Is a Letter of Intent Enforceable as a Binding Contract in California?

I reported on the opinion in the previous appeal in this case of Munoz v. Pater on January 8, 2022, and this new decision confirms when a letter of intent constitutes a binding contract.

Luis Munoz and LR Munoz Real Estate Holdings, LLC (LRM Holdings) (together, Munoz) bought a hotel from a company owned and managed by Rajesh Patel (Rajesh) and his son, Shivam Patel (Shivam). Before escrow closed, the parties negotiated a leaseback arrangement requiring Munoz to lease the hotel back to the Patels’ company after the sale.

Escrow closed and the parties thereafter executed the previously-negotiated lease—or so Munoz thought.

According to Munoz, the Patels secretly swapped out the agreed- upon lease for a different one—a lease substantially more beneficial to the Patels and worse for Munoz—and then tricked him into signing it.

Munoz filed the present action against the Patels, an alleged alter ego entity of the Patels called Inn Lending, LLC (Inn Lending), and other defendants involved in the sale.

Rajesh and Inn Lending demurred to the operative second amended complaint, the trial court sustained the demurrer without leave to amend, and Munoz appealed the ensuing judgment.

In a prior opinion, the appellate court reversed the judgment and determined, among other things, that Munoz alleged a viable fraud cause of action based on a theory of fraud in the execution.

With the benefit of supplemental briefs, the appellate court now concluded the operative complaint alleged facts sufficient to state a viable cause of action for fraud in the execution against Rajesh, but not against Inn Lending.

Additionally, it concluded the complaint plead facts sufficient to state an elder financial abuse cause of action against both Rajesh and Inn Lending.

Finally, it concluded Munoz failed to establish that the trial court erred in dismissing his breach of contract and bad faith causes of action.

Munoz was told that a private lender, Inn Lending, would finance the Hotel purchase at six percent annual interest, secured by a deed of trust on the Hotel only. Munoz would need to execute a personal guarantee, but he would not have to pledge collateral in connection with the guarantee.

These proposed terms were presented to Munoz in a letter of intent, which he signed on August 6. That same day, Munoz paid Hamilton a $7,500 administrative fee to have the loan documents prepared.

As it turns out, Inn Lending did not exist when Munoz signed the letter of intent. It came into existence several weeks later, on August 23. Even worse, Inn Lending—once it finally came into existence—was the Patels’ alter ego entity, which they managed and controlled.

On August 24, Hamilton sent the loan documents to Munoz. Like the leaseback arrangement, the loan was another bait-and-switch.

The approximately 300 pages of loan documents varied from the letter of intent in several ways: (1) the interest rate was 7.3 percent, not 6 percent; (2) the payoff amount was $300,000 higher than it should have been; and (3) the loan was secured not only by the Hotel, but also by Munoz’s personal property and his other real estate holdings worth “several millions of dollars.”

On September 5, Munoz—unaware of these differences—signed the loan documents, and Inn Lending became Munoz’s secured lender.

In November, Munoz filed a complaint in the superior court against the Patels, PL, Inn Lending, and other defendants involved with the sale and loan.

For the fraud cause of action, Munoz sought: (1) monetary damages; (2) a judicial declaration of the parties’ contractual rights; and (3) either rescission of the purchase agreement, the September 13 lease, and the loan documents, or reformation of the September 13 lease and the loan documents.

The trial court sustained the demurrer to Munoz’s first cause of action for breach of contract, reasoning he failed to plead facts showing the existence of a binding contract between himself and the demurring parties.

On appeal, Munoz contended the letter of intent—which the parties executed in anticipation of the loan transaction—was “binding as to certain loan terms” because the loan terms were “negotiated and agreed to.” The appellate court disagreed.

Preliminary negotiations or an agreement for future negotiations are not the functional equivalent of a valid, subsisting agreement.  A manifestation of willingness to enter into a bargain is not an offer if the person to whom it is addressed knows or has reason to know that the person making it does not intend to conclude a bargain until he has made a further manifestation of assent.

On its face, the letter of intent does not evince the parties’ mutual assent to the proposed loan terms expressed therein.

It begins with a proviso stating it is merely a “financing proposal,” and the “proposal is for discussion purposes only.”

