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Third-Party Beneficiaries Lack Standing to Seek Reformation of Contracts

January 4, 2012
Morris James LLP
Delaware Business Court Insider

Reformation is an equitable remedy whereby the Court of Chancery will modify a written agreement to reflect the "true" intent of the parties. To obtain reformation, a party must establish by clear and convincing evidence that the written contract does not reflect the actual intent of the parties as a result of fraud, mutual mistake or unilateral mistake plus fraud by the other party. Reformation is not a means for courts to rewrite parties' agreements. Rather, it is a way for courts to modify an agreement so that it conforms with the parties' prior, actual intent.

Nonparties to a contract generally have no rights under the contract. There is an exception, however, for third-party beneficiaries. A nonparty is a third-party beneficiary if the contracting parties intended to benefit the nonparty through the contract, the benefit is intended to serve as a gift or in satisfaction of a pre-existing obligation to the third party, and the benefit to the third party was a material part of the contract. This raises the question of whether a third-party beneficiary may seek reformation of a contract. In the context of insurance policies, the Court of Chancery has answered that question in the negative in its 1987 decision in Malone v. United States Fidelity and Guaranty Co., holding that a third-party beneficiary had no standing to reform a contract between the insured and his insurance company.

The Court of Chancery recently indicated that third-party beneficiaries also lack standing to seek reformation outside of the insurance policy context in In re Mortgage Between Pantalone and Wells Fargo Bank N.A. In that case, the petitioner, proceeding pro se, sought reformation of a mortgage. Nonparty Pamela Pantalone had executed a mortgage in favor of nonparty Wells Fargo Bank. Although the mortgage was intended to create a security interest in a particular property, the petitioner's law firm had described the property incorrectly in the mortgage. The petitioner was not a party to the mortgage or the loan and had no interest in the underlying property. Pantalone defaulted on the loan secured by the mortgage. When Wells Fargo Bank tried to foreclose on the mortgage, it was unable to do so because of the incorrect legal description of the property. Recognizing his potential exposure for negligence, the petitioner sought to reform the mortgage by including the correct legal description of the property. He did not sue on behalf of Pantalone or Wells Fargo Bank or name them as defendants.

The court raised the issue of whether the petitioner had standing to seek reformation of the mortgage. In response to the court's questions, the petitioner claimed that his potential exposure for negligence gave him standing and that the court historically granted petitions like his (without citing any examples of such cases). The petitioner also claimed that his law firm had a fiduciary duty to close the loan in accordance with the lender's closing instructions, even though the firm represented Pantalone in the transaction, not Wells Fargo Bank. The court rejected these arguments, stating that nonparties, including third-party beneficiaries, to a contract lack standing to seek reformation. The court held the petitioner was not a party to the mortgage or loan and therefore lacked standing to reform the mortgage.

As the Pantalone case reflects, the Court of Chancery takes standing seriously. Counsel representing nonparties to a contract should also keep Pantalone in mind if they wish to seek reformation of a contract. In light of decisions like Pantalone and insurance policy cases involving nonparties, it appears unlikely that a nonparty could convince the Court of Chancery to reform a contract. Nonparties will have to pursue avenues other than reformation to obtain relief.