The Parol Evidence Rule. The Gatekeeper of Evidence in Contract Cases
By Mark B. Wilson, P.C.
The parol evidence rule has nothing to do with convicted criminals getting out of prison early. Instead, it governs how trial courts are supposed to decide which evidence to exclude from the jury in cases involving contract interpretation. Juries are not competent to interpret contracts. Instead, contractual interpretation is purely a judicial function. Accordingly, when a contract can be (and legally should be) interpreted on its face, juries are not supposed to get involved.
Anytime a written contract is at issue, trial lawyers should evaluate the impact the parol evidence rule has on what evidence a jury should hear. Failure to consider the parol evidence rule may result in the court inadvertently permitting a jury to consider legally irrelevant evidence which can affect the outcome.
A. The Parol Evidence Rule
In contract disputes, parties often have different interpretations of what the contract means. For instance, if a farmer enters into a written contract to sell 100 "baskets of apples" to a local grocer, the parties may disagree on the size of the basket and whether the contract anticipated the sale of green or red apples. The grocer may say the parties agreed a "basket" is the standard size used by the local growers' union. The farmer may argue that when the parties referenced "basket" in their contract, they were referring to the farmers' "baskets" which are smaller than the union's baskets (and so on).
The parol evidence rule, codified in Code of Civil Procedure section 1856, governs how court's are supposed to filter evidence in disputes like this. The essence of the rule is that evidence (oral or written) of prior or contemporaneous agreements to add to or modify the terms of an unambiguous "integrated" written agreement is barred. Masterson v. Sine (1968) 68 Cal.2d 222, 225. While the rule is straightforward, its application is not.
B. Is the Agreement Integrated?
The first step in analyzing admissibility of parol evidence is for the trial court (without assistance from the jury) to determine whether the contract is "integrated" or the "final expression of [the parties'] agreement with respect to such terms as are included therein." Code of Civil Procedure section 1856(a); Esbensen v. Userware Int'l, Inc. (1992) 11 Cal.App.4th 631, 637. Courts usually consider the following factors in making this determination: (1) whether the written agreement on its face appears to be a complete statement of the parties' agreement; (2) whether the parol evidence contradicts the written agreement; (3) whether any alleged "collateral oral agreement" might naturally be made as a separate agreement; and (4) whether the parol evidence is likely to mislead the jury. Banco Do Brasil, S.A. v. Latian, Inc. (1991) 234 Cal.App.3d 973, 1002-1003.
Often, written contracts contain an "integration clause," stating the agreement is "integrated" and there are no other agreements between the parties. [T]he presence of an 'integration' clause will be very persuasive, if not controlling, on this issue of integration." Banco Do Brazil, S.A. v. Latian, Inc., supra, 234 Cal.App.3d at 1002-03. Emphasis added. In the case of the "apple contract," even if there were an integration clause, the court would probably allow a jury to hear parol evidence on what "baskets" means because the contract does not define this ambiguous term, and contracts can be supplemented by "course of dealing," "usage of trade," and "course of performance." Code of Civil Procedure section 1856(c) and (g). However, if the "apple contract" defined all terms and contained an integration clause, a court probably should not permit evidence to contradict the parties' written terms.
Once a court has determined a contract is integrated, "extrinsic evidence is admissible only to supplement or explain the terms of the agreement - and even then, only where such evidence is consistent with the terms of the integrated document, and only where the writing is not also intended as an exclusive statement regarding its subject matter." EPA Real Estate Partnership v. Kang (1992) 12 Cal.App.4th 171, 176-177. See also, Code of Civil Procedure section 1856(b) and Esbensen v. Userware International, Inc. (1993) 11 Cal.App.4th 631, 637 [when a contract is fully integrated, "parol evidence is inadmissible even to add terms NOT inconsistent with the writing."] Emphasis added.
EPA Real Estate Partnership v. Kang (1992) 12 Cal.App.4th 171 is a good case study on how trial courts should apply the parol evidence rule. EPA Real Estate Partnership ("EPA") owned an apartment complex and signed a listing agreement with Feher Young to sell it. The listing agreement contained a provision entitling Feher Young to a commission if EPA contracted to sell the property within the listing period. About one month before the listing expired, Kang offered in writing to purchase the property from EPA. EPA said it could not accept the offer because of its obligation to pay Feher Young a commission. Kang agreed to revise his offer and include a promise to indemnify EPA if Feher Young sued EPA for its commission. Id. at 173.
