State Bank of Toulon v. Covey (In re Duckworth), 776 F.3d 453 (7th Cir. 2014) –
A chapter 7 trustee sought to treat a secured lender as unsecured based on an error in the security agreement. The lender argued that the error was subject to reformation to conform to the intent of the parties. The bankruptcy court and the district court found in favor of the lender, and the trustee appealed to the 7th Circuit.
A security agreement dated December 13, 2008 granted a security interest to secure the “Indebtedness,” which was defined as indebtedness evidenced by the “Note or Related Documents.” In turn “Note” was defined as “the Note executed by [the debtor] in the principal amount of $________ dated December 13, 2008, together with all renewals of, extensions of, modifications of, refinancing of, consolidations of and substitutions for the note or credit agreement.”
Unfortunately for the lender, the note was dated December 15, 2008, and all parties acknowledged that a December 13 note never existed. The reference to “Related Documents” did not help the lender because they were defined as documents executed in connection with the “Indebtedness,” which referenced the nonexistent December 13 note. So, read literally, the security agreement secured only the nonexistent December 13 note.
In addition to parol evidence of the parties’ intent, the lender relied on the December 15 note, which referenced the security agreement, as evidence of the parties’ intent. It argued that (1) parol evidence was admissible since it aided in interpretation of an ambiguous document, and (2) under the “composite document rule” under applicable state law the security agreement and note should be read together since they were executed as part of the same transaction. In both cases, the lender was attempting to use external evidence to interpret the security agreement.
The 7th Circuit freely...
