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Reading a questions and answers from a secured transactions exam (2)

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1. Explain what a dragnet clause is.

Dragnet clauses secure all of a debtor’s obligations to a creditor, regardless of whether those obligations arise before or after the date of the document containing the dragnet clause. Because these clauses provide security not only for the current debt, but also for future advances made to the debtor, the clauses are sometimes called “future advance” clauses.

2. Clause 3.0 is based on a financing agreement between a Chrysler dealership and the Chrysler Financing Company. Does the clause qualify as a dragnet clause? Explain why or why not, with specific reference to the definition you gave in #1.

3.0 Security – Debtor hereby grants to Secured Party a first and prior security interest in and to each and every Vehicle financed hereunder. The security interest hereby granted shall secure the prompt, timely and full payment of (1) all future advances, (2) all interest accrued thereon under the terms of this Agreement and the Promissory Note, (3) all costs and expenses incurred by Secured Party in the collection or enforcement of the Promissory Note or of the obligations of the Debtor under this Agreement, (4) each and every other indebtedness or obligation now or hereafter owing by Debtor to Secured Party including any collection or enforcement costs and expenses or monies advanced on behalf of Debtor in connection with any such other indebtedness or obligations.

Clause 3.0 qualifies as a dragnet clause because it includes proviso #4, which clearly states that under the terms of the contract, all of the debtor’s obligations to the creditor are secured, whether they arise before or after the document from which this clause was extracted. Through proviso #4, the creditor has secured not only the current debt, but also any future advances made to the debtor.

3. Explain why dragnet clauses are generally held to be enforceable in commercial contracts under the revised Article 9 of the UCC, but have generally not been held to be enforceable in consumer contracts.

Both the former and revised Article 9 specifically permit dragnet clauses. (See, for example, the dragnet clause held to be enforceable in the First Circuit case, Price Hyundai, Inc. v. Chrysler Financial Co., LLC.) Revised § 9-204 explicitly states that “[a] security agreement may provide that collateral secures…future advances or other value, whether or not the advances or value are given pursuant to commitment.” Official Comment 5 to this section similarly states: “Under subsection (c) collateral may secure future as well as past or present advances if the security agreement so provides.” This approach is appropriate in commercial settings, where the parties typically have some business sophistication and negotiate the terms of their agreements in arm’s length transactions.

Vendors and creditors in the consumer setting have long included dragnet clauses, which provide a method for recoupment of losses that occur when consumers default on “future advances” (i.e. advances made after the date of the document securing the original debt). However, the courts generally disfavor1 such clauses in consumer financing agreements. In such cases, the courts generally hold that the original security interest is extinguished when the consumer repays the antecedent debt. Thus, when creditors seek to collect an unpaid debt incurred after the date of the original security agreement, they cannot replevy goods that the debtor has already paid for. Their only recourse is to get a new security interest in the later purchased items themselves, and to seek repossession of those items.

1 UK: disfavour

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