met with them and told them that the Credit Association would extend the loan for two (2) years in exchange for Borrower’s pledging additional collateral approved by the Credit Association.  However, the actual restructuring agreement signed by the Borrowers provided for only a three (3) month forbearance while identifying more new collateral than the Borrowers contended to understnad was required. The Borrowers further alleged as part of their damages, that to avoid a loss of the pledged assets, the Borrowers sold part of the newly pledged collateral in what they contended was a “soft market” to pay off the Credit Association loan.

The Credit Association contended that the Borrowers’ suit was barred in its entirety since the claims asserted by the Borrowers directly contradict the express terms of the signed Loan Restructuring Agreement.  Prior to the California Supreme Court’s holding in the Riverisland case, unless certain special circumstances existed (e.g. the nature of the document being signed was misrepresented or the Borrowers were under duress or incapacitated when they signed the agreement), in most instances, the Credit Association would lhave been successful in ending a lawsuit such as brought by the Borrowers before trial.

However, in Riverisland,  the California Supreme Court found  that the reasoning behind the long established rule excluding a defense based on an allegation of fraud sought to be established by extraneous communications to the loan documents had been poorly analyzed and demonstrated a lack of reliance on properly reasoned precedent holding to the contrary. Based on its analysis, the Supreme Court held that parol or extrinsic evidence, whether written or verbal, can be introduced by a party to a lawsuit seeking to establish fraud in the inducement even if these assertions directly conflicts with the terms of a signed integrated written agreement.

In Riverisland, the Supreme  Court emphasized that the party asserting the purported fraud still must establish justifiable reliance on the purported fraudulent misrepresentation or promise to prevail.  Despite this limitation, it cannot only be anticipated that more of these fraud claims will be asserted by Borrowers and Guarantors against Lenders but that it will be far more difficult to terminate such claims at the pleading stage of a Lawsuit or even by a summary judgment motion. As a result, where Lenders would generally refuse to consider settlement of such claims, the Borrower may be able to force some form of a settlement so that the Lender is no faced with protracted litigation and the costs and risks attendant to such proceedings.

Two immediate responses to the Riverisland case that the authors recommend are:

(1) In appropriate cases,  require the Borrower to have independent counsel sign an acknowledgement that the loan documents are fully reflective of all agreed terms, that there are no terms or representations made by or on behalf of the lender not included in the loan documents and that he or she has fully reviewed all loan documents and loan terms with his or her client. Similar kinds of legal acknowledgements are commonly obtained in attorney opinion letters. In light of the Riverisland case, expansion of the use of these kinds of letters appears prudent and warranted in connection with commercial loan agreements.

(2) Require the Borrower to sign a letter of acknowledgment before a notary including such things as that he or she has fully reviewed and read all of the loan documents before signing, that the Borrower had an opportunity to consult with independent counsel of the Borrower’s choice, that there have been no representations made by the lender or any agent of the lender or any terms or conditions agreed to that are not expressly set forth in the loan documents, and that any question the Borrower may have had as to the loan documents was fully and accurately responded to by the lender in all respects.

While the suggestions in the preceding paragraphs may not end the expansion of the risk of promissory fraud lawsuits produced by the Riverisland Case, these suggestions would appear to negate the ability of the Borrower to establish justifiable reliance and set up the framework to successfully challenge a claim or defense under Riverisland.