Lender Beware: Loan renewal may cause lender’s security interest in collateral to be subordinated to judgment creditor’s lien.

Loans are renewed for a number of reasons. But when a borrower has an outstanding judgment lien, lenders must be sure that any renewal does not constitute an advance under the Texas Business & Commerce Code that will subordinate the lender’s security interest in collateral to the judgment creditor’s lien.

The Texas Business & Commerce Code provides that a perfected security interest in property generally has priority over all other claims to the property. Consequently, a judgment lien is usually subordinate to a perfected security interest in collateral. But section 9.323(b) of the Texas Business & Commerce Code sets out a narrow exception relating to the priority of claims in order to protect a judgment lienholder’s right to property that is subject to a perfected security interest. Section 9.323(b) states:

…a security interest is subordinate to the rights of a person that becomes a lien creditor to the extent that the security interest secures an advance made more than 45 days after the person becomes a lien creditor unless the advance is made: (1) without knowledge of the lien; or (2) pursuant to a commitment entered into without knowledge of the lien.

Essentially, section 9.323(b) protects a judgment lienholder who has successfully levied on an asset that is subject to a security interest from being squeezed out by a later enlargement of the security interest through an additional advance.

The key for lenders looking to navigate section 9.323(b) when extending a loan is to avoid making an advance. But what constitutes an advance? This issue was recently addressed by the Dallas Court of Appeals in Inwood Nat’l Bank v. Wells Fargo Bank, N.A., No. 05-13-01689, 2015 WL 1929251 (Tex. App.—Dallas April 29, 2015). In that case, Inwood National Bank (“Inwood”) challenged the trial court’s conclusion that a renewal and extension that Inwood gave Charles Paschall, Jr. (“Paschall”) on a loan subordinated Inwood’s perfected security interest in an investment account owned by Paschall to a judgment lien obtained by Wells Fargo, N.A. (“Wells Fargo”).

In reversing the trial court, the Dallas Court of Appeals noted that although the renewal and extension was made more than 45 days after Wells Fargo obtained its judgment lien and was made with knowledge of the judgment lien, the renewal and extension was not a new note, did not provide additional funds to Paschall and did not place an additional burden on the collateral in the investment account. As a result, the Dallas Court of Appeals found that the renewal and extension was not an advance under section 9.323(b).

The lesson from the Inwood case is that in extending or renewing a debtor’s obligation in the face of a judgment lien, lenders must not create a new note that replaces the debtor’s previous obligation and need to avoid taking any actions that put an additional burden on the collateral in which they have a security interest in order to preserve priority.