Legal Developments in Banking

There are two significant issues for banks that have made their way through the court system recently. One involves waiver of jury trials in the event of a dispute and the other impacts cross collateralization. Banks need to be mindful of these developments as they move forward with drafting loan documents.

tJury Trial Waiver he last 2 years have seen a lot of activity with regard to jury trial waiver provisions, including multiple court decisions and legislative activity. Earlier this year, the Arkansas Supreme Court weighed in again and the opinion seems to be largely good news in that it supports the validity of jury trial waiver provisions in lending transactions.

In late 2017, in Tilley v. Malvern National Bank (Tilley I), the Arkansas Supreme Court invalidated the jury trial waiver provision in the loan documents. The Court held that a jury trial waiver can only be done in the manner “prescribed by law” and, since the legislature had not passed a law allowing a waiver in that manner, the Court declined to enforce the provision.

In the wake of that decision, in a 2018 special session, the legislature passed Act 13, which allowed for a jury trial waiver in lending contracts. After Act 13 was adopted, MNB again sought to enforce the waiver against Tilley. That issue went back up to the Supreme Court and, in December of 2019, the Court essentially ruled that Act 13 could not be applied retroactively to Tilley’s claim against MNB. (Tilley II)

The majority opinion in Tilley II was troubling because it contained some language that suggested that Act 13 wasn’t valid in any case, present or future. The good news is recently, in BHC Pinnacle Pointe Hospital v. Nelson , the Arkansas Supreme Court issued an opinion that should ensure that Act 13 is valid, and jury trial waivers are enforceable in lending transactions.

In Nelson, the two named plaintiffs filed a class action suit against Pinnacle alleging violations of the wage and hour laws in Arkansas. Pinnacle moved to dismiss relying on a clause in the employment agreement calling for such disputes to be submitted to arbitration, rather than to a court. The circuit court denied Pinnacle’s request, but the Supreme Court reversed and held the matter should be dismissed and submitted to arbitration.

One of the plaintiffs’ arguments in the case relied on Tilley v. Malvern National Bank. Plaintiffs claimed that since the arbitration clause in the employment agreement was based on federal arbitration law that is was invalid because a wavier can only be provided by “Arkansas law.” The Court rejected that argument, holding that the jury trial waiver can be based on court rule, Arkansas law and/or federal law.

In short, while a borrower may still try to argue otherwise, Nelson strongly suggests that Act 13 is valid and enforceable moving forward despite the loose language in Tilley II. Indeed, it holds that a jury trial waiver can be enforced in the manner prescribed by both state and federal law.

Cross Collateralization

In March, the Arkansas Court of Appeals handed down an opinion in Equity Bank vs. Southside Baptist Church, 2020 Ark App. 199. 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 is $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 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, when cross collateralization is desired, the existing notes should be unambiguously identified by referencing the specific debt obligation document, and attaching it, and a mortgage modification should be filed referencing the cross collateralization.