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Court of Appeals Takes Hard Line Against Bank’s Typo in Loan Document

See page for author [CC BY 2.5 (http://creativecommons.org/licenses/by/2.5)], via Wikimedia CommonsA drafting error in a security instrument rendered the security interest invalid, according to the Seventh Circuit Court of Appeals. In re Duckworth, Nos. 14-1561, 14-1650, slip op. (7th Cir., Nov. 21, 2014). Specifically, the date of the security instrument did not match the date of the promissory note. The bank argued, in part, that it should be allowed to reform the security agreement using parol evidence, which is evidence of the parties’ intent that is not found in the language of the document itself. The court held that the bank could not correct the error in this manner. The ruling ought to be good news for debtors, since it places the burden firmly on banks and other lenders to draft loan documents correctly and removes nearly all room for error on their part.

The debtor borrowed $1.1 million from the bank on December 15, 2008. On that date, he signed a promissory note for that amount and delivered it to the bank. Two days earlier, he had signed a security instrument that granted the bank a security interest in most of the debtor’s personal property, which included crops and farm equipment. The security instrument stated that it was securing a note “in the principal amount of $_______ dated December 13, 2008.” Duckworth, slip op. at 3 [emphasis in original].

Two years later, the debtor filed a Chapter 7 bankruptcy petition. The trustee’s position was that the bank’s claimed security interest was defective and therefore voidable under 11 U.S.C. § 544(a)(1). The bank filed two adversary complaints seeking to correct the drafting error and preserve its security interests. One proceeding claimed a security interest in the debtor’s crops, and the other in his farm equipment. The bankruptcy court ruled for the bank in both proceedings, holding that the mistaken date did not invalidate the security instrument. Different district judges heard the trustee’s appeals of the two rulings, and both affirmed the bankruptcy court.

On appeal to the Seventh Circuit, the trustee argued that the security instrument failed to create a valid security interest because it referenced a promissory note dated December 13, which did not exist. The bank argued that it could use parol evidence, such as communications between the debtor and the bank indicating their intention to create a security interest, to correct the error. The trustee’s argument may seem like hair-splitting, but contract law generally prefers to hold parties to the actual language of their agreements, even when the result might seem odd.

The Seventh Circuit reversed the lower courts, finding that the security instrument was invalid. It noted that the language of the security instrument was unambiguous on its face, and that courts generally do not allow the use of parol evidence with regard to an unambiguous contract. It cited a prior decision that specifically prevented a lender from using parol evidence to correct a security instrument in a challenge by a bankruptcy trustee. In re Martin Grinding & Machine Works, Inc., 793 F.2d 592, 595 (7th Cir. 1986). See also In re Robert Bogetti & Sons, 162 B.R. 289 (Bankr., E.D. Cal. 1993).

For more than 17 years, personal bankruptcy attorney Devin Sawdayi has represented individuals and families in Chapter 7 and Chapter 13 bankruptcy cases in the Los Angeles area. To schedule a free and confidential consultation with a skilled and knowledgeable consumer advocate, contact us today online or at (310) 475-9399.

More Blog Posts:

Transfer of Real Estate by Debtor More than One Year Before Filing Chapter 7 Bankruptcy Petition Does Not Bar Discharge of Debt, According to California Appellate Court, Los Angeles Bankruptcy Lawyer Blawg, January 9, 2015

Ninth Circuit Rules that Bankruptcy Trustee Has Authority to Recover Debtor’s Property at Any Time While the Case Is Pending, Los Angeles Bankruptcy Lawyer Blawg, December 30, 2014

Debtors Allowed to Sue Loan Servicer for Charging Unapproved Fees During Chapter 13 Bankruptcy, Los Angeles Bankruptcy Lawyer Blawg, December 23, 2014

Photo credit: See page for author [CC BY 2.5], via Wikimedia Commons.