Whenever a UCC-3 termination statement is being filed, all parties need to carefully review such termination statement to make sure the termination statement is releasing the secured interests that the parties intend to be released.  Failing to diligently review termination statements can lead to the inadvertent release of a security interest that a secured party may not intend to release.  A recent opinion by the Second Circuit Court of Appeals in In re Motors Liquidation Company, et al.[i]   held that a secured party had authorized the filing of a termination statement that was filed in error, and was therefore unsecured.

Under the UCC, financing statements can be terminated without the signature of the secured party of record; in fact, all filings can be done without the signature of the debtor or the secured party.  However, in order to be effective under the UCC, a termination statement must be authorized by the secured party.[ii]  The UCC defers to other non-UCC law to determine whether a filing has in fact been authorized.[iii]  The Motors Liquidation case examined whether the secured party had authorized the filing of the termination statement.

In 2001, a syndicate of lenders that included JPMorgan Chase Bank ("JPMorgan") provided a $300 million synthetic lease financing (the "Synthetic Lease") to General Motors (“GM”).  JPMorgan was also administrative agent for a syndicate of lenders that provided a $1.5 billion term loan facility to GM in 2006 (the "Term Loan"), which was separate from the Synthetic Lease.  When the Synthetic Lease was approaching maturity in 2008, in connection with a payoff of the Synthetic Lease, GM requested that its counsel, Mayer Brown LLP ("Mayer") prepare the documents that were needed to release the security interests securing the Synthetic Lease.  When Mayer conducted a lien search, three financing statements were identified that listed JPMorgan as secured party, two that related to the Synthetic Lease and one that related to the Term Loan.  Mayer then prepared UCC-3 termination statements for all three financing statements and copies were sent to JPMorgan and Simpson Thatcher & Bartlett LLP ("Simpson"), JPMorgan's counsel, for review.  No one at GM, Mayer, JPMorgan or Simpson noticed that the third UCC-1 financing statement was filed to secure the Term Loan, and not the Synthetic Lease, and all three UCC-3 termination statements were filed with the Delaware Secretary of State.  None of the parties noticed the error until after GM filed for bankruptcy in 2009 and JPMorgan informed the unsecured creditors’ committee that the UCC-3 termination statement relating to the Term Loan had been filed in error.

JPMorgan argued that it authorized GM only to terminate security interests relating to the Synthetic Lease and instructed Mayer and Simpson to only take actions to accomplish that objective, and that  therefore, when Mayer filed the UCC-3 to terminate the financing statement securing the Term Loan, it exceeded the scope of authority granted to it by JPMorgan.  The United States Bankruptcy Court for the Southern District of New York agreed and ruled that although the parties and their counsel reviewed and found no issue with the UCC-3 termination statements, Simpson's comment in an e-mail stating "nice job on the documents" did not constitute an authorization by JPMorgan to terminate the UCC-1 related to the Term Loan.[iv]  The Bankruptcy Court found that although JPMorgan and Simpson reviewed the UCC-3, such review was not sufficient to establish that JPMorgan had intent to terminate the security interests relating to the Term Loan.

The Bankruptcy Court undertook an analysis of agency law to determine whether GM, Mayer (as GM’s agent) or Simpson (as JPMorgan’s agent) had been granted authority (actual or apparent) by JPMorgan to file a termination statement for the Term Loan.  The Bankruptcy Court found that no such authority had been granted.  The Bankruptcy Court determined that, under agency law, an agent does not have actual authority to do an act if it does not reasonably believe the principal has consented to such act.[v]  GM and Mayer each testified that they did not believe they were authorized to terminate any lien securing the Term Loan.  The Bankruptcy Court also found that the various documents executed by JPMorgan in connection with the termination of the Synthetic Lease did not authorize the termination of the Term Loan financing statement.  The Bankruptcy Court examined in particular whether it was JPMorgan’s intent to terminate the Term Loan financing statement.  It concluded that there was no such intent.

The Second Circuit reversed the Bankruptcy Court's decision by finding that, although JPMorgan had not intended to terminate the security interests securing the Term Loan, it  had authorized the filing of the UCC-3 that terminated the security interest securing the Term Loan.  In other words, it was the intent to do the act of filing, and not necessarily the intent to effect the consequences of the filing, that was relevant.

In connection with the appeal, the Second Circuit certified a question to the Delaware Supreme Court

Under UCC Article 9, as adopted into Delaware law by Del.Code Ann. tit. 6, art. 9, for a UCC–3 termination statement to effectively extinguish the perfected nature of a UCC–1 financing statement, is it enough that the secured lender review and knowingly approve for filing a UCC–3 purporting to extinguish the perfected security interest, or must the secured lender intend to terminate the particular security interest that is listed on the UCC–3?

In response, the Delaware court held that

[F]or a termination statement to become effective under § 9–509 and thus to have the effect specified in § 9–513 of the Delaware UCC, it is enough that the secured party authorizes the filing to be made, which is all that § 9–510 requires.  The Delaware UCC contains no requirement that a secured party that authorizes a filing subjectively intends or otherwise understands the effect of the plain terms of its own filing.[vi]

There was evidence that JPMorgan and Simpson had been sent a draft of the termination statement relating to the Term Loan prior to its filing, as well as a closing checklist prepared by Mayer that listed such termination statement.  Simpson had signed an escrow agreement that had specified the termination of the Term Loan financing statement.  The Second Circuit found this sufficient evidence to establish that JPMorgan had authorized the filing of the termination.

in responding to the certified question, the Delaware Supreme Court had stated that allowing parties to be relieved of the consequences of mistaken filings would provide “little incentive” to ensure the accuracy of information contained in UCC filings, a statement that the Second Circuit quoted with approval in its opinion.

The Second Circuit’s decision is a warning to secured creditors to exercise care.  We note that the Official Comments to the UCC clearly state that the burden of determining whether any filing has been authorized is on the searcher,[vii] and the statements of the Delaware Supreme Court and the Second Circuit regarding the secured party’s incentives to make accurate filings may be viewed as inconsistent with that allocation of burden.  While it remains the case that a filed financing statement must be authorized to be effective under the UCC, courts may view skeptically any claims by a secured party that a termination was not authorized in cases where the secured party and its counsel are involved in the process in which termination statements are prepared.

It is imperative for secured parties to examine the UCC-1 financing statement to be terminated by a UCC-3 termination statement in order to ensure the proper termination statements are being filed.  It is not enough to simply run a lien search and prepare UCC-3s for any lien that appears.  The effect of not carefully reviewing a UCC-3 termination statement in conjunction with the originally filed UCC-1 financing statement can become a costly mistake for a secured party, as happened in this case.