Daily Development for Wednesday, July 18, 2001

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

BANKRUPTCY; SECURED CLAIMS; DRAGNET CLAUSES:

Lender may not use a dragnet clause in a personal property security agreement to add to its secured claim future advances made on a credit card; nor may it add unpaid balances on loans made prior to the secured transaction without a specific reference to the prior loans in the subsequent security agreement.

In re Wollin, 249 B.R. 555 (Bankr. D. Or. 2000).

The Bankruptcy Court, applying Oregon law, ably reviewed the most common principles applicable to the question of how to interpret a lender's dragnet, or crosscollateralization, clause found in many mortgages. The specific primary, secured obligations in these joint cases were car loans and a credit card loan, not real estate, but the principles will apply to real estate mortgages as well.

The lender argued that, according to its plain meaning, the cross collateralization (dragnet) clause in a purchase money loan for a truck covered "any other amount" owed "in the future" to the same lender, and thus included subsequent advances on a credit card issued after the truck loan. the Bankruptcy Court applied a stricter test, holding that the subsequent advance must be "of the same class as the primary obligation...and so related to it that the consent of the debtor to its inclusion may be inferred."

The lender then argued that the truck loan and the credit card loan were of the "same class" because both were consumer loans. There was some authority from other jurisdictions supporting this analysis, but the court here rejected it, stating that "[a] loan to purchase a vehicle differs both in scope and solemnity from the miscellaneous charges typical of a VISA account."

Similarly, the Bankruptcy Court rejected the "plain meaning" test for deciding whether prior advances were covered. Here, there was no express Oregon authority, but the court again turned to cases in other jurisdictions. It conceded that the majority rule appears to be the "plain language" test here, since at the time of the subsequent loan the debtor certainly is aware of the existence of any prior loans and ought to be expected to read the instruments referring to prior loans. Other courts have held that prior loans are included if they are in the same "class" as the subsequent secured loan.

The Oregon Bankruptcy Court could have followed the latter authority and found, as it had with regard to the subsequently incurred debts, that the prior debt was of a different "class," even though consumer debt.

It elected not to do so, however, and adopted an even broader consumer protective view: "Guided by the policy that dragnet clauses are generally disfavored and strictly construed," the Bankruptcy Court held that there must be a specific reference in the security agreement to any prior debt which the parties intend to be covered by a later security. Although it noted that the rule was especially applicable to consumer transactions, it did not limit the rule to such transactions. It relied upon an Alaska case that reasoned that, since the preexisting debt was known to the parties, there was no reason not to refer to it specifically in the subsequent security agreement, instead of relying upon general language.

Comment 1: With regard to the notion of future advances being limited to the same "class" of debts, it is important to note that such a requirement is only a means to an end. The real question is whether the subsequent debts are of a nature that the debtor should have anticipated would be picked up by the cross collateralization clause. For instance, where there is a line of credit established, the debtor may later use money on that line of credit for business or for personal purposes. That shouldn't matter, so long as the parties are operating under the same basic credit understanding.

Further, it is quite possible that a debtor could borrow money for debt consolidation or some other consumer purpose, and years later take out a new loan from the same creditor for a similar purpose, and that the distance in time and the existence of two separate loan events would indicate that the future advance clause in the first loan ought not to apply, even though both loans are of the same "class."

Comment 2: Note that the court here applies a more stringent standard for the dragnet clause picking up prior loans. The new loan must explicitly refer to such prior loans. This may be an acceptable rule, albeit a severe one, for consumer loans. But, in the editor's view, it is an unacceptable rule for the commercial context, and the court here does not differentiate, citing both commercial and consumer cases back and forth.

There may be room to argue, in the exceptional case, that a prior loan is not implicitly picked up by express language in a later agreement stating that it secures all prior loans from the same creditor to the same debtor.

But that is the exceptional case in the commercial context. We should expect commercial debtors to know that they own other debts to a given lender and we should also expect them, in general, to read and understand what they sign, or to live with the consequences. It is quite common for commercial parties to renew credit lines on a regular basis, and to add new security to keep the credit arrangement alive and well. The kind of general language used in the transaction in this case ought to be enough to bind a commercial debtor in the typical case.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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