Kang revised his written offer as promised and added the indemnity provision ("Agreement 1"). After EPA's listing agreement with Feher Young expired, Kang and EPA signed a new agreement for Kang to buy the property ("Agreement 2"). Agreement 2 contained an integration clause, but it did not contain the indemnification clause set forth in Agreement 1. Kang then purchased the property from EPA. EPA did not pay Feher Young a commission, and Feher Young sued EPA and recovered almost $300,000. EPA then sued Kang for indemnity pursuant to the indemnity provision in Agreement 1 and claimed the integration clause in Agreement 2 did not bar the action. EPA Real Estate Partnership v. Kang, supra, 12 Cal.App.4th 171, 174-175.
Kang filed a motion in limine to exclude Agreement 1 on the basis the parol evidence rule barred this evidence. EPA argued: (1) it was suing on Agreement 1, not Agreement 2, and these agreements were completely separate; (2) Agreement 1 was not encompassed by the integration clause in Agreement 2, and Agreement 2 had nothing to do with indemnity (i.e., they covered different "subjects"); (3) Agreement 2 was a final expression of the parties' agreement only with respect to the terms included in Agreement 2; and (4) since Agreement 2 was silent on the issue of indemnity, evidence of indemnity would not contradict Agreement 2. EPA Real Estate Partnership v. Kang, supra, 12 Cal.App.4th 171, 174-175, fn.2 and 176.
The trial court in EPA Real Estate Partnership v. Kang, supra, 12 Cal.App.4th 171 rejected all EPA's arguments and granted Kang's motion in limine excluding evidence of the indemnity agreement in Agreement 1. As a result, the trial court entered judgment for Kang. EPA Real Estate Partnership v. Kang, supra, 12 Cal.App.4th at 172-176. The court of appeal affirmed. Ibid. The appellate court reasoned the parol evidence rule:
"prohibits the introduction of extrinsic evidence -oral or written-to vary or contradict the terms of an integrated document. [Citations omitted.] According to this substantive rule of law, when the parties intend a written agreement to be the final and complete expression of their understanding, that writing becomes the final contract between the parties, which may not be contradicted by even the most persuasive evidence of collateral agreements. Such evidence is legally irrelevant." [Citation omitted.] Id. at 175. Emphasis added.
Contrary to EPA's argument, the appellate court reasoned the indemnity provision in Agreement 1 addressed the same subject as Agreement 2 (i.e., the sale of the property). And the indemnity provision (EPA wanted to introduce) varied the extent of Kang's obligation with respect to the sale under the terms of Agreement 2; accordingly, the appellate court held the indemnity provision in Agreement 1 was encompassed within the integration clause of Agreement 2. EPA Real Estate Partnership v. Kang, supra, 12 Cal.App.4th at 176.
The issue of whether an agreement is integrated is often where the battle is won or lost because if the court determines the contract is integrated, extrinsic evidence is not admissible to contradict its terms. Code of Civil Procedure section 1856(a). Accordingly, trial attorneys who are concerned that opposing counsel will attempt to introduce evidence which contradicts the terms of a written contract should take active steps to: (1) determine the opposing side's view on integration of the contract; and (2) exclude evidence which contradicts the plain terms of the written contract.
Discovery should include requests for the opposing side to admit the contract is unambiguous and fully integrated with follow up interrogatories to explain denials of these requests. Often, motions for summary judgment are appropriate in contract interpretation cases because, as a matter of law, courts, not juries are supposed to interpret contracts (unless the interpretation turns on the credibility of evidence). City of Chino v. Jackson (2002) 97 Cal.App. 4th 377, 382-383. See also, O'Connor v. West Sacramento Co. (1922) 189 Cal. 7, 16-17 [the construction of a contract is a matter for the court, and it is only appropriate to involve a jury when there is some ambiguity and parol evidence is necessary to resolve it] and Mobile Oil Corp. v. Handley (1978) 76 Cal.App.3d 956, 961 ["only after the court finds the agreement not integrated may parol evidence be admitted to amplify its terms"]. If the court denies a motion for summary judgment, the trial attorney should consider filing a motion in limine to exclude any evidence which is contrary to the written agreement.
