On November 21, 2014, the United States Court of Appeals for the Seventh Circuit issued a very tough opinion for lenders.  In this case, a borrower signed a $1,100,000.00 Promissory Note dated December 15 and an Agricultural Security Agreement dated December 13. The Security Agreement said that it granted the bank a security interest in crops and farm equipment. The Promissory Note referred to the Security Agreement. Unfortunately, the Security Agreement stated that it secured a Promissory Note dated December 13, not December 15.

The borrower filed a Chapter 7 bankruptcy in 2010 and the trustee argued that the Security Agreement failed to grant a security interest because there was no note dated December 13. The bank argued that the Security Agreement was enforceable based on parole evidence and the parties’ intent.

The Seventh Circuit held that the Security Agreement did not grant the lender a security interest in the collateral because it was unambiguous. Even though it was clear the bank made a mistake in preparing the documents, parole evidence could not be used to reform the contract as against the bankruptcy trustee. The court said the bank would have been able to obtain reformation of the contract against the original borrower but the bankruptcy trustee is different. The bankruptcy trustee can use its “strong arm” power under the Bankruptcy Code. The trustee is deemed to be in the position of a hypothetical lien creditor without regard to any knowledge of any creditor. The court said that the trustee can void a security interest because of defects that need not have misled, or even have been capable of misleading, anyone.  The court held that “the mistaken identification of the debt to be secured cannot be corrected, against the bankruptcy trustee, by using parole evidence to show the intent of the parties to the original loan.”

Proofreading, proofreading and proofreading is key to preserving the lender’s expectations.