Drafting Errors: The Importance of Proofreading Cannot Be Overestimated

Scott v. U.S. Bank N.A. (In re Scott), 600 B.R. 506 (Bankr. W.D. Pa. 2019) –

A stipulation between the debtor and a mortgagee misstated the original principal amount of the mortgage debt. Eventually the debtor sought to enforce the stipulation, claiming that the parties agreed to the incorrectly stated amount.

In particular, the debtor originally challenged the mortgage lien and the mortgagee’s claim. After the parties settled, they executed a “Stipulation and [Proposed] Order Approving the Settlement.” Under the settlement, the debtor was given time to sell the property. If a sale occurred by a designated date the loan would be paid in full. Otherwise, the mortgagee would be granted relief from the stay.

Unfortunately for the mortgagee, the stipulation contained a drafting error. The stipulation included a statement at the beginning that the original principal balance of the mortgage debt was $51,200 instead of $511,200.

More than a year after the deadline for selling the property passed the debtor filed a motion to enforce the stipulation. The debtor asserted that the mortgagee breached the stipulation because the mortgagee was claiming that he owed hundreds of thousands of dollars. The mortgagee countered that the “$51,200” was an error caused by inadvertently dropping a “1” from the amount.

The court began by considering whether the paragraph with the error was binding on the mortgagee. It noted the structure of the stipulation: There was an introductory paragraph and a “Background” section, followed by a “Therefore” clause and then the operative provisions. The error occurred in the background information, not the operative language after the “Therefore” clause.

As an initial matter, the court noted that a consensual stipulation is interpreted according to general principles of contract construction. Generally, recitals are “merely explanations of the circumstances surrounding the execution of the contract, and are not binding obligations, unless referred to in the operative provisions of the contract” (emphasis added). However, recitals may control if the operative provisions are ambiguous, although if the recitals are broader they will not serve to extend the operative provisions.

Under the circumstances of this case, the court determined that the debtor failed to show any reason why the court would need to look to the recitals for clarification. Thus, the debtor was not entitled to the relief requested.

Regardless, the background statement did not purport to state the current balance. Instead, it went on to state that the loan was subsequently modified by a Loan Modification Agreement. A copy of this agreement was provided by the mortgagee. It established that the new modified principal balance was ~$663,500 with a deferred balance of ~$245,500 and an interest-bearing balance of $418,000.

The debtor tried arguing that the Loan Modification Agreement was irrelevant because it was “pre-contractual conduct” (i.e. signed before the stipulation). However, the same thing could be said about the statement of the original loan balance.

Accordingly, the court ruled that the recitals were not binding on the parties. Further, if they were, the court would still deny the debtor’s motion because even if the original principal amount “was” $51,200, the court would look to the loan modification agreement as a more recent statement of the balance.

Lenders have not always been so lucky. Dropping a couple of 0’s in a statement of a loan balance can be disastrous.

In this case the decision rested in part on the fact that the incorrect amount was set forth in a recital, but not in the operative provisions of the document. In drafting a complaint, litigators tend to incorporate prior allegations by reference to avoid unnecessary repetition while still allowing each count to survive on a standalone basis. Consistent with this habit, when drafting agreements some litigators will begin the operative portion of the agreement by incorporating the recitals by reference. Generally, that is not necessary, and as illustrated by this case, could cause a problem (i.e. if incorporation of the recital typo caused the error to become part of the operative provisions).

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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