On Jan. 21, in Official Committee of Unsecured Creditors of Motors Liquidation v. JPMorgan Chase Bank (In re Motors Liquidation), No. 13-2187, (2d Cir. Jan. 21, 2015), the U.S. Court of Appeals for the Second Circuit addressed whether a UCC-3 termination statement, which was improperly filed as part of the repayment of an unrelated loan, may be considered effective to terminate the security interest in question, even where none of the parties intended that result. After receiving guidance from the Delaware Supreme Court, to which a portion of the legal issues implicated in this case had been certified for opinion, the appellate court held that even though none of the parties intended for the security interest in question to be terminated, the filing of the termination statement was nevertheless effective.
This case is one of many that stems from the General Motors bankruptcy case, and relates to two large loans entered into by GM before its bankruptcy filing. In October 2001, GM entered into a synthetic lease financing transaction, whereby it obtained $300 million in financing from a syndicate of lenders, which included JPMorgan Chase Bank (JPMC) as a lender and as administrative agent for the loan. The synthetic lease was secured by liens on 12 pieces of real estate owned by GM. In 2006, GM entered into a term loan facility, whereby it obtained $1.5 billion in financing from a different syndicate of lenders, but one that also included JPMC as administrative agent. The term loan was secured by a large variety of GM's assets. UCC-1 financing statements were filed in connection with the synthetic lease and the term loan in order to effectuate a perfection of the lenders' security interests in their respective items of collateral. One such financing statement related to the $1.5 billion term loan, bearing file number 6416808, was filed with the Delaware secretary of state and covered all of GM's equipment and fixtures at 42 different facilities (the Main Term Loan UCC-1). The Main Term Loan UCC-1 was considered "by far the most important" of the financing statements filed in connection with the term loan.
As the synthetic lease neared maturity in September 2008, GM contacted its counsel responsible for the synthetic lease, and informed it that GM planned to repay the synthetic lease loan facility in full. GM requested that its counsel prepare the documents necessary to evidence repayment of the synthetic lease loan facility, as well as the documents that would accomplish a release of the lenders' security interest in the collateral covering the synthetic lease loan facility. GM's counsel, through a paralegal unfamiliar with the details of the transaction, conducted a UCC search for financing statements that had been recorded against GM in Delaware. This search identified three UCC-1 financing statements, including the Main Term Loan UCC-1, which had been filed in connection with the term loan.
GM's counsel prepared a closing checklist for the termination of the synthetic lease, and identified the Main Term Loan UCC-1 along with the other financing statements related to the synthetic lease for termination, and prepared a UCC-3 statement terminating the Main Term Loan UCC-1. Copies of the closing checklist were sent to a managing director at JPMC, who was responsible for the repayment of the synthetic lease, and who had signed the term loan documents on JPMC's behalf. JPMC's counsel was also sent copies of the closing checklist, the draft UCC-3 termination statements and other closing documents, some of which required JPMC's counsel's signature. Everyone who reviewed these documents approved them for inclusion at closing.
Unfortunately, no one realized that the UCC-3 purporting to terminate the Main Term Loan UCC-1 was improperly included in the documents related to the repayment of the synthetic lease. When the proper UCC-3 termination notices were filed in connection with the repayment of the synthetic lease, the UCC-3 terminating the Main Term Loan UCC-1 was filed as well.
GM filed for bankruptcy in 2009 and, until that time, the termination of the Main Term Loan UCC-1 had gone unnoticed. After the bankruptcy filing, JPMC informed the committee of unsecured creditors that the Main Term Loan UCC-1 had been unintentionally terminated and that, because the termination was unauthorized, it was ineffective. On July 31, 2009, the committee commenced an adversary proceeding against JPMC seeking a determination that the inadvertently-recorded termination statement was nonetheless effective to terminate the Main Term Loan UCC-1, rendering JPMC an unsecured creditor on par with the other unsecured creditors of GM.
