A key part of understanding why an integration clause is important is understanding what the parol evidence rule is.
What is the Parol Evidence Rule?
Generally speaking, the parol evidence rule bars (or keeps out) extrinsic evidence of a prior or contemporaneous agreement. In English, this means that once parties to a contract sign and agree to the terms of the contract, the parol evidence rule will keep the parties to the agreement from trying to submit prior oral or written statements to modify or contradict terms or clauses in the contract.
Take the example we posted in our previous blog post on integration clauses. In that example, Party B agreed to buy “industry standard gears” for a specified sum, but in Party B’s conversations with Party A, they discussed “type-1” gears. Thus, when Party A delivers “type 3” gears, Party B will go to court and attempt to submit parol evidence that the agreement was for 100 “type-1” gears.
As we noted in prior posts, the parol evidence rule is codified in California Code of Civil Procedure section 1856, which states that the “[t]erms set forth in a writing intended by the parties as a final expression of their agreement with respect to the terms included therein may not be contradicted by evidence of a prior agreement or of a contemporaneous oral agreement.” Likewise, California Civil Code section 1625 states that “[t]he execution of a contract in writing, whether the law requires it to be written or not, supersedes all the negotiations or stipulations concerning its matter which preceded or accompanied the execution of the instrument.”
As we explained in our prior blog post, most contracts have an integration clause, which will be used to determine whether the contract is “a final expression” of the parties’ agreement. Assuming that is the case, a party will have to show that an exception to the parol evidence rule applies.
What are the Exceptions to the Parol Evidence Rule?
Generally, the parol evidence rule will not allow a party to a written agreement to submit prior inconsistent statements (written or oral), although there are exceptions. The following general circumstances are exceptions to the parol evidence rule:
- Incomplete writings
- Collateral or independent agreements
- Subsequent agreements
- Ambiguity or uncertainty in instrument
- Illegality or bad faith
- Lack of consideration
If one of these exceptions applies a party may then be able to submit evidence that was prior to or contemporaneous with the written contract in order to explain or contradict the terms of the deal.
An integration clause (also known as a merger clause or an entire agreement clause) is found in most contracts and simply provides that the agreement or contract between the parties is the final and complete understanding between the parties, and supersedes all prior negotiations, agreements, or understandings on the subject.
The typical integration clause will say something like this: This Agreement is the entire agreement between the parties in connection with the subject matter of this Agreement, and supersedes all prior and contemporaneous discussions and understandings.1
Integration clauses are key when there is a dispute between two or more contracting parties and one party wants to use prior or contemporaneous discussions to contradict or explain terms within a contract.
By way of example, suppose that Party A negotiates to sell Party B 100 “type-1” gears for a specified sum. The parties sign a contract which states that Party A agrees to sell Party B 100 “industry standard gears” for a specified sum, but with no reference to “type 1” in the description. Party A delivers 100 “type-3” gears (considered “industry standard”) and demands payment. Party B refuses to pay. Party B wants to use communications between the parties before the contract was signed to show that Party A was to deliver 100 “type-1” gears. Party A, on the other hand, claims that the gears delivered are “industry standard” and the contract contains an integration clause that excludes prior or contemporaneous agreements.
How would a court decide whether the pre-contract communications about “type-1” gears can be used? Determining whether the written contract was meant to be the exclusive embodiment of the parties’ agreement is known as determining whether the contract is “fully integrated.” Thus, the existence of an integration clause is a key factor because an integration clause is typically conclusive as to the issue of integration. The court will therefore look at the contract to determine whether the parties intended the written agreement to be a final and complete expression of their understanding. (Code Civ. Proc., § 1856, subd. (d).)
California has codified (i.e., set out by statute) many rules of contract interpretation; these rules apply to all contracts, absent exceptional circumstances. Civil Code § 1635. The basic goal of contract interpretation is to give effect to the parties’ mutual intent that existed at the time of contracting. Civil Code § 1636. When an agreement is set forth in a final written contract, the parties’ intent is determined from the writing alone, if possible. Civil Code § 1639. “The words of a contract are to be understood in their ordinary and popular sense” (Civil Code § 1644), and the terms of a final, integrated contract “may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement” (CCP § 1856).
Nevertheless, in our example above, Party B may still be able to submit evidence that the agreement was for 100 “type-1” gears. This is because a written contract “may be explained or supplemented by evidence of consistent additional terms unless the writing is intended also as a complete and exclusive statement of the terms of the agreement.” Code Civ. Proc., § 1856, subd. (b). Also, technical words are to be interpreted as usually understood by persons in the profession or business to which they relate, unless clearly used in a different sense. Civil Code § 1645; Cal. Civ. Proc. Code § 1856 (“The terms set forth in a writing described in subdivision (a) may be explained or supplemented by course of dealing or usage of trade or by course of performance.”).
Thus, the dispute between the parties in our example above will center on the court’s determination as to whether the prior and contemporaneous statements are admissible as consistent additional terms and/or to explain what “industry standard” means in this context.
1 Grey v. Am. Mgmt. Servs., 204 Cal. App. 4th 803, 805 (2012).