C. Is the Agreement Ambiguous?
If the agreement is ambiguous (i.e., the apple contract example), the court should permit the jury to hear evidence to explain the ambiguity. See, Pacific Gas & Elec. Co. v. G.W. Thomas Drayage & Rigging Co. (1968) 69 Cal.2d 33, 40 and Bionghi v. Metropolitan Water Dist. of So. Calif. (1999) 70 Cal.App.4th 1358, 1366. For instance, in Morey v. Vannucci (1998) 64 Cal.App.4th 904, 912-913 the trial court properly admitted extrinsic evidence to explain the meaning of the term "affiliated entities" in an option contract in order to determine whether the term referred only to the contracting party and its wholly-owned subsidiaries or whether it also included independent subcontractors.
D. Post-contract Conduct and Discussions
Sometimes, parties do and say things after they sign contracts which are inconsistent with the contract terms. Trial attorneys arguing that the contract terms control (despite conduct and discussions to the contrary) must take active steps to exclude this evidence. When properly applied, the parol evidence rule and basic contract interpretation rules prevent "he said, she said" arguments by parties who are not satisfied with the documents they sign. Accordingly, trial courts should not permit parties to introduce evidence of the parties' subjective intent when the written contract is integrated and unambiguous. See, Purdy v. Buffums, Inc. (1928) 95 Cal.App. 299, 303 ["subsequent conduct may be invoked to interpret a contract ONLY in cases whereupon the face of the contract itself there is doubt, and the evidence is used to dispel that doubt, NOT by showing that the parties meant something other than what they said, but by showing what they meant by what they said"]. Emphasis added.
Under California law, the fundamental goal of contract interpretation is to give effect to the mutual intent of the parties as it existed at the time of contracting. Civil Code section 1636 and City of Atascadero v. Merrill Lynch, Pierce Fenner & Smith, Inc. (1998) 68 Cal.App.4th 445, 474. When a contract is reduced to writing, this intent "is to be ascertained from the writing alone . . . ." Civil Code section 1639. Emphasis added. See also, Brinton v. Bankers Pension Services, Inc. (1999) 76 Cal.App.4th 550, 559.
Only the language of the contract is to govern its interpretation. Civil Code section 1638. "[E]vidence of the undisclosed subjective intent of the parties is irrelevant to determining the meaning of contractual language." Winet v. Price (1992) 4 Cal.App.4th 1159, 1166, fn. 3. It is the outward manifestation or expression of assent that is controlling. Titan Group, Inc. v. Sonoma Valley County Sanitation Dist. (1985) 164 Cal.App.3d 1122, 1127. "The true, subjective, but unexpressed intent of a party is immaterial and irrelevant." Vaillette v. Fireman's Fund Ins. Co. (1993) 18 Cal.App.4th 680, 690. Once again, motions in limine are good tools to try and exclude evidence contrary to the express terms of the contract.
E. Exceptions to the Parol Evidence Rule
There are a number of exceptions to the parol evidence rule, including:
1. The rule does not prevent a party from introducing evidence to show the party was fraudulently induced to enter the agreement (Code of Civil Procedure section 1856(g));
2. Parol evidence is admissible where a mistake or imperfection of the writing is put in issue in the pleadings (Code of Civil Procedure section 1856(e)) or where the validity of the agreement is in dispute (Code of Civil Procedure section 1856(f));
3. Extrinsic evidence is admissible to show the contract is illegal (Code of Civil Procedure section 1856(g));
4. Extrinsic evidence is admissible to show the original writing has been altered (Akopoff v. Mesropian (1929) 96 Cal.App. 128, 129); and
5. The parol evidence rule does not bar extrinsic evidence offered to prove a writing was a mere sham (FPI Develop., Inc. v. Nakashima (1991) 231 Cal.App.3d 367, 401).