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Bankruptcy Court’s Interpretation of Parties’ Contracts Expands Scope of Preference Avoidance

By: Stephanie Hung

St. John’s Law Student

American Bankruptcy Institute Law Review Staffer

 

        In In Re Omni Enterprises, an Alaska Bankruptcy Court held that a bank may enforce the security interest of a prior loan that has already been repaid to cure a new loan that is in default.[1] In 2009, a borrower entered into a loan agreement with a bank for $1.3 million.[2] The loan was partly secured by the borrower’s deposit accounts.[3] After the 2009 loan was repaid, the borrower entered into a new loan agreement with the same bank for $2.6 million.[4] The new loan was secured by, among other things, the borrower’s equipment, furnishings, and fixtures, but did not explicitly include the deposit accounts.[5] In 2015, the borrower defaulted on the loan and the bank swept the deposit accounts, causing the borrower to file for chapter 7 under the Bankruptcy Code.[6] According to the bank, it continued to have a lien on the deposit accounts notwithstanding the repayment of the 2009 loan.[7] The borrower’s trustee then filed suit in the United States Bankruptcy Court for the District of Alaska.[8] The Court ultimately agreed with the bank’s interpretation of the loan agreements, and held that the sweeping of the deposit accounts was permissible.[9]

        The court noted that there were two contract provisions at issue.[10] First, the 2009 loan contained a future advances clause that stated, “[T]his Agreement secures all future advances made by lender to Grantor . . . .”[11] Second, the 2013 loan contained an integration clause that stated, “This Agreement, together with any Related Documents, constitutes the entire understanding and agreement of the parties . . . .”[12] The court concluded that the 2013 loan defined the Related Documents as including the 2009 loan.[13] Thus, the deposit accounts, which were clearly subject to the liens securing the 2009 loan, also secured the 2013 loan even though the 2009 loan was completely paid off.[14]  Moreover, because the Court interpreted the 2013 loan to include the deposit accounts, the bank was protected from an avoidance preference.[15]

        Borrowers and lenders must be mindful when drafting a contract.[16] There are various ways borrowers and lenders could protect their interests. For example, a borrower could request a termination statement from a bank following repayment.[17] A lender could expressly itemize the collateral, as opposed to cross referencing collateral through a future advances clause or an integration clause.[18] Alternatively, if the lender decides that a cross reference is more preferable, the lender could include the referenced loan as an exhibit in the current loan.[19] Had the parties in this case explicitly listed the collateral or attached the prior loan as an exhibit, the dispute could have been avoided. Perhaps even at the negotiation stage, the borrower could have refused to allow the deposit accounts to act as collateral in the first place. Proper drafting and review can help protect both parties’ interests, and ultimately prevent litigation.



[1] In re Omni Enters. v. First Nat’l Bank Alaska, No. A15-00076-HAR, 2016 WL 3213562, at *11 (Bankr. D. Alaska May 31, 2016); a security interest is a legal claim on collateral that has been pledged in exchange for something, usually a loan.

[2] Id. at *1.

[3] Id.

[4] Id.

[5] In re Omni Enters. v. First Nat’l Bank Alaska, No. A15-00076-HAR, 2016 WL 3213562, at *3 (Bankr. D. Alaska May 31, 2016).

[6] Id. at *1.

[7] Id.

[8] Id.

[9] Id. at *10-11.

[10] In re Omni Enters. v. First Nat’l Bank Alaska, No. A15-00076-HAR, 2016 WL 3213562, at *4–5 (Bankr. D. Alaska May 31, 2016).

[11] Id. at *4.

[12] Id. at *5.

[13] Id. at *10–11.

[14] Id. at *11; the court’s interpretation also means that a deposit account swept under such circumstances does not constitute a preference under Section 547(b). Id. at *3. A preference is “a transfer that enables a creditor to receive payment of a greater percentage of his claim against the debtor than he would have received if the transfer had not been made and he had participated in the distribution of the assets of the bankrupt estate.” In re Issac Leaseco, Inc. v. Cranshaw, 389 F. 3d 1205, 1209 (11th Cir. 2004).

[15] Under Section 547(b), a borrower’s trustee may avoid a preference, subject to various exceptions. 11 U.S.C. § 547 (2016).  In re Omni Enters. v. First Nat’l Bank Alaska, No. A15-00076-HAR, 2016 WL 3213562, at *3, 11 (Bankr. D. Alaska May 31, 2016).

[16] In writing his decision, Judge Herb Ross stated, “I started to write a memorandum to that effect, but after endlessly reading and rereading the Related Documents and Indebtedness clauses and trying to parse them to fit my original conclusion I found that I was probably wrong. The memorandum would not ‘write’.” Id. at *11.

[17] Even Though Original Loan Had Been Paid Off, Lender’s Former Security Interest in Deposit Accounts is Impliedly Incorporated by Reference Into Second Set of Loan Documents, 2016-27 Com. Fin. Newsl. 54, July 4, 2016.

[18] Id.

[19] Id.