Seventh Circuit holds that error in security instruments renders instrument unenforceable against a Bankruptcy trustee

If the security instruments collateralizing a troubled account contain minor mistakes the lender is at serious risk of losing its right of enforcement if the debtor files bankruptcy. In re Duckworth, Nos. 14-1561 & 14-1650 Cons. (November 21, 2014) the Seventh Circuit reversed a decision by the district and bankruptcy courts in an action by a lender seeking to enforce a security interest. The debtor in that case borrowed $1,1000 which was evidenced by a promissory note that was dated and signed on December 15, 2008 and an Agricultural Security Agreement dated two days earlier, December 13, 2008. The security agreement said that it secured a note in the principal amount of $_________ dated December 13, 2008. But no promissory note dated December 13, 2008 existed. The Seventh Circuit held that under Illinois’ enactment of the Uniform Commercial Code a secured lender cannot use parol evidence against a bankruptcy trustee to correct a mistaken description of the collateral in a security agreement. Although the court was confident that the bank would have been able to obtain reformation against the original borrower if it had tried to avoid the security agreement based on the mistaken date, a bankruptcy trustee is in a different position. Bankruptcy law requires the court to treat the trustee as if he were a hypothetical later lien creditor. Such a creditor would be entitled to rely on the text of a security agreement, despite extrinsic evidence that could be used between the original parties to correct the mistaken identification of the debt to be secured.

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