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COA adopts rule allowing for partial subordination of 1st lienholder’s interest

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The Indiana Court of Appeals Wednesday decided the state should follow the majority rule on agreements to modify the priority of liens securing interests in a borrower’s assets.

Timothy, Lisa, Ross and Dane Clark and their farming operations pledged their 2010 crops as collateral to obtain loans from First Farmers Bank & Trust, Co-Alliance, LLP, and Monticello Farm Service, Inc. First Farmers was the first lienholder, Co-Alliance the second lienholder, and Monticello the third lienholder.  In June 2010, the bank and Monticello entered into an agreement in which Monticello would finance the Clarks’ 2010 crops, and in turn, the bank agreed to subordinate its interests in those crops to Monticello’s interests in the same.

Due to financial issues, Timothy and Lisa Clark entered into a settlement agreement which held the proceeds of their 2010 crop – $181,000, in an escrow account. Monticello sought to claim those proceeds based on the subordination agreement; Co-Alliance counterclaimed against Monticello, asserting it held the first priority lien. The trial court found Monticello was entitled to the disputed funds.

“The clear language of the subordination agreement shows that the parties’ intent was for the Bank to assign to Monticello a portion of any 2010 crop proceeds received by the Bank based on its status as the first lienholder. How else could the Bank have induced Monticello to make a loan but to guarantee it the right of first payment? Under these circumstances, treating a subordination of an interest differently from an assignment of that interest would add confusion to the law, not clarity, and would allow an intervening lienholder to obtain a windfall by becoming a senior lienholder through no action of his own,” Senior Judge Randall T. Shepard wrote. “Put another way, the agreement in this case is the functional and legal equivalent of a partial assignment. And in fact, such ‘partial subordination’ is the majority approach to subordination agreements.”

The appellate court rejected Co-Alliance’s claim that the court should adopt the approach that the bank’s lien drops to the end of the line based on the agreement. The COA instead adopted the majority rule, which allows for partial subordination of the first lienholder’s interest.

“The Bank could induce Monticello to finance the Clarks’ 2010 crops by giving Monticello its right to first payment. By virtue of the subordination agreement, Monticello would be paid first, but only up to the amount of the Bank’s senior claim, to which Co-Alliance was in any event junior. Co-Alliance would still receive what it expected to receive had there been no subordination agreement,” he wrote in Co-Alliance, LLP v. Monticello Farm Service, Inc., 91A05-1312-PL-607.
 

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