Our Advances are Senior Based on a Dragnet Clause, Right? Not So Fast

In the midst of the COVID-19 pandemic, the Iowa Supreme Court’s opinion released on March 27, 2020 in Blue Grass Savings Bank v. Community Bank & Trust Company has the potential to disrupt the lending industry for years. In what started as a simple foreclosure of a mortgage by a lender, where the borrower took a default judgment, the Iowa Supreme Court ultimately provided a ruling on Iowa Code § 654.12A that should make senior lienholders worry about the security of their seniority.

In this case, Blue Grass Savings Bank (“BGSB”) loaned money to a borrower in exchange for a mortgage. As with all other standard mortgages in Iowa, this mortgage included a clause that stated:

NOTICE. THIS MORTGAGE SECURES CREDIT IN THE AMOUNT OF $148,000.00. LOANS AND ADVANCES UP TO THIS AMOUNT, TOGETHER WITH INTEREST, ARE SENIOR TO INDEBTEDNESS TO OTHER CREDITORS UNDER SUBSEQUENTLY RECORDED OR FILED MORTGAGES AND LIENS. HOWEVER, THE PRIORITY OF A PRIOR RECORDED MORTGAGE UNDER THIS SECTION DOES NOT APPLY TO LOANS OR ADVANCES MADE AFTER RECEIPT OF NOTICE OF FORECLOSURE OR ACTION TO ENFORCE A SUBSEQUENTLY RECORDED MORTGAGE OR OTHER SUBSEQUENTLY RECORDED OR FILED LIEN.

The mortgage also stated that “[a]ll present and future debts from Mortgagor to Lender” were secured by the mortgage.

BGSB then loaned additional money to the borrower, securing those loans by the same mortgage. At the time of the foreclosure, the total amount owed to BGSB exceeded $500,000.

Between the time of the mortgage and the foreclosure, the borrower obtained a loan from Community Bank & Trust Company (“CBTC”) for nearly $600,000. This loan was secured by a mortgage on the same property that was mortgaged to BGSB.

When BGSB commenced the foreclosure, it sought to recover from the secured property the full amount of the indebtedness. CBTC denied this, and argued that BGSB’s senior security in the real estate was capped at $148,000 (plus interest and fees). CBTC argued that the provision in the mortgage which stated, “This mortgage secured credit in the amount of $148,000.00. Loans and Advances up to this amount, together with interest, are senior . . .” capped the amount of senior security that BGSB had in the property.

The Iowa Supreme Court agreed.

The Court reviewed the mortgage and Iowa Code § 654.12A. The Court ruled that under § 654.12A, the amount stated in the notice of the amount of credit in the mortgage is a cap on the extent of the senior security of the mortgage (plus interest). Thus, even if a mortgage contains a dragnet clause securing future loans which the same mortgage, the seniority of those future loans are dependent upon the amount of credit listed in the mortgage.

Thus, even though BGSB did have security for the full amount of its loan to the borrower (~$500,000), only a portion of that amount was senior to CBTC’s security in the same property.  As stated above, the Court did allow accrued interest on the initial $148,000 loan to be included in the max senior secured amount. However, all of the other advances made by BGSB were junior to CBTC.

What does this case tell lenders in Iowa? Check for subsequently recorded mortgages before advancing money under a dragnet clause! Also, the Court pointed out that BGSB could have required the borrower to execute amended mortgages increasing the amount of credit secured by the mortgage before extending any additional credit (obviously, after checking to see if there were any subsequent liens on the mortgaged property).

Lenders should not relax and rely on dragnet clauses only. Diligence in checking the records for subsequent liens is a must. For those lenders who have already advanced funds beyond the credit limit in the mortgage and have now discovered a subsequent lien on the property, contact the Dickinson law firm to discuss your options.