LLC Buyout Dispute Hinges on Parol Evidence Rule and Integration Clause
California’s “parol evidence rule” codified in Code of Civil Procedure section 1856 and Civil Code section 1625 provides that when parties enter an integrated written agreement, extrinsic evidence may not be relied upon to alter or add to the terms of the writing. In contrast, if the agreement is unintegrated, parol evidence is admissible to explain, supplement, and sometimes even contradict the agreement.
Contracts often contain an “integration clause” stating that the contract is the “entire agreement” between the parties and that the parties cannot rely on any other prior or contemporaneous agreements or understandings.
Is a contractual integration clause conclusive evidence that the contract is, in fact, integrated?
California’s Fourth District Court of Appeal recently addressed the issue in Kim v. Koo. While the opinion is unpublished and therefore not binding precedent, it still provides useful guidance.
Facts: LLC buyout devolves into litigation
Jacob Koo and Dean Kim created Damon Capital, LLC to operate a high-end bed and mattress store. Each member invested initial funds in exchange for a 50 percent interest in the LLC.
Kim later agreed to sell his 50 percent interest in the LLC to Koo.
Koo signed two promissory notes — a $350,000 note in favor of Kim and a $500,000 promissory note in favor of Kim. The $500,000 note stated that it was made in exchange for Kim’s 50 percent membership interest. The $350,000 notes simply stated it was for “value received.”
The parties also signed a Membership Interest Transfer Agreement. The Transfer Agreement recited that the purchase price for Kim’s LLC membership interest was $500,000. The Transfer Agreement also contained a standard integration clause stating that the agreement “supersedes any and all other agreements….”
Kim alleged the agreed purchase price was $850,000 — the sum of both notes. Koo argued that the purchase price was $500,000, as stated in the Transfer Agreement.
Koo never made any payments on the $350,000 note. Kim sued.
Trial court: buyout price was $850,000, including the $350,000 note
At trial, Kim testified that after he had lost trust in Koo and stated his intent to exit the LLC, Koo offered to buy out Kim’s LLC interest for $850,000. Kim believed his interest was worth between $1.25 million to $1.4 million, but accepted the lower offer to end the relationship. However, Koo informed Kim that he could only qualify for a $500,000 loan from Wells Fargo to effectuate the buyout. Kim testified that as a result, he agreed to lend Koo the remaining buyout amount ($350,000) via a carryback note. Kim signed the Transfer Agreement to facilitate the approval of Wells Fargo’s $500,000 loan to Koo, but never intended to extinguish the $350,000 note.
A third party who helped draft the documents testified that he understood the LLC buyout price would be $850,000 as reflected by the two notes, that the Transfer Agreement recited the $500,000 figure to enable Koo’s loan approval, and that notwithstanding the Transfer Agreement’s integration clause the parties intended the $350,000 note to be part of the purchase price. He testified that the integration clause was simply part of the template he used to draft agreements.
In contrast, Koo testified that the purchase price was $500,000, and that amount was determined based on the amount of the loan for which he could qualify. He testified that the $350,000 note represented the value of gifts from Kim that he wanted to return.
The trial court held that the parties entered into an agreement for Koo to purchase Kim’s LLC interest for $850,000, which included the $350,000 note. The court held that the Transfer Agreement and its recitation of a $500,000 purchase price was prepared “for the purpose of securing the loan, and not for the purpose of limiting the true and actual buyout agreement between the parties….” The court further found that Koo’s testimony was not credible.
Koo appealed, arguing that the trial court’s judgment violated the parol evidence rule.
Court of Appeal: affirmed; “integration clause” is not conclusive
The Court of Appeal affirmed the trial court’s judgment.
The court emphasized that the presence of an integration clause in a contract is one factor but “not conclusive” as to whether parol evidence could be considered.
In making the threshold determination as to whether a written agreement is integrated, “the court must consider the writing itself, including whether the written agreement appears to be complete on its face; whether the agreement contains an integration clause; whether the alleged parol understanding of the subject matter at issue might naturally be made as a separate agreement; and the circumstances at the time of the writing.”
The court found no error in the trial court’s conclusion that the Transfer Agreement “is an unintegrated agreement, notwithstanding the fact that it had an integration clause.” Kim’s credible testimony, as well as the corroborating third party testimony, “explained why the $350,000 promissory note was not included in the purchase price set forth in the Transfer Agreement.” The Transfer Agreement’s provisions were aimed at facilitating the approval of Wells Fargo’s loan to Koo because Koo “would not have qualified for the $500,000 loan if Wells Fargo was informed of the $350,000 promissory note.”
Accordingly, the court held: “Because there was no integrated agreement, the parol evidence rule did not apply. The trial court could consider the $350,000 promissory note and conclude it was part of the buyout agreement and enforceable.”
Lesson
As shown by the Kim opinion, the inclusion of an integration clause in a written agreement is one factor but not conclusive as to whether the agreement is truly integrated. If it is not integrated, parol evidence may be considered to explain, supplement, and sometimes even contradict the agreement.