Big Case for UCC Aficionados
Though the Second Circuit’s decision is only a couple of days old, hundreds of e-lerts, blog posts and articles will have been published as I write this. The decision was featured as the top article in this week’s ABA Law Journal. I suspect many will enjoy the spectacle of two “BigLaw” firms’ failure to identify and correct an error in filing a UCC termination statement that had the effect of terminating a $1.5 billion security interest that should not have been terminated.
There is no doubt the decision is an important one. Prior to 2001, signatures were required on UCC financing statements and amendments. Signatures were an impediment to electronic filing (or at least were thought to be) and, because they were not verifiable by filing offices, they were not truly an effective means of ensuring that UCC filings were legitimate. As a result, the signature requirement was replaced with the requirement that UCC filings instead be properly authorized to be effective.
Of course, it is inevitable that, in addition to fraudulent, completely unauthorized filings, errors would be made by employees and authorized agents and the question of what constitutes proper authorization would be put to the courts. Now, nearly fifteen years later, the Motors Liquidation case provides significant guidance.
But Not a Bad Case
I understand there will be a lot of concern over the decision and there is no doubt that the holders of the $1.5 billion claim will not be happy with the decision. Personally, I feel sympathy for those involved, understanding the pressures of the practice, the inevitability of human error, and the potentially devastating impact of a typo in a debtor name on an initial financing statement or in a file number on a financing statement amendment.
But, it should not be the case that a secured party could limit authority to prepare and file a UCC amendment such that any error committed by its authorized agent would be unauthorized and ineffective. Generally, principals are responsible for the acts of their agents. More important in this context, there needs to be some reliability in the UCC filing system. While a searcher needs to know that everything in the UCC filing system is not necessarily legally effective, the system should be generally reliable. It is impractical for searchers to verify the legal effectiveness of every UCC filing. An appropriate balance needs to be struck between the interests of filers and searchers and while the system will never be perfect, I think the Second Circuit reached the proper decision.
Motors Liquidation, the case reversed this week
In re: Motors Liquidation Company, 486 B. R. 596, 2013 Bankr. LEXIS 814 (Bankr. S.D.N.Y. March 1, 2013), arising out of the GM bankruptcy, presented a difficult case. The secured party was the secured party on two different secured transactions, a $300 million synthetic lease and a $1.5 billion term loan. The synthetic lease transaction was paid off and the debtor, as is often the case today, prepared the termination statements. A paralegal at the debtor’s law firm ran a search, identified all the financing statements where the secured party was the secured party of record and prepared termination statements for all of them. The draft termination statements and a related escrow agreement authorizing them to be filed upon payment of the synthetic lease obligation were circulated to the secured party and its counsel and were approved. No one spotted the error – that one of the terminations statements would terminate a financing statement for the unrelated term loan.
In a close case, the Bankruptcy Court sided with the secured party, holding that because the secured party had not intended that the security interest relating to the term loan be terminated, the filing of that termination statement had not been authorized and was thus not effective. The case was appealed to the Second Circuit, which first certified a question to the Delaware Supreme Court: “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?” (2014 U.S. App. LEXIS 11598, June 17, 2014)
The Delaware Supreme Court held that it is enough that the secured lender authorizes the filing and need not understand the effect of the filing nor intend that effect to occur. As the court noted, the UCC §9-509 rule that a secured party must authorize the filing “promotes sound policy. It is fair for sophisticated transacting parties to bear the burden of ensuring that a termination statement is accurate when filed. It would be strange and inefficient for the UCC to make the effectiveness of a termination statement depend on whether the secured party subjectively understood the terms of its own filing and the effect the filing would have on the security interests the filing’s own words address.” Official Committee of Unsecured Creditors pf Motors Liquidation Company v. JPMorgan Chase Bank, N.A., Case No. 325, 2014, 2014 Del. LEXIS 491 (Sup. Ct. Del., October 17, 2014). I think this decision was correct and consistent with customary principles of agency and vicarious liability.
After the Delaware Supreme Court answered that the subjective intent of the secured party to terminate a particular security interest is not relevant to whether a UCC filing is effective under Delaware law, the Second Circuit was left to re-visit the question of whether or not there was adequate authorization for the filing of the (erroneous) termination statement. The court noted that what the secured party of record intended to accomplish “is a distinct question from what actions it authorized to be taken on its behalf.” In re: Motors Liquidation Company, Case No. 13-2187, January 21. 2015. The Second Circuit concluded that the secured party and its counsel knew that borrower’s counsel was going to file the termination statement in question, even though they did not know it was erroneous and would have an undesired effect. The secured party of record “reviewed and assented to the filing of that statement. Nothing more is needed.”
A secured party is the master of its own termination statement and it should embrace this responsibility. The elimination of the signature requirement caused many secured parties to become casual about the termination process and it has become typical that secured parties leave the termination job to the debtor and its counsel. This practice may not be wise as Motors Liquidation informs us that the secured party may well suffer the consequences of an error made by the debtor or its counsel. Any authorization analysis will necessarily be fact-specific and Motors Liquidation does not stand for the proposition that a secured party is always bound by errors of others, but I believe secured parties will now exercise more careful control over the termination process.