Cross-Collateralization: Beware The Intricacies Of Local Real Estate Law

Hari Aum, LLC v. First Guar. Bank (In re Hari Aum), 714 F.3d 274 (5th Cir. 2013) -

A debtor and its lender sought a determination of whether a mortgage on the debtor's motel secured only a loan to the debtor, or also a loan by the lender to a second affiliated entity. The bankruptcy court granted the mortgagee's motion for summary judgment, and on a direct appeal to the 5th Circuit, it agreed that the cross-collateralization in the mortgage was effective, and the lien on the debtor's motel secured both its loan and the loan to an affiliate.

This case was governed by Louisiana law. For those of you (like me) who are mystified by Louisiana mortgage documentation, the 5th Circuit's description of a traditional collateral mortgage (which involves the pledge of a note secured by a mortgage) is enlightening:

It "consists of at least three documents, and takes several steps to complete: first there is a promissory note, usually called a collateral mortgage note... The collateral mortgage note is secured by a mortgage, the so-called collateral mortgage. The mortgage provides the creditor with security in the enforcement of the collateral mortgage note... [M]oney is not directly advanced on the note that is paraphed for identification with the act of a mortgage. Rather the collateral mortgage note and the mortgage which secures it are Pledged [sic] to secure a debt."

As further explained, a "paraph" is a signature (typically a notary's signature), and when a note is "paraphed for identification with a mortgage" that means that the note is specifically linked to the mortgage through this signature.

However, a newer form of mortgage was introduced in the early 1990s - referred to as a "multiple indebtedness mortgage"(MIM), "future advance mortgage," or "equity line mortgage" - to provide a more convenient mechanism for securing obligations that are not currently identifiable.

Under the statute establishing this type of mortgage (Article 3298), a mortgage may secure future advances and the priority with respect to third parties will relate back to the time that the mortgage is recorded. A promissory note secured by a MIM does not need to be paraphed for identification and need not recite that it is secured by the mortgage. Article 3298 provides:

The mortgage must be granted in favor of a specifically named and designated mortgagee. The mortgage must provide that it is being granted to secure present and future indebtedness of the borrower in favor of...