May 7, 2012
Posted in: Alerts
By: Gerson

A recent bankruptcy case should give pause to lenders who when making commercial loans prepare documents in-house using LaserPro or other automated loan documentation software.

In “In Re Duckworth” (March 22, 2012), the Chief Bankruptcy Judge for the Central District of Illinois issued a decision that will have far reaching effects on some lenders using LaserPro, and other automated loan documentation software. The lack of a “future advances” (aka cross-collateralization) clause in the LaserPro documents resulted in a loss of the bank’s security for a loan.

In this case, the State Bank of Toulon used LaserPro to generate loan documents for a $1.1 million loan. The bankruptcy trustee and a subsequent creditor challenged the assertion of the Bank that its security interest secured the loans and had priority. Their first argument was that the security agreement did not properly identify the 2008 promissory note because the security agreement stated that it secured a Note dated December 13, 2008 and the Note was actually dated December 15, 2008. The bankruptcy judge determined that although there was an inconsistency, the Bank could prove that there was a “clerical error” and that the security agreement did secure the promissory note. Although the lender prevailed on this issue, it incurred considerable expense to address a “clerical error” in the loan documents.

The second argument was that the security agreement did not secure a later 2010, promissory note even though it stated that it was secured by the security agreement, because the security agreement did not contain a cross-collateral (or dragnet) clause. This argument was more successful—the court determined that the definition of Indebtedness in the security agreement was circular and actually served to limit the coverage of the security agreement to just the 2008 promissory note. The court also found that the statement in the 2010 note that it was secured by the prior security agreement was ineffective to overcome the absence of cross-collateralization language in the security agreement. As a result, the security interest of the Bank in the borrower’s property did not secure the 2010 loan.