We are not aware of any laws that would prohibit modifying a commercial loan to allow for additional disbursements, but we recommend consulting with bank counsel to address certain risks created by this type of modification.

At the outset, it would be prudent to ensure that either your original security agreement or your modification documents for the closed-end loan extend your original security interest to a disbursement of new funds. The Uniform Commercial Code expressly permits security agreements to secure future advances, and Illinois courts generally have upheld “cross-collateralization” clauses in security agreements to secure future debts, provided the clause is “clear and unambiguous.” If you do a modification, we recommend consulting with your bank counsel to ensure that the new advance of funds is fully secured.

In addition, your bank counsel can help ensure that your modifications are executed in a way that protects your lien priority. Under applicable Illinois law, if the modified loan is considered a new agreement — a “novation” — the bank should record a new mortgage to secure the new debt. A new agreement is considered a novation if a four-part test is met: there must be (1) a previous valid obligation, (2) a subsequent agreement by all of the parties to the new contract, (3) the extinguishment of the old contract, and (4) the validity of the new contract. If a modified loan extinguishes the prior loan, it will be considered a novation, and the Conveyances Act would require recording the new mortgage before it could take effect.

In the context of consumer loans, there are some Illinois court cases that address the difference in language that modifies a loan, rather than creates a new loan. We have included excerpts from some of those cases in our resources below. You and your bank counsel will need to examine the loan modification documents to see whether they are intended to extinguish and replace the original loan agreement or merely to extend or supplement the original loan agreement.

Accordingly, although your bank may disburse new funds through a loan modification, we recommend consulting with bank counsel to confirm that your bank is adequately protected against these or other potential risks associated with such a transaction.

For resources related to our guidance, please see:

• Uniform Commercial Code, 810 ILCS 5/9-204(c) (“A security 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.”)

• Universal Guar. Life Ins. Co. v. Coughlin, 481 F.3d 458, 463 (7th Cir. 2007) (“Dragnet clauses are not favored in Illinois, but they are enforceable if they are clear and unambiguous.”) (Cross-collateral provisions often are referred to as a “dragnet clause” or “anaconda clause.”)

• First Midwest Bank v. Thunder Road, Inc., 359 Ill. App. 3d 921 (3rd Dist. 2005) (“Novation is the substitution of a new debt or obligation for an existing one, which is thereby extinguished. The elements of novation are: (1) a previous valid obligation; (2) a subsequent agreement by all of the parties to the new contract; (3) the extinguishment of the old contract; and (4) the validity of the new contract.”)

• Illinois Conveyances Act, 765 ILCS 5/30 (“All deeds, mortgages and other instruments of writing which are authorized to be recorded, shall take effect and be in force from and after the time of filing the same for record, and not before, as to all creditors and subsequent purchasers, without notice; and all such deeds and title papers shall be adjudged void as to all such creditors and subsequent purchasers, without notice, until the same shall be filed for record.”)

• Aames Capital Corp. v. Interstate Bank of Oak Forest, 734 N.E.2d 493, 497 (Ill. App. 2d Dist. 2000) (“In cases of a dispute concerning priority when the original note and mortgage are renewed, the court looks to the intent of the parties in determining whether the renewal extinguishes the original mortgage lien. In Winnetka Bank, the court was persuaded that the mortgage lien survived the renewal of the original mortgage and the tender of an additional loan because there was no evidence that the original mortgage was ever canceled or released.”)