Recitals in a Contract Do Not Create Binding Obligations

Contract recitals are often included at the beginning of an agreement to lay out the background of the deal. The Minnesota Court of Appeals recently addressed whether such recitals are binding and what happens when the recitals contain terms or obligations not included in the actual terms of an agreement.

In the case of Construction Mortgage Investors Co. v. Darrel A. Farr Development Corp., et al, the Appellate Court reversed the trial court on the issue of whether or not a personal guaranty’s recital clauses created ambiguity when read in conjunction with a loan amendment. The case concerned loan transactions related to Darrel A. Farr Development Corporation’s (DAFDC) development of land. DAFDC sought to modify the terms of a revolver loan from Construction Mortgage Investors Co. (CMIC). CMIC provisionally agreed to suspend the interest payments, but only if Darrel A. Farr (Farr) signed a personal guaranty. CMIC drafted a personal guaranty which contained recitals referencing DAFDC’s request that CMIC suspend the requirement of payment of monthly interest and CMIC’s agreement to do so if Farr provided CMIC with a guaranty. The operative language of the personal guaranty did not, however, reference any suspension or reduction of DAFDC’s monthly interest obligation. Instead, it bound Farr to the terms of the revolver loan and permitted CMIC to alter those terms without notice to Farr.

After further negotiations, CMIC prepared an amended loan agreement which provided, among other things, that DAFDC was obligated to pay one-half of the monthly interest payments. The recital portion of the personal guaranty was not revised to reflect this fact. Farr testified that he would not have signed the personal guaranty if he knew that the loan amendment required DAFDC to pay one-half of the monthly loan interest.

Farr argued that even though the operative terms of the guaranty did not refer to monthly interest payments or any of the other payment terms contained in the loan amendment, and are not ambiguous, the personal guaranty’s recitals were ambiguous or created ambiguity when read in conjunction with the loan amendment. The trial court agreed. However, the Court of Appeals reversed, holding that “[a]lthough recitals may be useful in determining the intent of contracting parties when the operative terms of a contract are ambiguous, they cannot by themselves create ambiguity . . . Here, there is no ambiguity in the operative terms of either the personal guaranty or the loan amendment that would permit a court to look beyond the clear operative terms of the agreements.”

The Court of Appeals further found that the trial court’s conclusions of law relating to mutual mistake of fact, unilateral mistake and condition precedent were erroneous. The Court stated that “[r]ecitals in a contract do not create binding obligations on a party” and concluded that “if recitals cannot create binding obligations, they cannot create conditions precedent.”

This case serves as a reminder that 1) all key terms must go into the body of the contract, not the recitals clauses and 2) the parties to a transaction should always review all the terms of every agreement governing the transaction before signing anything.