State Bank of Toulon v. Covey (In re Duckworth)

776 F.3d 453

In re David L. DUCKWORTH, Debtor.State Bank of Toulon, Plaintiff–Appellee

v.Charles E. Covey, Chapter 7 Trustee, for David L. Duckworth, Defendant–Appellant.

Nos. 14–1561, 14–1650.

United States Court of Appeals, Seventh Circuit.

Argued Sept. 9, 2014.

Decided Nov. 21, 2014.

Timothy J. Howard, Attorney, Howard & Howard Attorneys PLLC, Peoria, IL, for Plaintiff–Appellee.

Andrew White Covey, Attorney, Peoria, IL, for Defendant–Appellant.

Before FLAUM, ROVNER, and HAMILTON, Circuit Judges.

HAMILTON, Circuit Judge.

In these appeals we consider whether a secured lender can use parol evidence against a bankruptcy to save a security agreement from a mistaken description of the debt to be secured. The security agreement here said that the collateral secured a promissory note made on a given date. The date was a mistake. The borrower had executed a promissory note but two days after the stated date. This is the sort of mistake that can be corrected as between the original parties to the loan by reforming the instrument based on parol evidence.

We have previously held, however, that under Illinois' enactment of the Uniform Commercial Code a secured lender cannot use parol evidence against a bankruptcy to correct a mistaken description of the collateral in a security agreement. In re Martin Grinding & Machine Works, Inc., 793 F.2d 592, 595 (7th Cir.1986). Similarly, the First Circuit has held that a lender cannot use parol evidence against a bankruptcy to change or add to the debts secured by the security agreement, relying on the same provisions in Massachusetts' enactment of the UCC. Safe Deposit Bank & Trust Co. v. Berman, 393 F.2d 401, 402–03 (1st Cir.1968). The reasoning of these cases persuades us that the lender in these appeals was not entitled to use parol evidence against the bankruptcy to correct the mistaken description of the debt to be secured. We therefore hold that the security agreement did not give the lender a security interest in the specified collateral that could be enforced against the trustee. We reverse the judgments of the district courts and remand for further proceedings in the bankruptcy court.

I. Factual and Procedural Background

The parties filed cross-motions for summary judgment based on the following undisputed facts. On December 15, 2008, David L. Duckworth borrowed $1,100,000 from the State Bank of Toulon. The transaction was executed through a promissory note that was dated and signed on December 15 and an Agricultural Security Agreement dated two days earlier, December 13, 2008. The security agreement said that Duckworth granted the State Bank of Toulon a security interest in crops and farm equipment. The promissory note referred to the security agreement. The security agreement identified the debt to be secured, but the identification had a critical mistake. The security agreement said that it secured a note “in the principal amount of $_______ dated December 13, 2008.” But there was no promissory note dated December 13. Both the December 15 promissory note and the security agreement were prepared by the bank's loan officer.

In 2010, Duckworth filed a petition for bankruptcy protection under Chapter 7 of the bankruptcy code. Appellant Charles E. Covey was appointed trustee. The bank filed two complaints in bankruptcy court to initiate adversary proceedings. On cross-motions for summary judgment, the bankruptcy court held that the mistaken date in the security interest did not defeat the bank's security interest and that the security agreement of December 13, 2008 secured the note of December 15, 2008. The bankruptcy court issued two decisions in favor of the bank, one for proceeds from the sale of Duckworth's crops and another for proceeds from the sale of some of his farm equipment. The trustee appealed both bankruptcy court orders to the district court, where the appeals were assigned to different judges. Both district judges affirmed, and the trustee has appealed, in No. 14–1561 regarding the crop sale and in No. 14–1650 regarding the equipment sale. The issue before us is whether the mistaken date in the security agreement defeats the banks' asserted security interest in the crops and farm equipment.

II. Analysis

We review de novo a grant of summary judgment, meaning we decide the questions of law without giving deference to the decisions of the district court or the bankruptcy court. See In re ABC–Naco, Inc., 483 F.3d 470, 472 (7th Cir.2007). The trustee argues that the security agreement unambiguously identified the debt to be secured, but did so only for a nonexistent debt and therefore failed to grant a security interest to secure the note of December 15, 2008. Even if the mistake in the security agreement might be corrected as between the original parties to the loan, the trustee argues, parol evidence of such a mistake cannot be used against a bankruptcy trustee to save the faulty security agreement.

