The most common, or at least the most preventable, way for a security interest to perish involuntarily is a drafting error made by the author of the security instrument. The Seventh Circuit recently confirmed a security agreement's demise by this method in State Bank of Toulon v. Covey (In re Duckworth), Nos. 14-1561 and 14-1650 (7th Cir. Nov. 21, 2014).
Duckworth, a bankruptcy debtor later charged with money laundering and bankruptcy fraud, borrowed $1.1 million from the State Bank of Toulon in 2008. The loan was evidenced by a promissory note dated December 15, 2008, and the parties intended to secure it with certain crops and farm equipment. However, the Agricultural Security Agreement the bank prepared didn't provide the intended security. The agreement stated that it secured a note "in the principal amount of $_________ dated December 13, 2008." Not only was the amount left blank, but the referenced note, dated two days before the actual note, did not exist.
The bankruptcy trustee sought to avoid the bank's security interest using his strongarm powers under 11 U.S.C. § 544. Both the bankruptcy court and the district court denied the trustee's claim, enforcing the bank's lien. The bank had submitted uncontested evidence that the security agreement was in fact meant to secure the December 15 promissory note, and that the December 13 date was merely a typographical error. The lower courts simply gave effect to the intent of the parties.
The Seventh Circuit, however, declined to consider the evidence of the parties' intent because the security agreement wasn't ambiguous. The court didn't need parol evidence to construe the terms of the agreement—it very plainly secured indebtedness under a December 13, 2008 promissory note. The result was the same under U.C.C. § 9-201, which provides that "a security agreement is effective according to its terms." Because there was no December 13 note, there was no debt to secure and no security interest.
Also guiding the court's holding was a 28-year-old decision, In re Martin Grinding & Machine Works, Inc., 793 F.2d 592 (7th Cir. 1986), in which the court rejected a similar argument that the security agreement at issue had inadvertently omitted the debtor's inventory and accounts receivable from the collateral description. The court simply confirmed that Martin is still good law, and that an unambiguous security agreement will be enforced according to its exact terms, regardless of the intent of the parties.
As the Seventh Circuit noted, the realities of commercial transactions favor adherence to such technicalities. The smallest of details included in a large set of transaction documents may be relied upon later by third parties who have no way of knowing whether the original drafter made a mistake. Courts must eschew the "fireside equities" of the bank's quandary in favor of the predictability offered by enforcing the plain language in the contract.
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