Barry M. Klayman and Mark E. Felger

A recent report submitted by Master in Chancery Patricia W. Griffin serves as a good reminder of some basic principles in a field not often the focus of Chancery cases. In Cache Private Capital Diversified Fund v. Cove at Sandy Landing, C.A. No. 12511-MG (Del. Ch, Jan. 17, 2019) (Final Report), Griffin recommended that the Court of Chancery grant a creditor's motion for summary judgment and order the entry of personal and in rem judgments against its debtors based on a finding that the undisputed facts gave rise to an enforceable equitable mortgage.

Although there appeared to be no genuine issue of material fact, the significance of the facts was contested. Cove MD and Meris, limited liability companies organized under Maryland and Delaware law, respectively, executed a note in favor of Cache. At the same time, they executed a mortgage and security agreement on real properties in Sussex County, Delaware, to secure the debt. The mortgage was not under seal. In addition to listing Meris as a borrower, the mortgage listed Cove MD as a borrower at the beginning of the document, but Cove DE, a Delaware limited liability company, as borrower and signatory at the end of the document. An individual named Daniels, who was the sole member of Cove MD, Cove DE, and Meris, signed the mortgage as sole member and manager of Meris and Cove DE.

After Meris and Cove MD failed to make payments under the note, they entered into a forbearance agreement with Cache. In the agreement, they acknowledged that Cove MD had executed and delivered the mortgage and note. Subsequently, Cove MD and Meris failed to make the payments required by the forbearance agreement, and Cache filed an action against them in the Court of Chancery pursuant to 10 Del. C. Section 3901. Cache sought an in rem judgment on the mortgage against Cove MD, Cove DE and Meris, and personal judgments on the Note against Cove MD, Cove DE and Meris, as well as against Daniels, as the guarantor of the note. Cache also sought to foreclose on eight lots and 20 boat slips in Sussex County that it claimed were secured property under the mortgage.

The defendants argued that defects in execution of the mortgage made it unenforceable, since the proper party did not execute the mortgage, and the forbearance agreement was not recorded so it was not effective under 25 Del. C. Section 2101(b). Cache argued that the mortgage was enforceable because Cove MD, the real property owner, was initially identified in the mortgage as the borrower, and Cove MD and Meris had admitted they had entered into the mortgage and executed the note and acknowledged the debt and default on the loan in the forbearance agreement, thus confirming Cove MD's intent to have the mortgage secure the indebtedness under the note.

Griffin noted that there are two types of mortgages: legal and equitable. Foreclosure of an equitable mortgage is within the jurisdiction of the Court of Chancery. The Delaware Supreme Court recognized the Court of Chancery's equitable power to disregard defects in the execution of a mortgage based upon the principles that equity regards substance rather than form, and equity regards that as done which in good conscience ought to be done. The key to establishing an equitable mortgage is the intent of the parties to create a mortgage or lien on property. Instruments intended as mortgages to pledge property to secure debts are enforceable as equitable mortgages even if they are not regarded as legal mortgages because of defects.

Griffin agreed that the mortgage was defective, both because it was not under seal and because the mortgagor did not formally sign the mortgage as the borrower. However, she found that the mortgage was nonetheless enforceable as an equitable lien. The evidence showed that Meris and Cove MD intended to create a mortgage lien on the property, and the mortgage designated Meris and Cove MD as the borrower at the beginning of the mortgage document, although another entity, Cove DE, was listed as the signatory under the mortgage. Daniels executed the document and he was the sole member for all entities. These circumstances, when considered as a whole, supported a finding that the alternative reference to Cove MD and to Cove DE was an error in form and not substance.

The forbearance agreement further showed that Cove MD intended to execute the mortgage and understood that it had done so. In the forbearance agreement, Cove MD and Meris acknowledged that Cove MD had executed and delivered the mortgage and other loan documents. It was immaterial that the forbearance agreement was not recorded, since forbearance agreements do not have to be recorded to be effective. The same Delaware statute which provides that  mortgages that are not in the prescribed form are not invalidated, 25 Del. C. Section 2101(c), would apply to forbearance agreements acting as a mortgage lien or conveying property interests. More importantly, in this case the forbearance agreement was not being relied upon to convey a property interest, but as evidence of Cove MD's intent to be bound by the equitable mortgage or lien.

The defendants argued that Cache should have sought to reform the mortgage. However, reformation is only available when the contract does not represent the parties' intent, because of fraud, mutual mistake or a unilateral mistake coupled with the other parties' knowing silence. Here reformation was not available, because the evidence showed that the mortgage represented the parties' intent. Both Cache and Cove MD intended to enter into the mortgage agreement. There was no mutual mistake, only a scrivener's error in listing Cove DE and not Cove MD as the signatory under the m ortgage.

Griffin's report stands as a reminder of the equitable powers of the Court of Chancery to exalt substance over form, and to regard as done that which in good conscience ought to be done. She recommends that the Court of Chancery enforce the mortgage as an equitable mortgage despite the defects in its execution based on a finding that the parties intended  to create a mortgage lien. The report also underscores the importance of carefully proofreading legal instruments, including the signature blocks, before execution.

Barry M. Klayman is a member in the commercial litigation group and the bankruptcy, insolvency and restructuring practice group at Cozen O'Connor. He regularly appears in Chancery Court.

Mark E. Felger is co-chair of the bankruptcy, insolvency and restructuring practice group at the firm.