It’s pretty rare to read a case in which a court renders a commercial mortgage invalid. But that’s what happened in SPCP v. Dolson, 2010 Ind. App. LEXIS 1852 (Ind. Ct. App. 2010) (.pdf). Secured lenders beware: if your mortgage contains an inaccurate and materially misleading description of the debt, you will lose your foreclosure remedy.
Purported mortgagor was a surety. In SPCP, the alleged mortgagor, Holland, owned real estate that she leased to Dolson, a company that operated a pub. The lease provided that Holland and Dolson could participate in a mortgage loan related to the real estate. In fact, a lender, SPCP, made a $700,000 loan to Dolson. The Dolls (officers in Dolson) and Thompson (Mrs. Doll’s father) guaranteed the loan. Holland co-signed a mortgage with Dolson in favor of SPCP. Holland did not, however, review or sign the underlying promissory note.
Mortgages 101. The SPCP opinion outlined the basic statutory requirements for a valid mortgage in Indiana (Ind. Code § 32-29-1-5). A mortgage must recite both (1) the date for repayment and (2) one or more of: (a) the sum for which it is granted; (b) the notes or evidences of debt; or (c) a description of the debt sought to be secured. Mortgages must also be dated and signed, sealed and acknowledged by the grantor.
Debt description. With regard to the accuracy of the debt description, Indiana cases say:
literal accuracy in describing the debt secured by the mortgage is not required, but the description of the debt must be correct, so far as it goes, and full enough to direct attention to the sources of correct information in regard to it, and be such as not to mislead or deceive, as to the nature or amount of it, by the language used. . . . A reasonably certain description of the debt is required so as to preclude the parties from substituting debts other than those described for the mere purpose of defrauding creditors.
SPCP refined this summary of the law into a two-part test: (1) whether the debt description was inaccurate and (2) whether the inaccuracy was sufficiently material to mislead or deceive the grantor/mortgagor as to the nature or amount of the debt.
The inaccuracy. The mortgage signed in SPCP secured debt “incurred under the terms of ‘a’ Promissory Note dated December 27, 2001 executed by Dolson, the Dolls and Thompson and maturing December 27, 2021.” This accurately described the date of execution of the subject note and the maturity date but inaccurately described the identity of the note’s makers. Thompson did not execute the note. He signed a guaranty. The Court held that the mortgage’s description of the debt was inaccurate.
Materially misleading. Moreover, the Court, in affirming the trial court’s summary judgment for Holland, concluded that the inaccuracy was sufficiently material so as to mislead Holland. The Court articulated three reasons for its decision, all of which centered on the role of Thompson:
1. Release. After Dolson defaulted on the loan, SPCP settled with Thompson for $550,000 and released him from liability. Holland, in agreeing to the mortgage, acted only as a surety pledging collateral to secure the loan of Dolson. If Thompson had been liable on the note as a primary obligor (a maker), and not a guarantor, then any release of Thompson would, under Indiana law, have released Holland and her real estate. Because Thompson was only a guarantor and thus a co-surety with Holland, the release of Thompson did not have that effect.
2. Subrogation. Thompson’s status as guarantor, instead of co-maker of the note, changed Holland’s recourse against Thompson. Under Indiana law, sureties have the right to complete reimbursement and subrogation from makers. As only a co-surety, Thompson, at most, was exposed to Holland for Holland’s pro-rata contribution to the debt. Thus the loan structure increased Holland’s risk of loss. (I discussed suretyship law on 5-23-07.)
3. Detrimental reliance. Holland testified it was her understanding that her real estate would be subject to foreclosure only if the Dolls and Thompson failed to pay the debt. Holland therefore relied to her detriment on the mortgage’s inaccurate description of Thompson as a co-maker. Holland claimed that she would not have signed the mortgage had she known that Thompson was only a guarantor.
Over the last few years, I have seen a handful of cases like SPCP in which the mortgagor was not the borrower but merely a pledgor of real estate. In those cases, unlike SPCP, the language in the mortgage clearly connected the mortgage with the note. The loan documents in SPCP lacked that clarity, and the alleged mortgagor was able to seize on the inaccuracy to save her commercial real estate from foreclosure.