Tuesday, March 24, 2015

Beware the Scrivener's Error - It Could Destroy Your Lien (Stephen Stapleton)

By Steve Stapleton

On December 15, 2008, David Duckworth borrowed $1.1 million from the State Bank of Toulon, Illinois.  The borrower signed a promissory note dated December 15 and an Agricultural Security Agreement dated December 13.  The security agreement said that the borrower granted the bank a security interest in crops and farm equipment.  The security agreement identified the debt to be secured but the identification had a critical mistake.  The security agreement said it secured a note “in the principal amount of $_______ dated December 13, 2008.”  In fact, there was no promissory note dated December 13.  In 2010, the borrower filed a petition for bankruptcy under chapter 7 and in subsequent proceedings the chapter 7 trustee asserted that the mistaken date in the security agreement defeats that bank’s asserted security interest in the crops and farm equipment.  On appeal, the Seventh Circuit Court of Appeals agreed.  In re Duckworth (State Bank of Toulon v. Covey), Nos. 14-1561 and 14-1560 (7th Cir., Nov. 21, 2014) (click here for a copy of the opinion).

Upon the filing of bankruptcy, under section 544 of the Bankruptcy Code, the trustee assumes the position of a hypothetical judicial lien creditor.  Such a trustee, said the court, may “void a security interest because of defects that need not have misled, or even be capable of misleading, anyone.”  Because third parties must be able to rely on unambiguous documents to determine the validity and priority of security interests, parol evidence (oral testimony) cannot be used to correct a mistake.  The security agreement must be enforced according to its terms even if such enforcement is contrary to the intentions of the original parties.
The Court stated:  “In a commercial world dependent upon the necessity to rely upon documents meaning what they say, the explicit recitals on forms, without requiring for their correct interpretation other documents not referred to, would seem to be a dominant consideration.  If security agreements which on their face served as collateral for specific loans could be converted into open-ended security arrangements for future liabilities by recitals in subsequent notes, much needless uncertainty would be introduced into modern commercial law.”
Thus, the court held, a party cannot enlarge the security interest to one other than that specifically referenced in the security agreement.  As §9-201 of the Uniform Commercial Code demands that the terms of a security agreement be enforced as written and since there existed no December 13 promissory note, the chapter 7 bankruptcy trustee could avoid the bank’s claimed security interest.  The court concluded:  “Later creditors and bankruptcy trustees are entitled to treat an unambiguous security agreement as meaning what it says, even if the original parties have made a mistake in expressing their intentions.”
The takeaway:  Verify that all blanks have been completed, and that all the pertinent information (names, dates, collateral descriptions, etc.) have been verified.  If there has been a mistake, have the borrower sign a modification or amendment correcting the mistake.  Finally, insert dragnet clauses to ensure that the collateral secures past, present and future debt.  The lien you save may be your own.

To read the United States Court of Appeals Opinion, please click here.

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