The U.S. Court of Appeals for the Seventh Circuit has held that a dragnet clause within a master security agreement was effective, even though a subsequent loan agreement remained silent as to whether pre-existing collateral secured the new advance. Universal Guaranty Life Ins. Co. v. Coughlin, 481 F.3d 458 (7th Cir., March 14, 2007).
On April 30, 2002, Marine Bank entered into a loan and security agreement with debtor Health Management Limited Partnership (the "Debtor"), granting Marine Bank a first priority security interest in, among other things, the Debtor's accounts receivable, to secure all "obligations" between the parties. The definition of "obligations" included all indebtednesses between the parties "now existing or hereafter arising" (i.e., a "dragnet" clause). Plaintiff Universal Guaranty Life Insurance Company ("Universal") held a junior lien against the Debtor's accounts receivable.
By early 2003, the Debtor had fully drawn on all available lines of credit and had insufficient cash to make payroll. On March 7, 2003, Marine Bank agreed to advance $250,000 to cover the Debtor's payroll on the condition that the loan was fully collateralized by cash. William Coughlin, a staff physician, assigned $250,000 of his own funds to secure the advance. The agreements memorializing the March 7, 2003 advance did not discuss a security interest in the Debtor's accounts receivable.
On April 2, 2003, the Debtor filed for bankruptcy. Substantially contemporaneous to the bankruptcy filing, Marine Bank took possession of Coughlin's $250,000 deposit. Within one month, the Debtor ceased operations, at which time Marine Bank collected the Debtor's accounts receivable until its debt was paid in full. Upon full satisfaction of Marine Bank's debt, Universal began collecting the remaining accounts receivable.
Coughlin, as the subrogee of Marine Bank under section 509 of the Bankruptcy Code, asserted his priority entitlement to $250,000 of the accounts receivable.
Universal filed an adversary proceeding alleging that the Debtor's accounts receivable did not secure Marine Bank's March 7 loan. Coughlin argued that the dragnet clause of the April 30, 2002 agreement extended the Debtor's grant of a security interest in its accounts receivable to all of the Debtor's then-existing and future indebtednesses, including the March 7 loan. In response, Universal argued that the agreements memorializing the March 7 loan did not mention a security interest in accounts receivable and therefore, the March 7 loan was secured only by Coughlin's $250,000 deposit.
The bankruptcy and district courts ruled that the Debtor's accounts receivable did not secure the March 7 loan; however, the Seventh Circuit reversed.
The Seventh Circuit found that "[t]here is nothing ambiguous or contradictory about two documents, one that secures a loan with collateral A [(i.e., the Debtor's accounts receivable)] and another that secures a loan with collateral B [(i.e., Coughlin's $250,000 deposit)]." Therefore, the Seventh Circuit held that there was no contradiction or inconsistency between the April 30, 2002 loan agreement and the March 7 loan agreement, and the plain and unambiguous language of the dragnet clause, which granted a lien on the Debtor's accounts receivable to secure future advances, controlled.
The Seventh Circuit indicated that if the March 7 loan agreement had affirmatively stated that the loan was not secured by the Debtors' accounts receivable rather than simply remaining silent on the point, then an ambiguity would have existed between the two agreements.
The Seventh Circuit's opinion indicates, under Illinois law at least, that a dragnet clause generally is enforceable despite the lender's failure to restate the grant of lien in a subsequent loan agreement covered by the dragnet clause. No ambiguity or contradiction arises solely as a result of the latter agreement's failure to reference the dragnet clause or restate the pre-existing collateral.
This article is presented for informational purposes only and is not intended to constitute legal advice.
