For a short opinion involving only $17,000 or so worth of money, there is a lot going on in in In re Hill, 210 B.R. 1016 (1997), not the least of which is enough discussions of “dragnet” clauses to repeatedly prompt someone to remember Joe Friday’s admonition, so we will begin with just the facts:
The Hills borrowed money from the bank and gave the bank a mortgage, securing the debt with their homestead and a vacant lot. That was in 1993. The mortgage contained a clause that said:
This Mortgage secures prompt payment to Lender of (a) the sum stated in the first paragraph of this Mortgage, plus interest and charges according to the terms of the promissory notes or agreement of Borrower to Lender identified on the reverse side, and any extensions, renewals or modifications of such promissory notes or agreement, (b) to the extent not prohibited by the Wisconsin Consumer Act (i) any additional sums which are in the future loaned by Lender to any Mortgagor, to any Mortgagor and another or to another guaranteed or endorsed by any Mortgagor primarily for personal, family, or household purpose and agreed in documents evidencing the transaction to be secured by this Mortgage, and (ii) all other additional sums which are in the future loaned by Lender to any Mortgagor, to any Mortgagor and another or to another guaranteed or endorsed by any Mortgagor, (c) all interest and charges, and (d) to the extent not prohibited by law costs and expenses of collection or enforcement (all called the "Obligations"). This Mortgage also secures the performance of all covenants, conditions and agreements contained in this Mortgage.Before that, the Hills had gotten a Mastercard from the bank, with a credit limit of $5,000. Following the mortgage, the Hills opened “Ready Reserve” accounts, which were essentially lines of credit for overdraft protection. The reserve account agreements said:
The Loan Balance and Finance Charges are or may be secured by a lien upon any credit balance or other money now or hereafter owed to Borrower by Bank, and by all security agreements of Borrower now or hereafter held or acquired by Bank.Then, the Hills borrowed money to get a car, and the Note for that said that:
Lender may, at any time after the occurrence of an event of default and notice and opportunity to cure, if required by § 425.105, Wis. Stats., set-off any amount unpaid on the Obligations against any deposit balances I may at any time have with Lender, or other money now or hereafter owed me by Lender. This Agreement is also secured (to the extent not prohibited by the Wisconsin Consumer Act) by all existing and future security agreements between Lender and any of us, between Lender and any guarantor or indorser of this Agreement, and between Lender and any other person providing collateral security for my Obligations. However, this Agreement is not secured by any principal dwelling unless described in this Agreement.
Got all that? What happened next is that the debtors sold the vacant lot, with the Bank’s consent, and the Bank, claiming the Hills didn’t care how it applied the $17,000 in proceeds did this:(1) $9,182.22 was applied to the debtors' MasterCard credit card debt;
(2) $4,935.62 was applied to the debtors' two Ready Reserve Accounts;
(3) $1,260.67 was applied to the debtors' delinquent real estate taxes on their homestead; (4) $612.74 was applied to the debtors' vehicle loan with the Bank; and
(5) $1,262.36 was applied to the debtors' Mortgage Note.
It’s tempting to think that banks started behaving with a callous disregard towards customers only after the mortgage crisis of the first decade of the 21st century; but this took place in 1997 or so, with the Bank deliberately leaving its debtors – who had a longstanding relationship with them – at risk of losing their home even though the debtors paid down their debts by $17,000+. Food for thought.
The debtors then filed for chapter 7 bankruptcy, and the trustee moved to recover the $17,000 as a preference, under a variety of theories. It all boiled down to this, though: how enforceable are dragnet clauses both in general and under the Wisconsin Consumer Act?
The Hill court gave the matter some thoughtful consideration, noting that Wisconsin had previously ruled that dragnets needed to be related to debts contemplated at the time of entering into the agreement, and that to make that decision you first look towards the terms of the agreement itself:
Thus, the antecedent liability of the debtors must be stated in clear terms and the subsequent liabilities must either relate to a similar course of financing or fall within the expressed intent of the parties.
The Court then determined that since the Mastercard debt predated the dragnets, it had to be clearly identified in the documents; it was not, and so the payment of the credit card was a preferential transfer (the result of that being the Bank would be required to pay that money to the Trustee, who would use it to pay claims.)
The reserve accounts and the car loan both contained language that included them in the mortgage debt – so the Court had to look to see whether the debts were “related” or not. The test for “relatedness” turns out to boil down to “is it business or is it personal,” despite a bunch of words devoted to how to determine that, and because these were all personal debts, the two factors (dragnet clause + relatedness) were met. The overdraft protections and the car loan were secured by the mortgage and therefore the payments were not preferential transfers.
(Food for thought, two: In the past, banks required checking accounts to have a minimum balance. They then eliminated that and instead had overdraft fees. Now, banks allow you to open lines of credit to cover bad checks and charge interest instead, and secure that protection by your primary residence in a voluntary lien that is not dischargeable in bankruptcy. Is that progress?)
The trustee had one final challenge to those overdraft loans, arguing (correctly) that the Wisconsin Consumer Act prohibits taking a security interest in a debtor’s homestead to secure debts of less than $1,000, and pointing out that the transactions on the Mastercard and overdraft accounts were each likely less than $1,000; but the interpretation of what is a “transaction” has always provided that it’s the total amount owed at the time of the enforcement that is important, including finance and other permitted charges. Since the amount owed on those balances was greater than $1,000 at the time of enforcement, the exclusion on liens did not apply.
(Food for thought, three: Could a creditor let an overdraft balance of, say, $600, grow over time to be more than $1,000 with late fees and penalties and allow it to be secured, then?)