The United States Court of Appeals for the Seventh Circuit recently issued a harsh opinion for lenders in In re: David L. Duckworth. The case provides a startling example of the drastic consequences of failing to carefully proofread loan documents.
In December of 2008, a borrower borrowed $1,100,000 from a lender. The lender’s loan officer prepared a promissory note dated December 15, 2008, and a security agreement dated December 13, 2008, intending to secure the loan with a lien on the borrower’s crops and farm equipment. The security agreement, however, erroneously referred to a note “dated December 13, 2008.”
In 2010, the borrower filed a Chapter 7 bankruptcy. The Chapter 7 trustee argued that the lender’s security agreement failed to grant an effective security interest in the crops and farm equipment because there was no note dated December 13, 2008.
The court determined that the security agreement itself could not be construed to secure the December 15th note, because the date of the note given in the security agreement was unambiguous. The court also held that the lender could not present any evidence to prove otherwise. The court explained that although the lender would have been permitted to use such evidence to correct the mistaken date in a suit against the borrower, it was not entitled to do so against the bankruptcy trustee. Unlike the borrower, the Bankruptcy Code placed the trustee in the shoes of a third party judgment creditor. Correction of the error in the document could not be done in the face of this “strong arm power.”
The case demonstrates in a startling and dramatic way just how important careful documentation and proofreading are to protecting a lender’s interests. Although decided in another state, the court relied upon UCC and Bankruptcy Code principles which are applicable in California.