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Hot Rods, LLC v. Northrop Grumman Systems Corp. – Can Extrinsic Evidence be Used to Alter the Meaning of a Contract?

On November 6, 2015, the California Courts of Appeal for the Fourth District, Division Three filed its decision in the case of Hot Rods, LLC v. Northrop Grumman Systems Corp., Case G049953 (Super.Ct. No. 30-2009-00118853) which arose out of Hot Rods, LLC’s purchase of an Orange County property from Northrop Grumman Systems Corporation, once used in Northrop’s manufacture of floor beams for Boeing’s 747s. During the negotiations that led up to the purchase, Northrop retained a number of environmental consultants to determine what, if any, environmental contaminants were present as a result of Northrop’s activities. While those studies were under way, Northrop entered into negotiations with Dan Weldon and his wife, the owners of Hot Rods, LLC, who were looking for a new location for their automobile parts reselling operation.

The purchase and sale agreement entered into between the Weldons and Northrop in November 1995 (the “Agreement”) was ultimately assigned to Hot Rods, LLC, wholly owned by them. Among the provisions contained in the Agreement, Northrop represented that “to the best of its information and belief”: (i) no underground storage tanks were located on the property; (ii) no hazardous materials were located on or under the property; and (iii) that there had been no release or presence of hazardous materials requiring remediation on the site. The results of the environmental studies that showed some issues with ground water contamination (although not requiring remediation) was provided to the Weldons, and the Agreement disclosed the ground water issue. The Agreement further defined the phrase “to the best of its information and belief” as “information actually known to seller.”

In the Agreement, Northrop agreed to indemnify the buyer from, “…any claims, demands, penalties, fees, fines, liability, damages, costs, losses, or other expenses including, without limitation, reasonable environmental consulting fees and reasonable attorney fees arising out of…” what amounted to environmental hazards and storage tanks. It also provided that the indemnity provision “be construed to effectuate the normal and reasonable expectations of a sophisticated Seller and Buyer.” The parties further agreed that “any dispute would be resolved by the reference procedures described in Code of Civil Procedure Section 638, et seq.” Finally, the Agreement included an integration clause that provided: “The Parties further intend that this Agreement constitutes the complete and exclusive statement of its terms and that no extrinsic evidence whatsoever may be introduced in any judicial proceedings involving this Agreement.”

After the sale closed, in November 1996, Hot Rod’s attorney notified Northrop that an underground storage tank had been located on the property. Northrop agreed to and did remove the tank and paid for an additional thirty environmentally related clean-up costs. Over the course of the next several years, various issues relating to environmental clean-up arose, and Northrop eventually refused to pay certain expenses demanded by Hot Rods. In April 2009, Hot Rods filed a complaint, and in June 2011, filed an amendment to the complaint alleging a variety of causes of action including breach of contract, fraud and public and private nuisance, among others.

The parties stipulated to trial of the case before a Referee pursuant to the Agreement. Prior to trial, Northrop sought exclusion of all extrinsic evidence regarding the meaning of the Agreement pursuant to the integration clause, which was denied by the Referee. According to the decision, “extensive” testimony and evidence was introduced regarding the negotiation of the Agreement following which the Referee entered judgment against Northrop in the amount of $1,116,450.00, together with attorney’s fees in the amount of $1,841,204.00 and costs in the amount of $250,092.00 and interest. Northrop understandably appealed and the case turned on the integration clause and the Referee’s admission of “extrinsic evidence.”

The Court first discussed the ordinary rule that when an agreement contains an integration clause, parole evidence (that is extrinsic evidence of its formation) is not permitted to the extent that it varies the meaning of the plain language of a contract. In California, however, extrinsic evidence can be introduced even in an integrated agreement so long as it is “reasonably susceptible” of the meaning ascribed to it in the agreement. After reviewing the applicable legal standards relating to extrinsic evidence, it stated that the Referee erred in admitting the extrinsic evidence introduced by Hot Rods. Although the Court ultimately found that Northrop was liable under a declaratory relief cause of action and awarded it damages for its damages measured by the amounts it expended to resolve certain environmental issues, it reduced those damages to just over $117,000.00 and consequently reduced the amount of attorney’s fees.

Any time you are purchasing real property in California, especially if it has been previously owned by a business engaged in manufacturing aircraft parts, you must seek the services of a competent, knowledgeable, experienced attorney to protect your interests and explain the meaning of the agreements you are signing. Michael Leonard, Esq. of San Diego Corporate Law is someone you can trust and who has that knowledge and experience. To schedule a consultation with Mr. Leonard to discuss the best way to protect your business, as well as any other business-related matter, you can visit San Diego Corporate Law or call (858) 483-9200.

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