MORTGAGES; FUTURE ADVANCES; "DRAGNET" CLAUSES;
VALIDITY: Even where two loans are related in character and entered
into simultaneously, language created cross collateralization contained in
"boiler plate dragnet clause" will not be enforced where there is parole
evidence that the parties did not intend that there be such cross
collateralization.

Fischer v. First International Bank, 2003 Westlaw 21463649 (Cal.
App. 6/25/03)

Fischers had an ongoing relationship with Bank regarding the
construction of a restaurant and entertainment facility. In the instant
transaction, they "took out" the construction loan used to build the
facility in one loan, and financed the acquisition of equipment for the
facility with another. Both loans were SBA guaranteed loans.
Apparently the SBA required additional collateral for the equipment
loan, and Fischers gave a deed of trust on their house. Fischers alleged
that on a number of occasions they discussed the collateralization of their
loans with the Bank loan officer, and he assured them repeatedly that the
deed of trust on the house secured only the smaller equipment loan.

In fact, there was a loan agreement that listed the two loans separately
and set forth plainly that the "take out" loan on the building was secured
by a deed of trust on that building and the loan for the equipment was
secured both by a second a deed of trust on the building and by a deed of
trust on Fischers' home.

At closing, Fischers noted that there was a reference in the deed of trust
on the house to both notes, and demanded that the document be changed.
The bank officer agree that there was no intent that the house serve as
collateral for the permanent loan on the restaurant real estate and
changed the note.

But the "boiler plate" language in the deed of trust (described by the
court as contained in "fine print") read as follows:

"The word 'Indebtedness" means all principal and interest
payable under the Note . . . In addition to the Note, the word
'Indebtedness" includes all obligations, debts and liabilities, plus
interest thereon, of Borrower to Lender . . . as well as all claims
by Lender against Borrower . . . whether now existing or hereafter
arising, whether related or unrelated to the purpose of the Note,
whether voluntary or otherwise, whether due or not due, absolute
or contingent, liquidated of unliquidated and whether Borrower
may be liable individually or jointly with other, whether obligated
as guarantor or otherwise, and whether recovery upon such
Indebtedness may be or hereafter may become barred by any
statute of limitations, and whether such Indebtedness may or be
hereafter may become otherwise unenforceable."

[The language at the end relates to the fact that, in California, a deed of
trust can be enforced by private sale even though the debt is barred by
limitations (subject to the marketable title period.) It is not clear to the
Editor whether this benefit is available for deeds of trust securing debts
unenforceable for other reasons.]

Fischers later elected to sell their home, which had substantial equity
even over the amount of the equipment loan. They intended to use the
equity to invest in their construction business. They later alleged that the
bank officer with whom they originally dealt verbally assured them that
they could have the proceeds remaining after satisfaction of the
equipment loan. But after they sold the house and the funds were in
escrow, the bank made a demand that the surplus proceeds be paid over
to it in order to pay down the first deed of trust on the restaurant
property. The case does not indicate whether this loan was in default at
the time.

The escrow company, believing that the Bank buttered its bread,
apparently paid the money over to the Bank despite Fischer's protests.
(The escrow company was a co-defendant below.)

Fischers' alleged that as a result of the diversion of these monies they
were forced to sell their business and other assets at a substantial loss to
meet their financial needs. They sued for conversion and a variety of
related claims, but the trial court, reading the express language of the
deed of trust for all it was worth, granted summary judgment.

The Bank's position, apparently, was that parole evidence should be
excluded and that the documents were clear and unambiguous on their
face, leading to the conclusion that it had a right to the excess proceeds
from the sale of the house.

The court noted several flaws in this reasoning. It pointed out that the
integration clause indicated that the loan agreement was part of the
overall contract. The loan agreement expressly provided that the house
secured only the equipment loan. Consequently, there was an ambiguity
in the documents that would have justified the admission of parole
evidence.

The court then, somewhat superfluously, went on to discuss at length the
question of whether a plainly written dragnet clause could still be subject
to reinterpretation by the courts through the use of parole evidence. If
suggested, but did not itself hold, that under California law "dragnet
clauses" ought not always to be interpreted exactly as written even when
they are clear and unambiguous. It began by discussing authorities
outside of California. It noted, for instance, that the Restatement of
Mortgages provides expressly that a broadly worded dragnet clause can
only have prospective effect except where preexisting indebtedness is
described with particularity. It cited to courts in other jurisdictions that
will never dragnet to other debts unless identified particularly. It
admitted that some courts enforce the clauses as written. But it stated
that many other courts take an "intermediate position," and look to
determine whether the parties in fact had a clear intent that given debts in
fact are to be secured. Typically, courts will look at such factors as
whether the dragnet clause is boilerplate; whether the other debts are of
the same kind as the primary debt; whether the other debts are identified
with any specificity (even if arising later); and whether the other loans
are otherwise fully secured.

The court concluded that California courts follow this middle position.
"California courts have consistently adhered to a construction of such
clauses that depends more on 'the actual expectations of the parties than
the literal wording of the boilerplate." The court noted that a dragnet
clause is one of the provisions least likely to be understood by layperson
borrowers. Further, such clauses, when appearing on preprinted forms
(as apparently was the case here) are treated as contracts of adhesion.
Such provisions will not be enforced in California if they do no fall
within the "reasonable expectations of the weaker or "adhering" party.

The court cited Roger Bernhardt's commentary to the effect that
California courts routinely admit parol evidence in such cases to show
what debts a broadly worded dragnet clause was intended to cover.

In the end though, the court fell short of opening up the parole evidence
rule completely:

"Because we find the related loan documents to be ambiguous for
other reasons, we need not consider whether parol evidence is
more generally admissible to determine the intended scope of a
broadly worded dragnet clause."

The court found even the definition of "indebtedness" discussed above to
be sufficiently ambiguous to warrant admission of parole evidence, since
it first identified the debt in terms of the notes and then went on to
expand the definition dramatically in the fine print. It also found, as
noted, that the loan agreement created an ambiguity when measured
against the definition of indebtedness. It also noted that it was unlikely
that a party would give a mortgage on his residence to secure debts that
were "unenforceable."

Although it was true that in this case the two loans were made
simultaneously and as part of the same business transaction, and were
related to one another, making cross collateralization more likely, the
court nevertheless concluded that the overall pattern of evidence made it
a triable issue of fact whether the lender and debtor mutually agreed that
the house secured both debts. The court therefore reversed the granting
of summary judgment, without commenting upon what would happen
next with respect to the various claims against the Bank and the escrow
company.

Comment 1: As the court indicated, it was hardly necessary to go through
the whole exercise about the evils of dragnet clauses when the
documents on their face contained an ambiguity and there was plenty of
alleged parole evidence that supported the borrower's construction of the
agreement. Nevertheless, the court's validation of the general judicial
hostility to these clauses will, one hopes, give some lender's counsel
pause in drafting these things so broadly, as they ought to give opining
attorneys pause in concluding that they are enforceable.

Comment 2: Lender overreaching in this area, such as including
boilerplate that renders a deed of trust for collection of all
"unenforceable" debts, is of course an invitation to courts to refuse
enforcement of agreements as written. The editor would prefer that
commercial loan documents would be enforced as written, and that
borrowers retain competent counsel and "duke it out" at the time of loan
negotiation, rather than at time of default. But the added cost of such
negotiations often is not worth the investment to optimistic borrowers at
time of borrowing, which is what leads lenders to sneak in all the
"gotchas." It's not a perfect world.

Readers are encouraged to respond to or criticize this posting.

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