Congratulations! You’ve wrapped up the year-end rush to close and book your loans and thanked your documentation staff on a job well done. But we all know that in the multi-tasking frenzy to fund time sensitive deals, mistakes can happen. A recent decision out of Illinois by the Seventh Circuit Court of Appeals in State Bank of Toulon v. Covey (In re Duckworth), (Click here to access full text of the Opinion) is a potent reminder that even minor mistakes, including typos, can have disastrous consequences on future debt collection efforts.
On December 15, 2008, a borrower obtained a $1,100,000.00 loan from a bank evidenced by a Promissory Note dated that same day. The Security Agreement securing the debt, signed contemporaneously by the borrower, was dated December 13th, two days prior to the date on the Promissory Note. The Security Agreement defined the secured “Indebtedness” by reference to a “Note” which was itself defined as the Promissory Note executed by the borrower on December 13, 2008. The Security Agreement failed to include a dragnet clause which would have provided that the collateral also secured all of borrower’s past, present, and future debt owed to the bank.
Nearly two years later, the borrower filed for bankruptcy and the bank attempted to collect the debt. Following litigation in Bankruptcy Court and District Court, the case made its way to the Seventh Circuit which accepted that the evidence showed that the bank made a mistake in preparing the Security Agreement and that the parties intended to secure the December 15th Promissory Note by the Security Agreement. Nonetheless, the Seventh Circuit held that as between the bankruptcy trustee and the bank, “the security agreement secures only a December 13 promissory note that never existed. The text of the security agreement does not incorporate the promissory note dated December 15 or the description of debt contained therein.” Therefore, the Court ruled that under Illinois law, the bank could not use parol evidence against the bankruptcy trustee to reform the Security Agreement to secure the December 15th Promissory Note.
In light of the outcome of this case, what’s a concerned and conscientious banker to do?
- First, review your fourth quarter transactions to verify that all blanks have been completed, that all names, dates, dollar amounts, and collateral descriptions have been verified and that any other typos or mistakes have been identified.
- Second, if you identify typos or other mistakes in your loan documents, arrange for the borrower to sign an amendment to correct the mistakes now while the relationship is still good and there is no immediate risk of bankruptcy.
- Third, if you haven’t done so already, modify your standard loan and lease documents to include a dragnet clause which will provide that the collateral also secures all past, present, and future debt of the borrower to the bank.
- Fourth, if a borrower demands that your standard dragnet clause be deleted, establish a policy that requires enhanced internal review of the final loan and security documents before the loan is funded.
Let’s face it, no one wants to spend time searching for mistakes, but by following these simple steps, you will save yourself time, money and stress when the time comes to collect a good loan that’s gone bad.