CHAPTER 6.02. Optional Provisions

• Jurisdiction: United States

6.02. Optional Provisions

[1] General

A mortgage may also contain other covenants between the parties, and modern mortgages frequently mirror the terms and conditions that would be found in a loan agree-ment.¹⁶ Among the most important to the lender are those covenants that protect the collateral, especially provisions regarding payment of real property taxes and for maintaining insurance on the collateral. While the lender may have a common law right to some of these protections, other protections are only enforceable if part of the mortgage.

For example, it is settled law that a lender has rights to make payments toward property taxes in order to protect its lien and can include those payments in the secured obligation.¹⁷ This right is the right of a mortgagee and not an independent right. In other words, if the lender was not also the mortgagee and paid the borrower's property taxes, that would be the act of a volunteer and the lender would not be subrogated to the right to collect those property taxes from the borrower in repay-ment.¹⁸ Accordingly, absent a right of recovery in the mortgage or other contract, the lender who has paid the property taxes on the collateral has only the right to add that amount to the secured obligations and recover that amount when the lender recovers the secured debt.¹⁹ Under Delaware law, the amount of the property tax payment added to the secured debt has the same lien priority as that of the original mortgagelien.²⁰ Cases from other jurisdictions hold that this same result would occur as a matter of common law.²¹

In the case of insurance, the lender does not have the right under common law to pay premiums on behalf of the borrower and include those payments in the secured obligation. Accordingly, a mortgage will usually require the borrower to maintain property insurance for the collateral and, if the borrower fails to do so, authorize the lender to do so at the borrower's expense, adding any expenses of the lender to the secured debt.

If the borrower is a franchisee, such as for a hotel or restaurant, the mortgage will usually include a covenant by which the loss of the franchise for that property is an event of default. Moreover, the lender will usually also obtain a separate agreement from the franchisor allowing the lender to cure the borrower's default under the franchise agreement and agreeing to reissue the franchise to the lender or its assignee in the event of foreclosure.

[2] Running with the Land

Lenders will often include in their loan documents a statement that the various covenants in those documents are covenants that run with the land. Such a clause might read:

All of the grants, terms, conditions, provisions and covenants of this Mortgage shall run with the land, shall be binding upon Mortgagor and shall inure to the benefit of Mortgagee, subsequent holders of this Mortgage and their respective successors and assigns.

The rationale for including this statement of intent is the lender's concern that many of the covenants—for example, the obligation to insure the mortgaged property—could be construed as personal covenants and therefore not binding or benefitting persons not in privity by virtue of the loan documents. If the mortgagor transfers the property, will the transferee still be bound to the lender for these covenants? Or if the lender assigns the mortgage and the loan documents, does the assignee get the benefit of the covenants? By stating that the covenants run with the land, the lender's intent is to make the mortgagor's transferee bound to the mortgagor's covenants and for the mortgagee's assignee to be able to enforce those covenants. But with a covenant, stating that it runs with the land does not necessarily mean that it in fact runs with the land.

Traditionally, the body of law relating to such covenants has distinguished between personal covenants and real covenants. What distinguishes a real covenant is that it is so connected with specific real property that the right to enforce the covenant or the duty to perform the covenant passes to the transferee of that real prop-erty.²² While there are several essential elements to a real covenant, the key element was established 450 years ago in Spencer's Case.²³ To run with the land, a covenant to do something not yet existing (the "in esse" test) must bind an assignee of that land (the "touch and concern" test).²⁴ Although there are no Delaware cases analyzing mortgage covenants specifically as covenants running with the land, courts in other jurisdictions have done so and held that at least certain of the covenants of the mortgagor (such as the obligation to pay taxes) may run with the land for the benefit of the mortgage holder.²⁵ However, even in those jurisdictions, the "touch and concern" element is necessary, and therefore not all covenants will run with the land.²⁶

Delaware courts have followed these long-standing rules and have held that a party seeking to establish the existence of an enforceable real covenant²⁷ must demonstrate that (i) the claimed covenant "touches and concerns" the land, (ii) the original covenanting parties "intended" to create a binding covenant, and (iii) the successor to the burden had "notice" of the covenant when it acquired its interest in the subject property.²⁸ To determine whether a covenant runs with the land, the court must consider if "it is so related to the land as to enhance its value and confer a benefit upon it."²⁹

Delaware courts have not stated a clear bright-line test to determine whether a covenant touches and concerns the land. In Delaware, most opinions have merely noted whether a covenant touched and concerned the land and do not specify as to how.³⁰ Under the common law as expressed by early English and American decisions, a distinction was made between affirmative and negative covenants.³¹ The early common law view was that affirmative covenants were personal in nature and thus did not touch or concern the land; consequently, such covenants could not run with the land.³² Under the modern view, the primary consideration in deciding whether a covenant runs with the land is whether it is so related to the land as to enhance its value and confer a benefit upon it, rather than whether the covenant is of an affirmative or negative nature.³³ As the court stated in Hunt v. Del Collo, "[g]enerally no distinction is now made between negative and affirmative covenants."³⁴

In Van Amberg, the plaintiffs sought a declaration by the Court of Chancery that certain alleged restrictive covenants relating to construction and renovation of units were binding upon the units in a community known as Sea Strand as well as upon the unit owners.³⁵ In determining that the claimed restriction touches and concerns the land, the court wrote, "As a threshold matter, the Court is persuaded that the claimed equitable restriction would impose a burden (inhibiting exterior modifications) and would arguably create a benefit (allowing for common development) on the land. The defendants do not appear to contend otherwise. Thus, the requirement that the claimed restriction must 'touch and concern' the property is satisfied."³⁶

Although it refers to servitudes, the Restatement (Third) of Property (Servitudes) applies to covenants.³⁷ The Restatement states that a servitude need not touch and concern the land for it to be valid.³⁸ However, most courts still require that the element of touch and concern be met.³⁹ As one Illinois court stated, "[a] covenant touches and concerns the land if it affects the use, value and enjoyment of the property."⁴⁰ Moreover, Delaware courts have not adopted the position of the Restatement of Servitudes on this requirement.⁴¹

As an example of a covenant that might superficially appear to be a covenant that could run with the land, courts do not typically hold that a right of first refusal touches and concerns the land.⁴² In Feider v. Feider, the court of appeals of Washington held that a right of first refusal does not touch and concern the land.⁴³ The court noted that the jurisdiction looked for an...