On March 22, 2012, the US Bankruptcy Court for the Central District of Illinois issued an opinion in an adversary proceeding relating to In re Duckworth, holding that a bank loan was not secured by a pre-existing security agreement because the security agreement did not contain a cross-collateralization provision providing that future debt could be secured by the security agreement. The court found that the failure of a security agreement to contain a cross-collateralization provision cannot be overcome by simply referring to the security agreement in a different instrument.

In December 2008, David Duckworth (Duckworth), a farmer, obtained a $1.1 million revolving credit loan from State Bank of Toulon (SBT). Duckworth also signed a security agreement that provided SBT with a security interest in certain collateral. Duckworth and SBT entered into a second loan transaction in January 2010 in the amount of $950,000. The promissory note stated that it was secured by the parties' 2008 security agreement.

In November 2010, Duckworth filed a Chapter 7 bankruptcy petition. SBT brought an adversary proceeding asking the court to determine that it has a first priority security interest in proceeds from the sale of certain farm products, equipment and crop insurance described in the security agreement. The bankruptcy trustee filed a counterclaim to avoid SBT's security interest.

Among other things, the court held that, although the 2010 promissory note provided that it was secured by the security agreement, this provision was ineffective to establish a security interest. This was because:

The security agreement was therefore effective to secure the 2008 promissory note but not the 2010 promissory note. The court stressed the importance for a lender to confirm that an existing security agreement contains a cross-collateralization provision before making additional loans to be secured by the liens on the existing collateral. The absence of a cross-collateralization provision in a security agreement cannot be overcome by simply referring to the security agreement in a later promissory note or loan agreement.

To learn more about security agreements, see Practice Note, Security Agreement: Overview.