Wednesday, March 19, 2008

Update on Dragnet Clauses

DragnetCourts are continuing to split on the efficacy of dragnet clauses in consumer transactions. Some courts give effect to such clauses, see In re Shemwell, 378 B.R. 166 (Bankr. W.D. Ky. 2007) (dragnet clause in open-ended line of credit granted to consumer is enforceable, and thus collateral secures all obligations of the consumer to the creditor); In re Nagata, 2006 WL 2131318 (Bankr. D. Haw. 2006) (credit card agreement, which provided for debt to be secured by all collateral provided for other loans made to the debtors, was secured by cars which debtor later refinanced, even though debtors had paid off the car loans); In re Franklin, 343 B.R. 815 (Bankr. N.D.W. Va. 2006) (enforcing a future advances clause in a consumer loan transaction without discussing the purpose of the future advance or how related it may be to the original loans). However, about an equal number do not. See Wooding v. Cinfed Employees Credit Union, 872 N.E.2d 959 (Ohio Ct. App. 2007) (although auto loan agreement provided that car would secure all obligations the borrower owed to the lender, nothing specifically indicated that the car would secure the borrower’s credit card account obligations and thus there was "no meeting of the minds with respect to the cross-collateralization of the automobile"); In re Yelverton, 2007 WL 841393 (Bankr. M.D. Ala. 2007) (neither first loan agreement, which included a clause indicating that collateral securing other loans also secures this one, nor second loan agreement, which included a clause purporting to make the collateral secure all other debts of the borrowers, was adequate to make the collateral granted in the second agreement secure the debt created in the first).

The most recent decision on this point is In re Keeton, 2008 WL 686938 (Bankr. M.D. Ala. 2008) (dragnet clause in security agreement with joint debtors did not clearly encompass obligations later incurred by only one of them, and thus the collateral did not secure those individual obligations). Decisions such as this are lamentable. They are a judicial invention that implicitly treats secured transactions as if they were governed by the common law, rather than a fairly detailed legislative code. Beyond that, they are expressly rejected in the comment to revised Article 9. See 9-204 comment 5 . More important, the requirement that the advances be of a similar kind is inconsistent with its own underlying rationale. In an effort to ensure that the debtor has truly consented to secured treatment of the future advance, courts refuse to enforce the parties’ agreement as written – which is the best evidence of their intent. Moreover, in the process, they relegate the unquestioned intent of the secured party to an irrelevancy. Most significantly, there is really no way to draft around the rule to ensure that all future advances will be covered, even if that is the true intent of both parties and even though the rule is ostensibly designed to give effect to their (or at least the debtor’s) intent.


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