The bank argues that the security agreement is enforceable against the original borrower and should also be enforceable against the trustee. The bank relies on the terms of the security agreement itself, parol evidence of the original parties' intent, and Illinois' “composite document” rule to save its security interest. The bank also contends that its transaction with the debtor satisfied the minimum requirements for an enforceable security interest under Illinois' enactment of the Uniform Commercial Code and therefore the security interest is effective against the trustee.

We first parse the terms of the security agreement and conclude that it cannot be construed to secure the December 15, 2008 note. We then consider the parol evidence argument. We conclude that although the evidence could have supported reformation of the security agreement as between the original parties, the evidence cannot be used against the bankruptcy trustee to reform the security agreement or otherwise to correct the mistaken identification of the debt to be secured. Nor does the composite document rule save the bank's security interest here. Finally, we examine the governing statute, Article 9 of the Uniform Commercial Code, and determine that it directs us to enforce the agreement according to its terms, which fail to secure the debt to the bank.

A. The Terms of the Security Agreement

The security agreement is governed by Illinois law, except where federal law might preempt it. Illinois adopts the familiar principle that an unambiguous contract is interpreted by the court as a matter of law without use of parol evidence. Air Safety, Inc. v. Teachers Realty Corp., 185 Ill.2d 457, 236 Ill.Dec. 8, 706 N.E.2d 882, 884 (1999).

The relevant provisions of the security agreement are unambiguous as applied to these facts. The security agreement grants the bank a security interest “to secure the Indebtedness,” which is defined as “the indebtedness evidenced by the Note or Related Documents.” The security agreement then defines the “Note” as “the Note executed by David L. Duckworth in the principal amount of $_______ dated December 13, 2008, together with all renewals of, extensions of, modifications of, refinancings of, consolidations of, and substitutions for the note or credit agreement.” In the security agreement, the dollar amount of the loan was left blank.

The bank faces two textual obstacles in arguing that the terms of the security agreement secure the debt embodied in the December 15 promissory note. First, the security agreement refers clearly to a December 13 promissory note that the parties agree never existed.¹ The promissory note that the Bank seeks to secure was signed and dated on December 15.

Second, the Bank cannot rely on the security agreement's “Related Documents” provision to incorporate the December 15 promissory note. The relevant definitions in the security agreement are essentially circular. The definition of “Indebtedness” points the reader to “Related Documents,” which are defined as documents “executed in connection with the Indebtedness.” The “Indebtedness” is defined in turn as the debt evidenced by the “Note or Related Documents,” and the Note again is defined as “the Note executed ... dated December 13, 2008.” These circular definitions thus offer no escape from the mistaken date. On its face, the security agreement secures only a December 13 promissory note that never existed. The text of the security agreement does not incorporate the promissory note dated December 15 or the description of the debt contained therein.

B. Parol Evidence Against the Trustee?

To cure the mistaken date in the security agreement and connect it to the December 15 promissory note, the bank relies primarily on parol evidence, from outside the four corners of the document. The bank relies on the December 15 promissory note itself and testimony regarding the bank's and the borrower's intentions.

The bank offers two related theories for reading the security agreement as securing the December 15 note. First, the bank contends that parol evidence is generally admissible to assist in interpreting the security agreement, which it asserts is ambiguous. Second, the bank argues that we should use the composite document rule to read the security agreement and the December 15 note together because the two documents were executed as part of the same transaction. See, e.g., Tepfer v. Deerfield Savings & Loan Ass'n, 118 Ill.App.3d 77, 73 Ill.Dec. 579, 454 N.E.2d 676, 679 (1983) (documents executed by same parties in course of same transaction are “construed with reference to one another because they are, in the eyes of the law, one contract”). Both arguments attempt to justify the use of evidence external to the security agreement itself.²

The testimony of both the bank officer who prepared the documents and borrower Duckworth makes clear that the bank made a mistake in preparing the security agreement. We are confident that the bank would have been able to obtain reformation—even of...