Act 313 of 2021

of 2021

RESTORES PROCESS FOR INCORPORATING CROSS-COLLATERALIZATION CLAUSES

by Justin T. Allen

Wright, Lindsey & Jennings LLP

Last year, we reported on the case of Equity Bank vs. Southside Baptist Church, 2020 Ark App. 199 and the impact it had on cross-collateralization clauses in lending documents.

As a refresher, Equity Bank (Bank) was the lender to Southside Baptist Church (Church) on two separate loans: a 2008 loan of $2,600,000 secured by a mortgage on real property owned by the Church (Note 1) and a 2012 loan with a principal amount of about $150,000 secured by the Church’s furniture, fixtures, inventory, and equipment (Note 2).

The church defaulted on the two notes, and the bank filed suit. The parties attended mediation and resolved most of their issues: The church deeded the land to the bank, the parties agreed that the remaining debt associated with Note 2 was $55,000, and the church sold the collateral securing Note 2 for $55,000. The only remaining issue was to which of the two outstanding debts the $55,000 would be applied.

The church filed a motion for summary judgment that the $55,000 should apply to the debt under Note 2. The bank asserted that, due to cross-collateralization language included in Note 2, it had the option to apply the $55,000 to the debt memorialized in Note 1. The circuit court granted the church’s motion for summary judgment and ordered application of the $55,000 to Note 2 after finding that the cross-collateralization clause in Note 2 did not clearly contemplate extending security to the Note 1 debt.

“... the parties agreed that the remaining debt associated with Note 2 was $55,000, and the church sold the collateral securing Note 2 for $55,000. The only remaining issue was to which of the two outstanding debts the $55,000 would be applied.”

“In short, Act 313 provides that a crosscollateralization clause that grants a security interest is valid and enforceable, whether or not the cross-collateralization clause is specific or general.”

The bank argued on appeal that language in Note 2 specifying that “this Agreement secures all obligations, debts and liabilities, plus interest thereon, of [Southside Baptist] to [Equity Bank] . . . whether now existing or hereafter arising” clearly referred to Note 1 and that all parties involved knew of the Note 1 debt at the time Note 2 was executed.

The Court of Appeals noted that while Arkansas law does permit parties to secure existing or future debt under the terms of a mortgage or security agreement given to secure a different debt, the security will not be extended to prior debts unless the instrument unambiguously identifies those debts intended to be secured. The Court did not find the phrasing “all debt” “now existing” to properly identify Note 1. The Court affirmed the circuit court’s decision to apply the $55,000 to Note 2.

As a result of this ruling, the Arkansas Bankers Association filed legislation this past session to address the ruling and, most importantly, restore the ability of a bank to make a general reference to existing debts and the collateral securing them. That legislation was House Bill 1255, which became Act 313 of 2021.

In short, Act 313 provides that a cross-collateralization clause that grants a security interest is valid and enforceable, whether or not the cross-collateralization clause is specific or general. It applies to security agreements, instruments, and mortgages executed on and after September 1, 2021.

Obviously, the safest approach for lenders is to make a specific reference when relying on cross-collateralization provisions to provide security for a loan, if possible. However, Act 313 should allow for general references that have been traditionally utilized in the industry.