Banking Law Roundup

Sharp   Thinking

No. 145     Perspectives on Developments in the Law from Sharp-Hundley, P.C.    January 2018

Citation Respondents Can’t Lend

To Judgment Debtor’s Entities

            By John T. Hundley, John@sharp-hundley.com, 618-242-0200

            Financial institutions subject to citations to discover assets had best not enter into loan agreements with entities affiliated with the judgment debtor until the citation proceedings have been resolved. 

            That’s the message of a majority of a panel of the Appellate Court in Chicago.  Writing in National  Life Real Estate Holdings LLC v. Scarlato, 2017 IL App (1st) 161943, the majority said that “extending a loan to a judgment debtor after having been served with a citation to discover assets runs contrary to [735 ILCS 5/]2-1402’s prohibition or allowing transfer or disposition of property belonging to the judgment debtor.”

            The majority made that holding even though (1) the loan was made to one of the judgment debtor’s companies, not to the judgment debtor personally; (2) the loan agreement wasn’t even applied for until four months after the citation was served; and (3) the loan agreement prohibited payment of the proceeds to the judgment debtor.                                                                                            

            In a decision the correctness of which we doubt, the majority reasoned (a) that loan proceeds vest in the borrower upon the making of the loan agreement and promissory note; (b) the judgment debtor (an individual) signed the loan documents (making him personally liable for repayment); and (c) he “arguably . . . could have used the loan proceeds for his own personal use or for payment to an entity outside of the construction project” even though that would have violated the loan agreement.

            Relying on such reasoning and the principle that the citation statute is to be “construed liberally,” the majority said that “proceeds of the loan here constituted ‘property *** belonging to the judgment debtor or to which he or she may be entitled or which may thereafter be acquired by or become due to him or her’ such that the advance and disbursement of said proceeds constitutes a violation.”

            The majority vacated that trial court’s decision to the contrary and remanded the case to the trial court to “exercise its discretion and determine whether to enter judgment” against the bank (emphasis added).  That directive seems contrary to the usual rule that a respondent has strict liability for releasing funds subject to the citation’s freeze.

            Leave to appeal has been denied by the Supreme Court.

New Guaranty Requires New Consideration

            A guaranty executed after all the other documents in a transaction requires new consideration, a panel of the Appellate Court in Chicago has held.

            Ruling in L.D.S., LLC v. Southern Cross Food, Ltd., 2017 IL App (1st) 163058, the panel dealt with a situation where a lessor demanded the guaranty in exchange for the lessor’s performance of duties he already was obligated to perform under a lease that was fully executed several days before.

            The court recognized that if a guaranty is executed contemporaneously with the original contract, the consideration for the original contract is sufficient consideration for the guaranty.  However, it said, “[i]f a guaranty is executed after the underlying obligation was entered into, new consideration is generally needed.”

            A couple of observations are appropriate.  First, the case dealt with a homemade guaranty which did not recite that it was given for consideration.  It thus is not dispositive of the more common situation when the guaranty recites it is for consideration, but the guarantor denies any new consideration was given. 

            Second, lessee in L.D.S. was not in default.  The case thus also does not reach the common situation where the lender requires a personal guaranty as a condition of forbearing from exercising its default rights.

Senior Creditor’s Loan Increase Not Entitled To Priority

            Where an intercreditor agreement provides that one creditor’s loan will be subordinated to the other’s and the senior creditor thereafter increases the amount of its loan without the consent of the junior, the increase in the loan amount is materially prejudicial and the junior will be entitled to priority to the extent of the loan increase. 

            So held a panel in the Appellate Court’s Second District in Bowling Green Sports Center, Inc. v. G.A.G. LLC, 2017 IL App (2d) 160656.  The court rejected an argument that the senior creditor’s loan increase was so great a violation of the intercreditor agreement as to justify priority reversal as to the amount which the junior had agreed to subordinate.

            The case apparently was one of first impression in Illinois courts.  The panel relied principally upon out-of-state cases and the Restatement (3d) of Property in reaching its decision. 

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