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As lenders are undoubtedly aware, the coronavirus/COVID-19 outbreak has or will cause significant issues with payments from their borrowers as the pandemic sends shockwaves through the economy. Extensions on current, distressed, and past due loans will be the norm for the next few months at least. Lenders should take this time to review their loan documents for any issues with securing, cross-collateralizing, and perfecting their loans to fix any possible issues with the extension or forbearance agreement. A recent Arkansas Court of Appeals decision underscores the need to double-check your security in one particular area: mortgages or security agreements that supposedly cross-collateralize antecedent debt.
In Equity Bank v. Southside Baptist Church, 2020 Ark. App. 199, the Arkansas Court of Appeals affirmed the trial court’s granting of a motion for summary judgment in favor of Southside Baptist Church.[1] The trial court found that the mortgage at issue, which the bank argued had been given to secure repayment of an earlier debt, was not specific enough as to that antecedent debt to secure it. Although a later mortgage can secure debt already in existence, the trial court said that mortgage or security agreement must provide for and identify the antecedent debt “in clear terms.” According to the trial court, the bank’s commercial security agreement did not.
The clause at issue contained language many lenders will find familiar. The Cross-Collateralization section of the commercial security agreement stated that:
In addition to the Note, this Agreement secures all obligations, debts, and liabilities, plus interest thereon, of [borrower] to [lender], or any one or more of them, as well as all claims by [lender] against [borrower], whether now existing or hereafter arising, whether related or unrelated to the purpose of [this promissory note] . . . .
Despite the clause stating that the agreement secured “now existing” debt, the trial court granted Southside Baptist’s summary judgment motion arguing that the clause was not specific enough to secure a promissory note that Southside Baptist had executed in favor of the bank a few years before.
On appeal, the Arkansas Court of Appeals agreed. Citing Arkansas Supreme Court precedent, the Court of Appeals held that “[w]hen a mortgage is given to secure a specific named debt, the security will not be extend to antecedent debts unless the instrument provides and identifies those debts intended to be secured in clear terms.” The appellate court explicitly rejected the bank’s argument that the “whether now existing or hereafter arising” was specific enough to secure the antecedent debt, even though both parties otherwise knew the antecedent debt existed.
The lesson: be specific when cross-collateralizing prior debt. Instead of simply referring to any “now existing” or “prior” debt, specify the existing promissory note(s)—by date, amount and loan number (as the court put it, “unambiguously”)—that the new collateral is also going to secure. The court’s decision follows established Arkansas case law, but the Equity Bank ruling makes clear that the principle of antecedent debt having to be specifically described in a security instrument extends to personal property as well as to real property.
As the COVID-19 outbreak is reshaping the economic landscape, lenders across the country are likely to be providing more extensions, forbearances, and modifications than new loans. The Equity Bank case turned on Arkansas law, so be sure to check the law in your jurisdiction as to what is required to secure antecedent debt. Regardless of your jurisdiction, this case serves as a reminder that now is the time to review your existing loan documents to be sure you are properly secured, cross-collateralized, and perfected on those loans. If you find something now, you can correct it when making the extensions and modifications rather than finding out after you’ve filed suit or the borrower has filed bankruptcy, when it may be too late.