As with all bankruptcy filings, GM's bankruptcy filing had the effect of granting the trustee or debtor-in-possession the status of a hypothetical lien creditor with a blanket lien on all of the debtor's assets. Because the offending UCC-3 termination statement was filed before GM's petition date, but this error was not discovered until after the petition date, JPMC was barred from attempting to re-perfect its security interest in the assets secured by the Main Term Loan UCC-1 once the bankruptcy case was filed.
Court Ruling, Parties' Arguments on Appeal
In the bankruptcy court, the committee argued that despite the fact that the filing of the UCC-3 termination statement purporting to terminate the Main Term Loan UCC-1 was in error, the termination of the Main Term Loan UCC-1 was nevertheless effective. JPMC disagreed, arguing instead that because no one at GM, JPMC, or their respective law firms intended that the Main Term Loan UCC-1 be terminated, the filing of the UCC-3 termination statement with respect to that financing statement was unauthorized and, consequently, ineffective. On cross-motions for summary judgment, the bankruptcy court sided with JPMC and concluded that the filing of the UCC-3 termination statement with respect to the Main Term Loan UCC-1 was not effective to terminate JPMC's security interest in the collateral identified in the Main Term Loan UCC-1.
The bankruptcy court decision was certified for appeal by the committee to the Second Circuit. The parties on appeal offered differing interpretations of UCC Section 9-509(d)(1), which provides that a UCC-3 termination statement is effective only if "the secured party of record authorizes the filing." JPMC argued that it could not have "authorized" the filing of the incorrect UCC-3 termination statement, because it never intended to terminate the security interest secured by the Main Term Loan UCC-1. Conversely, the committee argued that JPMC's subjective intent was irrelevant, and that the filing was "authorized" because JPMC had, in fact, authorized (albeit unwittingly) the filing of the UCC-3 termination statement. According to the committee, JPMC literally "authorized the filing" when it told its counsel to file the documents that included the improper UCC-3 termination statement.
The Court's Analysis
The Second Circuit was faced with "two closely related questions," namely, "first, what precisely must a secured lender of record authorize for a UCC-3 termination statement to be effective," and second, whether JPMC gave its counsel the relevant authority to file the offending UCC-3 termination statement. The court recognized that the first question was more appropriately addressed by the Delaware Supreme Court, as a matter of Delaware state law, and therefore certified this question to the Delaware Supreme Court, reserving for itself the second question.
The Delaware Supreme Court responded to the certified question by stating that, under Delaware law, if a secured party authorizes a filing to be made, then that filing is effective regardless of what the secured party subjectively intends or understands the outcome of that filing to be. The Delaware Supreme Court went on to state that the Delaware Uniform Commercial Code contains no provision that requires the secured party to understand the effect of its own filing.
With the requisite guidance from the Delaware Supreme Court on the first question, the Second Circuit went on to answer the second question implicated by the appeal, namely whether JPMC's actions were sufficient to "authorize" the filing of the UCC-3 termination statement that purported to terminate the Main Term Loan UCC-1. The court found that, despite the fact that no one at GM, JPMC, or their respective law firms took any action intended to affect the Main Term Loan UCC-1, JPMC had nevertheless "authorized the filing" by reviewing the documents related to the repayment of the synthetic lease (which inadvertently included the UCC-3 terminating the Main Term Loan UCC-1), and agreeing that those documents be filed.
A Cautionary Tale
The result in this case should serve as a cautionary tale to all secured parties and their counsel, underscored by the ever-present possibility that a borrower file for bankruptcy protection. A mistake on the part of counsel will not excuse the filing of an improper document, especially where all parties and their counsel have an opportunity to review the relevant documents, and sign off on their filing. The subsequent bankruptcy filing, with a trustee or debtor-in-possession empowered to relegate an unwitting secured creditor to unsecured creditor status, turned out to be a real game-changer under these circumstances.
This case presents a classic example of the tragedy of the commons, where everyone involved appeared to be relying on the review and diligence of the other parties, to disastrous effect for the secured party. Consequently, in order to protect its interests, a secured party and its counsel must conduct a detailed, rather than a cursory, review of any documentation filed on its behalf. Failure to do so could lead to an outcome that no one intended or anticipated.