Typo Terminates Bank’s Security Interest for Commercial Loan
Typos happen in everyday life. In the age of texts and instant messages, we all have inadvertently typed one word for another – “your” instead of “you’re,” “there” instead of “their.” Generally, people understand the intent and meaning of the conversation despite the typo, and no harm is done. For a creditor, however, a typo on a Security Agreement can be disastrous. By referencing the wrong date of a promissory note in a security agreement, a creditor may lose all security interest against a bankruptcy trustee or later creditor.
Some loans are secured by a security agreement in collateral of the borrower (“Security Agreement”). The Security Agreement gives the bank (“Creditor”) a security interest in all of the business assets or property of the borrowing person or company (“Debtor”). To perfect this security interest, the Creditor must file a Uniform Commercial Code (“UCC”) financing statement (“UCC Statement”) with the Office of Secretary of State or, in Wisconsin, the Department of Financial Institutions (“DFI”). The UCC Statement names the borrower as the Debtor and the Creditor as the secured party, and describes the collateral that is secured. The DFI then files that UCC Statement under the Debtor’s name.
A recent Seventh Circuit case demonstrates the importance of accurate information in a Security Agreement. In State Bank of Toulon v. Covey (In re Duckworth), the Creditor mistakenly referenced an incorrect date of a promissory note in the Security Agreement. When it sought to enforce the Security Agreement in a bankruptcy proceeding, it lost its security interest in the Debtor’s collateral.
The issue in this case was whether the bank could provide evidence against a bankruptcy trustee to save the Security Agreement from a mistaken description of the debt to be secured. The Security Agreement granted the bank a security interest to secure certain indebtedness, defined as “the indebtedness evidenced by the Note or Related Documents.” The Security Agreement defined the “Note” as the “Note executed by David L. Duckworth in the principal amount of $_____ dated December 13, 2008.” The amount was never filled in.
Unfortunately for the bank, the actual promissory note was dated December 15, 2008. The Note referenced and defined in the Security Agreement was dated December 13, 2008. Since no such promissory note dated December 13, 2008 existed, the Security Agreement secured no debt. The actual loan evidenced by the December 15, 2008 note was essentially unsecured.
The court looked to UCC Section 9-203, which sets out the minimum requirements that must be satisfied to enforce a security interest. It found the section does not provide a mechanism for rescuing a lender from its mistake in drafting a security agreement. The court held that, given the lack of a “gap-filling” provision in section 9-203, it would not invent one merely because the bank made a mistake in preparing its security agreement.
The court ultimately held that “[l]ater creditors and bankruptcy trustees are entitled to treat an unambiguous security agreement as meaning what it says, even if the original parties have made a mistake in expressing their intentions.” Such later creditors are “entitled to rely on the text of a security agreement, despite extrinsic evidence that could be used between the original parties to correct the mistaken identification of the debt to be secured.” The court noted the bank may have been able to reform the security agreement against the original borrower despite the mistaken date of the promissory note. But the court held that the bank could not use such extrinsic evidence against the bankruptcy trustee of such borrower.
Banks must be cognizant of all details in drafting a Security Agreement and a UCC Statement to ensure the correct debtor name(s), promissory note date(s), and description of collateral. While a bank may be able to reform an agreement based on mistaken information against the original debtor, such reformation is not possible against a later creditor or bankruptcy trustees.
This article is the first of a series of articles on UCC Statements and Security Agreements for commercial loans. Please also see Attorney Laura Peck’s related article, “What To Do When Your Borrower Changes Its Name,” that discusses a borrower’s name change and the effect of the name change on a UCC financing statement.
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