Elsewhere, it states it does “not serve as a binding agreement on the part of [the] lender or [the] applicant.”

Further, the letter of intent is notable for what it does not do. Nowhere does it require the lender to issue a loan upon the parties’ execution of the letter of intent or upon the satisfaction of any other condition precedent.

Instead, it simply requires the lender to “begin its due diligence” after the parties have executed the letter of intent and Munoz has paid an administrative fee.

Because the letter of intent unambiguously states it is a nonbinding proposal for discussion purposes only, it cannot reasonably be read as an enforceable contract binding the parties to issuance of a loan with specific loan terms.

On appeal, Munoz did not argue that Inn Lending or Rajesh entered into, or breached, any alleged contract other than the letter of intent.  Further, he made no other cogent argument in support of his claim that the trial court erroneously sustained the demurrer to his breach of contract cause of action.

Thus, Munoz did not satisfy his burden of establishing that the court erred by sustaining the demurrer to his breach of contract cause of action.

Munoz’s challenge to the dismissal of his bad faith cause of action fared no better.

The trial court found Munoz did not plead facts stating a bad faith cause of action because such a claim requires “the existence of a binding contract,” and, as just noted, the letter of intent is not a binding contract.

The operative complaint and Munoz’s appellate briefs were, at times, vague concerning which misrepresentations, and Munoz alleged there were three categories of fraudulent misrepresentations:

(1) the defendants’ false promises that PL would enter into a triple-net lease;

(2) the defendants’ misleading statements implying the September 13 lease was the July 17 lease, and their related concealment of the fact the Patels had swapped the leases; and

(3) the defendants’ false statements on the letter of intent for the loan.

The second category was sufficient to state a cause of action because it gave rise to a valid cause of action for fraud in the execution against Rajesh.

Fraud in the execution, sometimes known as fraud in the inception or fraud in the factum, occurs when “the promisor is deceived as to the nature of his act, and actually does not know what he is signing, or does not intend to enter into a contract at all.”

Where there is fraud in the execution, mutual assent is lacking, and the contract is void.

If, because of a misrepresentation as to the character or essential terms of a proposed contract, a party does not know or have reasonable opportunity to know of its character or essential terms, then he neither knows nor has reason to know that the other party may infer from his conduct that he assents to that contract. In such a case there is no effective manifestation of assent and no contract at all.

Fraud in the execution most often arises where some limitation—such as blindness, illness, or illiteracy—prevents a party from reading or understanding a contract he or she is about to sign.

Fraud in the execution can also arise in cases like the present one, where the parties reach consensus on the material terms of an agreement, but one side surreptitiously swaps or modifies the agreement memorializing the terms without the other side’s knowledge.

As a procedural matter, parties usually invoke fraud in the execution as a defense to the enforcement of an ostensible contract—for example, to oppose the enforcement of an arbitration agreement.

Or, in some cases, they invoke the doctrine while seeking rescission of a contract or a judicial declaration that the contract is void for lack of mutual assent.

This case did not fall neatly into either of these categories. Munoz sought recission or reformation of the September 13 lease. However, he prayed for these remedies in connection with a fraud cause of action that seeks, as an alternative remedy, monetary damages.

Despite the somewhat unusual procedural posture presented here, there was no reason why Munoz’s seventh cause of action cannot be based on a fraud in the execution theory— at least so long as he alleges and ultimately proves the essential elements of a traditional cause of action for fraud.

Without question, the allegations of fraud in the inception and fraudulent failure to perform state a cause of action for fraud.

Fraud in the factum is a traditional fraud.  Those essential elements are

(1) misrepresentation (false representation, concealment, or nondisclosure);

(2) knowledge of falsity (scienter);

(3) intent to defraud (i.e., to induce reliance);

(4) justifiable reliance; and

(5) resulting damage.

Generally, it is not reasonable to fail to read a contract; this is true even if the plaintiff relied on the defendant’s assertion that it was not necessary to read the contract.  Reasonable diligence requires a party to read a contract before signing it.

However, a party’s failure to read a contract does not necessarily negate reasonable reliance where, as here, an allegedly defrauded party seeks equitable remedies such as reformation of the subject contract.

