A Bank's Failure to Include a Reference to the Borrowing Base in a Promissory Note Negates the Declaration of Default
 
December 22, 2004
 
Michael Weissman - Chicago

In CWE Concrete Construction, Inc. d/b/a Elbrecht Concrete (Elbrecht) v. First National Bank, 814 N.E. 2d 720 (Ind. App. 2004), the bank’s error in failing to include a borrowing base requirement in a promissory note caused the Court to rule that the bank’s declaration of default was improper.

Elbrecht signed a promissory note for a $1.5 million revolving line of credit in favor of the bank on December 30, 1999. The note had a section captioned “additional terms” that stated there were additional terms and requirements set forth in a letter agreement dated December 10, 1999, that were made part of the note. When this note matured, it was replaced by a second promissory note for $2 million that also referred to the letter agreement of December 10, 1999, for additional terms and conditions. In September 2000, a loan commitment letter was tendered to Elbrecht establishing a borrowing base for the line of credit equal to the lesser of $2 million or 75 percent of eligible receivables.

Subsequently, the line was increased to $2.6 million. Another commitment letter was sent to Elbrecht on May 1, 2001, amending the previous commitment letters and stipulating that the line of credit was the lesser of $2.6 million or 75 percent of eligible receivables. In September 2001, another promissory note was executed by Elbrecht that incorporated by reference all the terms and conditions of the May, 2001 commitment letter.

Finally, Elbrecht executed still another promissory note in October 2001 that did not contain an additional terms section incorporating the terms and conditions of the commitment letters. It did however contain an integration clause that stated the note and any documents executed concurrently with it constituted the entire agreement of the parties.

Apart from the October 2001 note, Elbrecht also executed a $286,213 note in favor of the bank on April 25, 2000, and a $250,000 note in favor of the bank on March 28, 2001.

In January 2002, Elbrecht submitted a borrowing base calculation to the bank showing that the loan balance exceeded the borrowing base by $1,016,364. At this point, trouble reared its ugly head. The bank responded with a declaration of default. Although afforded an opportunity to cure this alleged default, Elbrecht did not do so. But Elbrecht did deposit $1 million in its deposit account at the bank.

Because Elbrecht did not chose to cure the default, the bank declared the October 2001 note immediately due and payable. Because of cross-default language in the other notes, the bank also elected to accelerate Elbrecht’s other notes. It also froze Elbrecht’s deposit account causing some checks to bounce. Following that, the bank sued to collect the balances due on each of Elbrecht’s notes.

When sued, Elbrecht asserted that the bank improperly accelerated all of its loans and improperly froze its deposit account since the October 2001 note could not have been declared in default for exceeding the borrowing base since it did not contain a reference to a borrowing base.

The bank tried to argue that because Elbrecht had submitted a borrowing base calculation for the period ending January 25, 2002, Elbrecht knew there was a borrowing base requirement. But the Court said that the note was clear and unambiguous and for that reason it would not look for evidence beyond the note’s four corners. The Court ruled in favor of Elbrecht.

To bolster its conclusion, the Court made two other points: first, the additional terms sections in the notes that preceded the October 2001 note demonstrated that the bank knew how to incorporate the borrowing base requirement from an outside reference, and, second, that the integration clause which said the note and any documents executed concurrently with it set forth the entire agreement of the parties prevented any reference to other documents, especially since none were executed concurrently with the note.

Based on all of the foregoing, the Court held that Elbrecht was not in default for exceeding the borrowing base limit because the October 2001 note did not reference the borrowing base.

What’s the point? Careful draftsmanship is critical to avoid errors that can frustrate a lender’s collection efforts. Often it is desirable to have two sets of expert eyes review important loan documents before they are exhibited to the borrower.

This case raises a number of questions without answers. Why did Elbrecht deposit $1 million in its deposit account rather than cure the default? Elbrecht obviously knew it was not in compliance with the borrowing base when it sent the January 2002 borrowing base calculation to the bank. And why didn’t the bank exercise its setoff rights to seize the $1 million in Elbrecht’s deposit account rather than commence litigation?

For more information e-mail Michael L. Weissman at michael.weissman@hklaw.com or call toll free, 1-888-688-8500.