While transaction agreements can vary widely from deal to deal, they usually contain surprisingly similar “boilerplate” provisions that receive little attention during negotiations but significant attention in the event of a later dispute. Sophisticated parties with ties to multiple states may have some flexibility in choosing the governing law of the contract and the jurisdiction where disputes arising under the contract will be resolved. When it comes to the so-called “boilerplate,” how much does the selection of one state over another matter?
This is the first installment of three articles that explore the manner in which provisions may be handled differently by courts depending on whether the underlying contract is governed by California, Delaware, New York or Illinois law. This installment addresses the fundamental issue of how the parties’ contract will be interpreted and to what extent courts can go beyond the words of the parties’ written agreement to give effect to their intentions.
Parol evidence rule
As everyone learns in law school, the parol evidence rule is supposed to protect the integrity of a written contract by prohibiting the admission of extrinsic evidence to vary or add to the terms of the contract. Although California, New York, Delaware and Illinois all apply some version of the parol evidence rule, there are important differences that can affect how a contract is interpreted. Most significantly, Delaware, Illinois and New York courts tend to use a “hard” parol evidence rule which prohibits parties from introducing extrinsic evidence to interpret a contract if the contractual language is integrated and clear and unambiguous on its face. Courts in those states are more likely to enforce the language of the contract as written, without wondering if there is some testimony or other evidence which could cause them to read the language differently.
By contrast, courts in California use a more liberal approach in which parol evidence is available in the first instance to determine whether the contract language is ambiguous and/or reasonably susceptible to a different interpretation. If so, then the court will use extrinsic evidence when determining what the parties intended.
Relatedly, many contracts contain boilerplate integration language that confirms the parties’ intention that the contract expresses the full and complete agreement of the parties and supersedes any prior agreements, understandings or discussions between the parties. While New York, Illinois and Delaware courts may be more inclined to take such clauses at face value, California courts do not treat such clauses as dispositive, particularly in light of evidence that is at odds with such clauses.
Fraud exception and disclaimers of reliance
A major exception to the parol evidence rule is the fraud exception, which allows admission of extrinsic evidence to challenge whether the agreement is valid or the product of fraud. One way parties attempt to protect against this possibility is by including a disclaimer of reliance, in which the parties confirm they are not relying upon anything not in the agreement itself.
The California Supreme Court recently breathed new life into the fraud exception by holding that parol evidence of oral misrepresentations can be admitted, even to contradict a written agreement, in order to prove fraud. While perhaps equitable, this ruling makes it more likely that contract disputes will need to be tried as factual matters rather than disposed of at the pleading stage. California courts are also less likely to enforce integration clauses and general disclaimers of reliance. A specific disclaimer of reliance limited to a particular subject matter is more likely to be enforced, as opposed to more general disclaimers.
Like California courts, New York courts draw a distinction between general boilerplate disclaimers of reliance and specific disclaimers. Thus, even if the contract includes a standard boilerplate integration clause, New York courts will not presume the contract to be the dispositive version of the parties’ agreement unless the defendant can prove that the parties, after extensive negotiations, drafted specific disclaimer clauses that address the disputed representations. New York courts are more inclined to enforce specific disclaimers of reliance when they are negotiated at arms-length by sophisticated parties. For example, well advised parties to New York M&A contracts will often have a tailored statement in the representations and warranties section of the contract that one party is relying solely on the representations and warranties of the other party that are listed in that specific section and not on any other representations, warranties or documents. This statement would be in addition to further non-reliance limitations that may negotiated in the indemnification section or included in the integration clause of the contract.
Delaware and Illinois courts have held, as a matter of public policy, that parties cannot shield themselves from fraud claims based on intentional misrepresentations that are in the agreement itself. As to representations not contained in the contract, however, Delaware, Illinois and New York courts typically enforce disclaimers of reliance. Thus, while both Delaware and New York courts would likely prohibit a party from asserting a claim for fraud with respect to extra-contractual representations, and Illinois courts would generally allow evidence proving fraud in the absence of a non-reliance clause, all three jurisdictions would exclude such evidence when the written contract disclaims reliance on any representations not in the contract.
Because mutual consent is essential to contract formation, in the event of a mutual mistake California courts typically allow parties to reform a contract to reflect their intended agreement. Courts may even rescind the contract when there is a unilateral mistake if one party knew of the other party’s mistaken belief regarding a material term of the contract. Like California, New York will also allow reformation or rescission based on mutual mistake if there is clear and convincing evidence of the mutual mistake; the mistake was regarding a substantial aspect of the contract at the time of contracting; and neither party knew of the other’s mistaken understanding. But unlike California, New York courts typically do not allow contractual reformation for unilateral mistake unless enforcing the contract terms would yield an unconscionable result or unjust enrichment. Taking an even more conservative approach, Illinois courts require a showing, regardless of whether the mistake is mutual or unilateral, that enforcing the contract as written would lead to an unconscionable result, that rescission would place the injured party in status quo and that the mistake occurred notwithstanding the exercise of due care by the party seeking rescission, along with the familiar requirement that the mistake be material. Delaware also permits contractual reformation where the parties are mutually mistaken as to a material portion of the written agreement, or where a party is aware of the other party’s mistaken understanding belief and knowingly remains silent.
The choice of governing law can impact fundamental issues such as how a court will interpret the contract, as well as how it can be challenged for fraud or reformed to account for mutual or unilateral mistake. The next installment will focus on boilerplate terms typically found in M&A contracts.