Disgruntled Borrowers More Likely to Sue Lenders for Fraud as a Result of Recent California Supreme Court Decision

For the past seventy years, California Courts have held that a party is barred from claiming fraud based on an alleged oral misrepresentation that directly contradicted the express terms of a written agreement. This rule had long been useful to lenders in defending a claim that a borrower was orally promised something in direct contradiction of the terms of a loan document.   In January 2013, however, the California Supreme Court reversed this 70 year old history and held that a borrower could sue its lender for fraud for alleged false promises in direct contradiction of the terms of a loan document. 

In Riverisland Cold Storage, Inc. v Fresno-Madera Production Credit Assn., the Supreme Court held that borrower could sue on the basis that a loan officer allegedly orally promised a forbearance term of two years in exchange for additional collateral and assured the borrower that the written forbearance agreement contained those terms. The borrower’s principals claimed they did not read the agreement but simply relied upon the assurance of the loan officer and signed the document. The agreement in fact provided for only a 90-day forbearance term. When the lender moved to foreclose at the end of the 90-day term, the borrowers paid off the loan and then sued the lender for fraud. The lender challenged the case based on the long-standing rule that the alleged oral promise directly contradicted the terms of the written agreement. Ultimately, the Supreme Court elected to reverse the rule on the basis that it did not comply with either current California statutory law or principles applied in other states. The Court therefore permitted the claim to proceed.   The Court left open the issue of whether the borrower’s principals could reasonably rely upon the loan officer’s oral assurances where they chose not to read the agreement.

The case has important implications in both loan originations and workouts. It likely will result in a substantial increase in lender liability claims.   Prophylactic measures that lenders should consider include: emphasizing in term sheets that only loan documents will express the parties’ agreement; expanding use of pre-negotiation agreements; having the borrower initial a provision stating that the borrower has read the loan agreement; and ensuring that loan agreements have effective alternative dispute resolution provisions to avoid jury trials.

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