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Consider these circumstances. The bank makes a loan to a borrower secured by a mortgage on real property – a pretty simple transaction. Almost four years later, the bank enters into a separate note with the same borrower that was secured by the borrower’s furniture and fixtures. The cross-collateralization provision in the security agreement related to the second note with the borrower provided, in part, that “In addition to the Note, this Agreement secures all obligations, debts and liabilities. . .” Notably, the cross-collateralization provision does not make specific reference to any prior debt. Most banks would argue that the language “all obligations” in this cross-collateral provision is sufficient to identify the first promissory note. Not so fast, says the Arkansas Court of Appeals.
In Equity Bank v. Southside Baptist Church of Lead Hill, 2020 Ark. App. 199, the Court restricted the application of a general cross-collateral provision contained in a mortgage or security agreement on the basis that the subsequent mortgage/security agreement did not adequately describe the pre-existing debt that was being secured by the subsequent security agreement. Specifically, the Court held that when a mortgage is given to secure a specifically-named debt, the security will not be extended to antecedent debts unless the instrument specifically provides for it and identifies those debts intended to be secured in clear terms. In other words, a general cross-collateralization provision without specific references to older debts may no longer be valid.
Ark. Code Ann. § 4-56-105 was passed in 2021 and attempted to address this very issue. This statute provides that a security interest in a consumer debt transaction is valid and enforceable whether it specifically lists or identifies existing debts or obligations. It eliminated this requirement that you specifically reference debts already existing to that borrower. Notably, this statute applies to security agreements or mortgages entered into after September 1, 2021. Many banks cheered this legislation, but it does not eliminate exposure.
Consider evaluating your loan portfolio to identify potential issues before those very loans are in default. Contact us to get our recommendations on the steps you should take to limit your exposure and best practices when preparing loan documents internally.
Jake Fair is a partner and licensed CPA with Wright Lindsey Jennings. Jake is a member of the firm’s Banking Law Group and routinely advises banks and businesses on issues related to secured transactions and bankruptcy, among other things.