A recent decision from the Eight Circuit Bankruptcy Appellate Panel highlights both the power of a dragnet clause in a security instrument and the ease with which it can be overlooked.  See Arvest Bank v. Empire Bank (In re Cook), __B.R. __, 2014 WL 68574 (8thCir. B.A.P. Jan. 9, 2014).

First, the power.  In Cook, the parties executed a guarantee that included a statement that it was unsecured.  Later, in connection with a different loan, the guarantors executed a deed of trust that contained a dragnet (or other-indebtedness) clause defining the “secured debt” to include, inter alia, obligations under any guaranty.  The court held that the clause was unambiguous and could not be rendered ambiguous by the statement in the earlier guaranty that it was unsecured.  

I disagree with that part of the decision since it should be possible to create an unsecured guaranty that will override later boilerplate dragnet provisions in other agreements.  Although both documents were unambiguous in isolation, the court should have recognized that together they formed the relevant agreement and addressed the conflicting terms.  Instead, the court chose to read the “unsecured” language as a mere assertion of fact rather than a statement of contract terms.  This allowed the court to discount the language because factually the guaranty was unsecured when executed and became secured only by the later execution of the deed of trust containing the dragnet clause.

Nonetheless, the opinion demonstrates the power of a dragnet clause to elevate the priority of an otherwise unsecured debt above a competing intervening secured lender’s claim.  Although this case arose in the real estate context, UCC Article 9 validates dragnet clauses for loans secured by personal property.  See UCC § 9-204(c).  Prior to the 2001 effective date of revised Article 9, courts generally construed dragnet provisions narrowly, however the comments to revised Article 9 indicate that rule is now rejected. See UCC § 9-204 cmt. 5.  Further, since financing statements under Article 9 are not tied to a particular debt or advance, the debt pulled in by a dragnet clause will enjoy the same priority as the original  advance, except in a few special situations like advances made more than 45 days after a judicial lien or tax lien attaches.  See UCC § 9-323(b) and 26 U.S.C. § 6323(c & d).

This brings me to my second point.  No doubt the priority secured status given to Empire Bank’s “unsecured” guaranty claim came as a surprise to Arvest Bank, but it also surprised Empire.  Empire initially filed its proof of claim as unsecured and was apparently unaware of the dragnet clause or it’s impact. One can imagine some poor associate discovering the clause buried in the debt definition in the wee hours of the morning.  It just goes to show how easy it is to miss the dragnet.