State Bank of Toulon v. Covey (In re Duckworth)

In Re: David L. Duckworth, State Bank of Toulon v. Charles E. Covey, Ch. 7 Trustee for David L. Duckworth, Case Nos. 14-1561 and 14-1650 (7th Cir. Nov. 21, 2014) (unpublished)
Parol evidence cannot be used against a bankruptcy trustee to reform a security agreement or to correct the mistaken identification of the debt to be secured. The lender cannot obtain reformation under the composite document rule because a bankruptcy trustee does not assume the position of borrower, but rather that of a subsequent creditor. Subsequent creditors are entitled to rely on the text of a security agreement absent of extrinsic evidence and giving no authority to the intent of the original parties.
Procedural context:
In 2010, the State Bank of Toulon filed two complaints against Charles E. Covey, Chapter 7 trustee of David L. Duckworth, in bankruptcy court. The first complaint was for proceeds from the sale of Duckworth’s crops; the second complaint was for proceeds from the sale of some of Duckworth’s farm equipment. On cross-motions for summary judgment, the bankruptcy court ruled in favor of the bank on both complaints, to which Covey appealed to the district court. Both judges in the district court affirmed the decisions and Covey again appealed. The appellate court ruled in favor of the trustee, reversing the decision of the lower courts and remanding the case for proceedings consistent with their opinion.
The State Bank of Toulon sought to have its interest in a security agreement secured in a Chapter 7 bankruptcy action, despite a clerical error identifying an agreement dated December 13, 2008 while the agreement in question was dated two days later, on December 15, 2008. David Duckworth had borrowed $1.1 million against an interest in his crops and farm equipment. The bankruptcy court held that the mistaken date did not negate the bank’s security interest and the district court affirmed. On appeal, Covey argued that the text of the security agreement purported to secure a debt that did not exist and therefore the bank had no security interest in the note in question. The bank’s argument that the security agreement was enforceable hinged on (1) the terms of the security agreement itself, (2) parol evidence of the original parties’ intent, and (3) Illinois’ “composite document” rule. The appellate court held that parol evidence cannot be used against the bankruptcy trustee to reform the security agreement and ruled in favor of Duckworth’s trustee, Charles Covey. The appellate court determined that according to Article 9 of the UCC, the agreement should be enforced according to its terms which, in this case, fail to secure the debt to the bank.
Flaum, Rovner, Hamilton

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