JPMorgan Chase & Co received a painful reminder recently that mistakes can be very costly after their appeal to the Second Circuit was remanded; the clerical mix-up could cost the company $1.5 billion.

Section 9-509(d)(1) of the Uniform Commercial Code (UCC) provides that a UCC-3 termination statement is effective only if “the secured party of record authorizes the filing.”

Interpreting this language, the Delaware Supreme Court held that a UCC-3 termination statement was authorized by and effective against a secured party despite the undisputed fact that the termination statement was prepared by mistake and the secured party did not intend to release its security interest.

This case presents a cautionary tale to lenders to take great care in the preparation and filing of UCC documents. (See Official Committee of Unsecured Creditors of Motors Liquidation Company v. JPMorgan Chase Bank, N.A., 2015 U.S. App. LEXIS 859 (2nd Cir. January 21, 2015).)

Factual and Procedural Background

JPMorgan Chase Bank, N.A. (JPMorgan), as administrative agent for a syndicate of lenders, made two entirely separate and unrelated loans to General Motors. The first was a $300 million loan made in October 2001 related to a synthetic lease financing transaction (Loan 1). To perfect its security interest in the collateral granted by General Motors to secure Loan 1 (primarily real estate), JPMorgan filed two UCC-1 financing statements with the Delaware Secretary of State.

The second was a $1.5 billion term loan made five years later (Loan 2). To perfect its security interest in the collateral granted by General Motors to secure Loan 2 (primarily equipment and fixtures at 42 GM facilities), JPMorgan filed a third UCC-1 financing statement with the Delaware Secretary of State.

In September 2008, General Motors informed its counsel that it intended to repay Loan 1. General Motors requested that its counsel prepare all documents necessary for JPMorgan to be repaid and to release the collateral securing Loan 1. A closing checklist was prepared by counsel for General Motors that erroneously identifying all three UCC-1s filed in Delaware, including the UCC-1 for Loan 2, to be terminated as part of the closing. In addition, counsel for General Motors prepared draft UCC-3 termination statements for all UCC-1s filed in Delaware, including the UCC-1 for Loan 2.

Although copies of the closing checklist and draft UCC-3 termination statements were circulated to General Motors, JPMorgan and each of their counsel, the mistake was never discovered. An escrow agreement was drafted as part of the closing, authorizing the escrow agent to terminate all three UCC-1s, including the UCC-1 for Loan 2, once General Motors repaid the amount due on Loan 1. The escrow agreement was approved by JPMorgan’s counsel and signed.

On Oct. 30, 2008, General Motors repaid Loan 1 and all three UCC-1s filed in Delaware, including the UCC-1 for Loan 2, were terminated.

The mistake went unnoticed until General Motors filed bankruptcy in 2009. After General Motors filed its chapter 11 bankruptcy petition, JPMorgan notified the Unsecured Creditors’ Committee of General Motors (Committee) that the UCC-3 termination statement related to Loan 2 was inadvertently filed. JPMorgan explained that it had intended to terminate only liens related to Loan 1 and stated that the filing was therefore unauthorized and ineffective under the UCC.

On July 31, 2009, the Committee commenced an adversary proceeding against JPMorgan seeking a determination that, despite the error, the UCC-3 termination statement was effective and rendered JPMorgan an unsecured creditor on par with all other unsecured creditors of General Motors. JPMorgan disagreed, reasoning that the UCC-3 termination statement was unauthorized and therefore ineffective because no one at JPMorgan, General Motors or their law firms had intended that the UCC-1 for Loan 2 be terminated.

The bankruptcy court agreed with JPMorgan and concluded that the UCC-3 termination statement was unauthorized and therefore not effective to terminate the security interest granted for Loan 2.

Appealing to the Second Circuit

On appeal to the Second Circuit, the parties offered competing interpretations of the meaning of the term “authorized” under 9-509(d)(1) of the UCC. While JPMorgan focused on the parties’ subjective intent, the Committee focused on JPMorgan’s act of authorizing the filing of the UCC-3 – even if by mistake.

The Second Circuit identified the two issues before it as (1) what precisely must a secured lender of record “authorize” for a UCC-3 termination statement to be effective; and (2) did JPMorgan grant such authority.

As to the first question, the Second Circuit certified the question to the Delaware Supreme Court. The Delaware Supreme Court held that for a termination statement to become effective, it is enough that the secured party authorizes the filing to be made – there is no requirement in the UCC that a secured party that authorizes a filing subjectively intends or otherwise understands the effect of the plain terms of its own filing. The Delaware Supreme Court reasoned that if parties could be relieved from the legal consequences of their mistaken filings, they would have little incentive to ensure the accuracy of the information contained in their UCC filings.

As to the second question, the Second Circuit found that although JPMorgan never intended to terminate the UCC-1 securing Loan 2, it authorized the filing of a UCC-3 termination statement that had that effect. The Second Circuit reversed the bankruptcy court’s entry of judgment in favor of JPMorgan and remanded with instructions to enter judgment in favor of the Committee as to the termination of the UCC-1 securing Loan 2.

Practice Pointers

The lesson of this case for secured lenders is that great care must be taken in the preparation and filing of UCC forms. Secured parties will be held accountable for authorized filings – even if made by mistake. The best practice for secured lenders is to take sole responsibility for completing and filing all UCC forms to avoid these harsh results.