What is a “Dragnet Clause?”

25 Aug What is a “Dragnet Clause?”

Many debtors are unaware of “dragnet clauses,” only to find out the same after a bankruptcy is filed. Dragnet clauses are “cross-collateralization” clauses typically used by credit unions to secure other contractual obligations against collateral that didn’t exist when the original security agreement was created.

Dragnet clauses are most commonly seen in car loans by credit unions, which state that any future advances will also be secured. For example, the clause might state, “This security agreement that you are providing this financial institution is to secure this loan and any other amounts you now owe or will owe this financial institution.”

Then the debtor obtains credit cards and personal loans at a later date, all of which do not mention any security interest. When the debtor defaults on the all the obligations except the car loan, repossession still takes place.  Too often this unfortunate surprise catches debtors off guard that are entirely current on their vehicle loan.

So are these dragnet clauses enforceable?  For the most part yes.  Most states follow the UCC and 9-204(c) which states, “An agreement may provide that collateral secures, or that accounts, chattel paper, payment intangibles, or promissory notes are sold in connection with, future advances or other value, whether or not the advances or value are given pursuant to commitment.”  Thus, most Courts throughout the Nation enforce dragnet clauses.

Nevertheless, In the context of Bankruptcy, there are ways around dragnet clauses. In chapter 7, a redemption offers the solution of only paying the fair market value of the vehicle, regardless of the amount and number of debts against it.  Moreover, while the redemption amount must be paid in full during the bankruptcy and generally requires a court order, fortunately there are companies that specialize in this by offering the lump sum payment in exchange for financing with a new loan on the vehicle.

In chapter 13, 11 USC 506 may be used to “cram down” the vehicle to the fair market value, wherein the debts are classified into secured and unsecured components. The fair market value would be the secured component and the remaining debt would be the unsecured component.

Finally, it can sometimes be argued that the dragnet clause is unenforceable when debtors were not aware of the clause, or did not understand it. However, courts will generally uphold these clauses when they consider the security agreement language to be clear, unambiguous and in keeping with the Truth in Lending disclosure requirements. The Truth in Lending Act Regulations provides that the statement: “Collateral securing other loans with us may also secure this loan,” qualifies as a valid disclosure.

So pay careful attention to your loan documents if you financed yoru vehicle with a credit union and have more than one debt with them.  As always, seek a competant attorney familiar with such clauses and credit unions to best plan your course of action with respect to the same.

Written by Michael G. Doan

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