Tennessee Supreme Court Issues Landmark Opinion on Use of Extrinsic Evidence

In a unanimous opinion written by Justice Holly Kirby, the Tennessee Supreme Court has held that extrinsic evidence cannot be used to interpret a contract if it contradicts the contract’s written terms. Individual Healthcare Specialists, Inc. v. BlueCross BlueShield of Tennessee, Inc. arose out of a dispute between BlueCross BlueShield of Tennessee (BCBS) and Individual Healthcare Specialists (IHS), which was authorized to hire subagents to solicit applications for BCBS policies. IHS claimed that BCBS breached the parties’ Agency Agreements: (1) when it reduced commission rates for IHS and its subagents upon renewal of its existing policies and; (2) when it, after terminating its agreement with IHS, began paying commissions directly to the subagents. IHS also claimed it was entitled to attorney’s fees under the general indemnity provision in the parties’ contract. The trial court had found in favor of IHS and awarded it more than $2.1 million in damages and prejudgment interest, based in part on extrinsic evidence – namely, the testimony of three former BCBS employees who, despite language in the contract to the contrary, claimed that the parties never intended BCBS to be able to unilaterally modify commission rates on renewed BCBS policies.

The opinion engages in a lengthy analysis of the history and use of extrinsic evidence in contract interpretation and the application of the parol evidence rule, both generally and in Tennessee. With regard to contract interpretation, the court observes that “Tennessee’s jurisprudence  … cannot be neatly characterized as wholly textualist or wholly contextualist.” Dating back to the 19th century, there are cases supporting a textualist approach that grounds interpretation in the written words of the contract and other cases supporting a contextualist approach that considers extrinsic evidence of the parties’ intent in divining the meaning of the contract. On the whole, Tennessee cases “reflect balance; they demonstrate a definite focus on the written words in the parties’ contract, but they also consider evidence related to the situation of the parties and the circumstances of the transaction in interpreting those words.” While Tennessee courts have taken a “balanced” approach to use of extrinsic evidence in contract interpretation, they also have consistently enforced the parol evidence rule, which “represents a straight line through Tennessee contract caselaw.” The court makes clear that “the parol evidence rule prohibits the use of evidence of pre-contract negotiations in order to vary, contradict, or supplement the contractual terms of a fully integrated agreement.” Moreover, the court implies strongly that the inclusion of a boilerplate merger or integration clause is sufficient to show the parties intended their agreement to be fully integrated.

Applying these legal principles to the facts of the case, the court determined that the modification provision in the Agency Agreements was clear: “[BlueCross] reserves the right to modify or change the commission and payment schedules with appropriate notice.” Moreover, the Agency Agreements included an integration clause. Therefore, it was error for the trial court to have considered testimony on the parties’ intent during pre-contract negotiations that “directly contradicts the carte blanche authority granted to BlueCross by the modification provision.” The trial court could, however, consider extrinsic evidence regarding the parties’ intent that commissions be paid directly to IHS, rather than directly to the subagents, because such evidence “illuminates the parties’ intent and is consistent with the plain language of the contract.” Finally, applying its decision in Cracker Barrel Old Country Store, Inc. v. Epperson, 284 S.W.3d 303 (Tenn. 2009), the court held that the indemnity provision was not “sufficiently specific to apply to the recovery of attorney’s fees in this interparty lawsuit.”

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