Incorporation By Reference

May 25 2023| News| | By Samantha Torres

“Incorporation by reference,” a common practice in the drafting of contracts, can cause issues if used improperly, ranging from ambiguities to a fundamentally unenforceable agreement.

The Northern District of Texas recently addressed the incorporation by reference doctrine in Balboa Capital Corporation v. Okoji Home Visits MHT LLC, a consolidated case involving claims that arose out of America’s Medical Home Team, Inc.’s (“MHT”) operation of the Medical Home Team Services Program (“MHT Program”), through which physicians could remotely supervise nurses making house calls in the physicians’ region. Civil Action No. 3:18-cv-0898-M, 2023 U.S. Dist. LEXIS 35590, at *1, *25-26 (N.D. Tex. Mar. 3, 2023).

To finance the MHT Program, MHT required each physician to create a limited liability company (“Physician LLC”) to obtain funding from a lender such as Balboa Capital Corporation (“Balboa”). See generally, id. Licenses funded by the lender and purchased from MHT corresponded to a nurse practitioner, with the individual physician and the physician’s professional corporation, if any, serving as guarantors. Id. at *26.

Completed applications were forwarded by MHT to Balboa for processing. Id. Balboa generated the form loan documents—an Installment Payment Agreement (“IPA”) or Monthly Payment Agreement (“MPA”)—to be executed by the Physician LLC, along with a guaranty agreement executed by the physician and the physician’s professional corporation. Id. MHT never executed a license agreement with any physician, and nurse practitioners were never hired. Id. at*27-28.

The IPA and MPA, governed by California law, included similar terms, but each omitted the loan amount, interest rate, the number of licenses being financed, the cost per license, and the identity of software and equipment. See generally, id. at *28. The executed MPA and IPAs included an “Equipment Supplier and Description” section, which incorporated by reference, “Exhibit ‘A1’ Invoices, or Schedules.” Id. However, Exhibit A1 was not attached and it was never provided to the physicians, nor was it included in the court’s record. Id. at *29-30.

Ruling against Balboa, the court held that the contract between Balboa and each respective Physician LLC was unenforceable and the associated guaranties were null and void due to the lack of essential loan terms and evidence of mutual consent. See generally, id. at *43-44. Balboa could not rely on Exhibit A1, purportedly incorporated by reference, to demonstrate mutual consent to the missing loan terms. Id. Instead, the court concluded that incorporation of Exhibit A1 was not for the disclosure of essential terms, but rather, Exhibit A1 was incorporated for a limited purpose—a “description of Equipment and Supplier.” Id. Moreover, Exhibit A1 was not known or easily available to the contracting parties. Id.=

Like California, an enforceable contract in Texas requires mutual assent to its subject matter and essential or material terms (e.g., loan amount, repayment terms, services to be rendered, or property). See Mann Frankfort Stein & Lipp v. Fielding, 289 S.W.3d 844, 850 (Tex. 2009). A contract will fail for indefiniteness when an essential term is omitted or not certain when the contract was allegedly formed. See Marx v. FDP, LP, 474 S.W.3d 368, 376 (Tex. App.—San Antonio 2015, pet. denied). A failure to form a meeting of the minds on a term of the contract, however, is only fatal to a contract if the term was essential or material. See Burrus v. Reyes, 516 S.W.3d 170, 187 (Tex. App.—El Paso 2017, pet. denied).

Though Texas law permits incorporation by reference, mere reference to the incorporated document is not enough. See Trico Marine Servs., Inc. v. Stewart & Stevenson Technical Servs., Inc., 73 S.W.3d 545, 549-50 (Tex. App.—Houston [1st Dist.] 2002, mandamus denied). Rather, the signed document must plainly refer to the incorporated document and it must be clear that the parties had knowledge of and assented to all or part of the terms in the referenced documents. See One Beacon Ins. Co. v. Crowley Marine Servs., Inc., 648 F. 3d 258, 267 (5th Cir. 2011) (citing 11 Samuel Williston & Richard A. Lord, A Treatise on the Law of Contracts § 30:25, at 234 (4th ed. 1999) (“in order to uphold the validity of terms incorporated by reference, it must be clear that the parties to the agreement had knowledge of and assented to the incorporated terms”). Only part of the document that falls clearly within the reference will become an enforceable part of the contract when the reference appears to embrace only a portion of the extrinsic document. See LeBlanc, Inc. v. Gulf Bitulithic Company, 412 S.W.2d 86, 93 (Civ. App.—Tyler 1967, writ ref. n.r.e.).

Unlike Balboa, however, in Texas a document might be sufficiently incorporated even when it is not attached to a contract or received by a party. In fact, courts have imposed a duty on parties to make an inquiry into missing documents and presume that a party knows the contents of what it signs, including items incorporated by reference. See In re Lyon Financial Services, Inc., 257 S.W. 3d 228, 232 (Tex. 2008) (orig. proceeding).

For instance, in In re International Profit Associates, Inc. the first page of the agreement included a forum-selection clause defendant sought to enforce. 286 S.W.3d 921 (Tex. 2009) (per curiam). Although the first page was missing from the copy plaintiff signed, the court held the plaintiff should have realized the first page was missing because he signed pages stating, “2 of 4”, “3 of 4,” and “4 of 4” along with a clause stating “…4 pages in total, constitutes the entire agreement…” Id. at 923. The Supreme Court of Texas stressed that the language indicated the first page was missing and was meant to be part of the contract. Id.

In Southern National Bank v. Crateo, Inc., the defendant received and signed a contract referencing attached documents, but the documents were not actually attached and were never received by the defendant. 458 F.2d 688, 692 (5th Cir. 1972). The Fifth Circuit Court of Appeals held that the contract, including the referenced document, was enforceable. Id. at 691. The defendant could not avoid liability based on the defense of mistake where it signed the contract without asking about the missing attachments. Id.

Of course, each situation is different, and incorporation may depend on the contract’s language or case facts, but in any situation, parties don’t want to be left wondering whether a document and its terms are really incorporated.