Dragnet Clause: What Did the Parties Expect? - Mary Beth Guard

Dragnet Clause: What Did the Parties Expect?
California Appellate Decision

The case of Fischer v. First International Bank will be of interest to banks that include a cross-collateralization clause, also known as a dragnet clause, in their loan agreements.

The Court of Appeal for the 4th District of California held that the enforceability of a dragnet clause in a loan agreement was dependent on the reasonable expectations of the parties.

The case involved two business loans obtained by the plaintiffs at the same time from the bank. A written agreement of the terms and conditions was prepared prior to closing. The document clearly stated loan 1 was secured by commercial property and the residence of the plaintiffs while loan 2 was secured only by the commercial property. The loan agreement, which was signed by the plaintiffs at closing, reflected the terms of the prior written agreement, but the deeds of trusts contained a "fine print" dragnet clause. The loan agreement also incorporated by reference the earlier written agreement.

At closing and prior to signing the loan agreement, the plaintiffs confirmed through their loan officer that the residence was only pledged as collateral on loan 1. Approximately a year later the plaintiffs decided to sell the residence. They again inquired as to the position of the residence as collateral. The loan officer indicated that if they sold their residence, the loan 1 must be paid off and any excess from the sale proceeds could be retained by the plaintiffs. After the sale, loan 1 was paid off, but the bank invoked the dragnet clause and claimed the excess proceeds. A suit was filed and the lower court granted summary judgment for the bank. The plaintiffs appealed.

The Court determined that for the dragnet clause to be enforceable, all parties must have a reasonable expectation of its effect. It must have been the mutual intent of the parties to cross-collateralize both loans.

First published on BankersOnline.com 6/27/03