It is established in California that the person who has been induced to enter into a contract by fraudulent misrepresentations as to its contents may rescind or reform the contract.

His negligence in failing to read the contract does not bar his right to relief if he was justified in relying upon the representations.

Where the failure to familiarize one’s self with the contents of a written contract prior to its execution is traceable solely to carelessness or negligence, reformation as a rule should be denied; but that where such failure, and perhaps negligence, is induced by the false representations and fraud of the other party to the contract that its provisions are different from those set out, the courts, even in the absence of a fiduciary or confidential relationship between the parties, should reform, and in most cases have reformed, the instrument so as to cause it to speak the true agreement of the parties.

Munoz alleges facts sufficient to establish reasonable reliance, despite his failure to read the September 13 lease. In particular, he alleges:

(1) he is 80 years old, Spanish is his primary language, and he is “not proficient” in reading English, the language in which the lease is written;

(2) he has never purchased a hotel before, let alone as part of a sale/leaseback arrangement; (3) the July 17 lease was circulated and confirmed as “the final lease at least four times,” with the last confirmation coming “just days before the close of escrow”;

(4) Munoz “reviewed and approved the July 17 Lease”;

(5) the email attaching the July 17 lease only reserved PL’s right to “make further edits in case there was an error or oversight,” and no one associated with PL ever claimed there was an error or oversight;

(6) in his email attaching the September 13 lease, Shivam did not disclose that he and Rajesh had swapped the leases; and

(7) the differences between the leases were “not so numerous to be obvious” to the naked eye.

These allegations plead adequate facts to satisfy the element of reasonable reliance.

For the reasons stated above, Munoz alleged facts sufficient to state a fraud in the execution cause of action based on Rajesh’s substitution of the leases and his related concealment of the swapped leases.

Munoz’s third cause of action alleges the demurring parties violated the Elder Abuse and Dependent Adult Civil Protection Act (Welf. & Inst. Code, § 15600, et seq.; hereafter, the Act).

In particular, it alleges they committed financial elder abuse in violation of Welfare and Institutions Code section 15610.30. Further, it alleges Munoz is entitled to remedies under Welfare and Institutions Code section 15657.6, which governs the return of property taken from elders who lack capacity or are of unsound mind.

The operative complaint does not allege that Munoz lacked capacity or was of unsound mind during the period described in the complaint. Indeed, Munoz does not contend otherwise. In the absence of such factual allegations, the complaint does not establish that the demurring parties had a duty to return property to Munoz under Welfare and Institutions Code section 15657.6.

However, that determination does not end the inquiry into whether Munoz alleged a violation of the Act. As noted, the third cause of action does not merely seek a return of property under Welfare and Institutions Code section 15657.6.

It also alleges the demurring parties committed financial elder abuse under Welfare and Institutions Code section 15610.30. A financial elder abuse claim lies when a person or entity “[t]akes, secretes, appropriates, obtains, or retains real or personal property of an elder or dependent adult for a wrongful use or with intent to defraud, or both,” or assists in such conduct. (Welf. & Inst. Code, § 15610.30, subd. (b).)

Under these standards, the operative complaint pleads facts sufficient to state a financial elder abuse cause of action. It alleges Munoz is 80 years old and a resident of Los Angeles. Thus, it alleges he is an “elder” for purposes of the Act. (Welf. & Inst. Code, § 15610.27.)

The complaint also alleged the demurring parties received Munoz’s property.

Because the operative complaint alleges that the demurring parties obtained the property of an elder for a wrongful purpose, or with fraudulent intent, it alleged facts sufficient to state a financial elder abuse cause of action.

LESSONS:

1.         Preliminary negotiations or an agreement for future negotiations are not the functional equivalent of a valid, subsisting agreement.

2.         If a letter of intent is intended to not be binding by one of the parties, it should unambiguously state it is a nonbinding proposal for discussion purposes only, it should not be read as an enforceable contract binding the parties to issuance of a loan with specific loan terms.

3.         If the operative complaint alleges that the demurring parties obtained the property of an elder for a wrongful purpose, or with fraudulent intent, it alleged facts sufficient to state a financial elder abuse cause of action.