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Commercial Banking, Collections, and Bankruptcy
The newsletter of the ISBA’s Commercial Banking, Collections, and Bankruptcy Section

June 2011, vol. 55, no. 3

Does my security agreement cover future advances?

Under Revised Article 9 of the Illinois UCC, “a security agreement may provide that collateral secures, or that accounts, chattel paper, payment intangibles, or promissory notes are sold in connection with, future advances or other value, whether or not the advances or value are given pursuant to a commitment.” 810 ILCS 5/9-204(c). Therefore, collateral may secure future advances, as well as past or present advances, if the security agreement so provides. Official Comment 5 to 810 ILCS 5/9-204. In fact, the UCC allows parties to agree that a security interest secures any obligation whatsoever. Official Comment 5 to 810 ILCS 5/9-204.

Deciding what obligations are secured by collateral is solely a matter of construing the parties’ agreement under applicable law. Official Comment 5 to 810 ILCS 5/9-204. Revised Article 9 has rejected the holdings of cases decided under former Article 9 that applied other tests, such as whether a future advance or other subsequently incurred obligation was the same or a similar type or class as earlier advances and obligations secured by the collateral. Official Comment 5 to 810 ILCS 5/9-204.

Ultimately, the intention of the parties controls whether a security agreement covers future advances. For example, a security agreement was interpreted to cover future advances when it stated that collateral was security “for the payment of any amount for which [the debtor] may be indebted to [the creditor].” Arco Petroleum Products Co., a Div. of Atlantic Richfield Co. v. R & D Automotive, Inc., 455 N.E.2d 227 (1st Dist. 1983). Further, there is no need to refer to future advances in a financing statement. Official Comment 7 to 810 ILCS 5/9-204.

Section 9-204 also authorizes “dragnet” or “cross-collateral” clauses. Official Comment 2 to 810 ILCS 5/9-204. Dragnet clauses act as both after-acquired property and future advances clauses by providing that collateral, acquired at any time, secures all advances, regardless of when they are made. Official Comment 2 to 810 ILCS 5/9-204. While dragnet clauses are not favored under Illinois law, such clauses will be upheld where there is no ambiguity and are interpreted according to the language used. Stannish v. Community Bank of Homewood-Flossmoor, 24 B.R. 761 (Bankr. N.D. Ill. 1982) (applying Illinois law); Metropolitan Life Ins. Co. v. American Nat. Bank and Trust Co., 682 N.E.2d 72 (1st Dist. 1997). If, however, a dragnet clause is too general or vague, it will be found insufficient. In re Swanson, 104 B.R. 1 (Bankr. C.D. Ill. 1989) (applying Illinois law). Overall, “antecedent debts may be secured by a mortgage containing a dragnet clause ‘only if the antecedent debts are clearly identified in the mortgage.’” In re Octagon Roofing, 124 B.R. 522, 528 (Bankr. N.D. Ill. 1991) (applying Illinois law), citing First Natl. Bank & Trust Co. v. Lygrisse, 647 P.2d 1268, 1271 (Kan. 1982). If an ambiguity exists between a dragnet clause and another provision regarding the same subject matter, such ambiguity could be construed against the application of the dragnet clause. See, Farmers & Mechanics Bank v. Davies, 422 N.E.2d 864 (3d Dist. 1981).

735 ILCS 5/15-1302 controls whether a future advances clause in a real estate mortgage is valid and enforceable. All future advances incurred by the mortgagee within the first 18 months after a mortgage is recorded are considered part of the mortgage lien. 735 ILCS 5/15-1302. Future advances made after 18 months are inferior to the claims of subsequent purchasers, mortgagees, or judgment creditors, subject to exceptions established in the statute.

If a future advance is mandatory (i.e. the lender is contractually bound by the mortgage or an instrument executed contemporaneously with the mortgage, and has no discretion in making the advance), then the advance will relate back to the date the mortgage is recorded. 735 ILCS 5/15-1302(b). In addition, advances made under a reverse mortgage or a revolving credit arrangement secured by a mortgage will be included in the mortgage lien. 735 ILCS 5/15-1302(b)(2) and (3). Further, all interest that is accrued or added to the principal amount in accordance with the terms of the mortgage constitutes a lien from the time the mortgage is recorded. 735 ILCS 5/15-1302(b)(4). Finally, funds advanced by the mortgagee in accordance with the terms of the mortgage to preserve or restore the mortgaged real estate, to preserve the lien of the mortgage or the priority thereof, or to enforce the mortgage will also be a lien from the time the mortgage is recorded. 735 ILCS 5/15-1302(b)(5). If a future advance fails to meet one of the statutory exceptions, and the advance is made more than 18 months after the date of recording, it is effective as of the date of the advance and does not relate back to the date the mortgage is recorded. 735 ILCS 5/15-1302.

Please note that future advance clauses are regulated by Regulation Z. For example, Regulation Z requires a creditor to disclose the existence of a future advances clause. 12 C.F.R. §226.6(c). Regulation Z should always be examined when working with future advance clauses. ■