According to a recent decision from the Delaware Supreme Court, a secured party bears the burden of any mistakes in its security documents. Official Comm. of Unsecured Creditors of Motors Liquidation Co. v. JPMorgan Chase Bank, N.A., No. 325, 2014 Del. LEXIS 491 (Del. Oct. 17, 2014) (“Del. Op.”). The Court’s decision is a wake-up call for all secured lenders to pay close attention to their loan documents and to any release of their security interests.
While the facts of this case are relatively straightforward, the case was procedurally complicated. In October 2001, General Motors entered into a syndicated financing transaction by which it obtained approximately $300 million to acquire and construct facilities on several properties (the “2001 Facility”). JPMorgan was the administrative agent and perfected the syndicate’s security interest by filing UCC-1 financing statements with the Delaware Secretary of State in each of the counties where the collateral properties were located. In November 2006, General Motors entered into an entirely different syndicated loan facility with a different syndicate of lenders, again with JPMorgan as the administrative agent (the “2006 Facility”). The administrative agent in the 2006 Facility also filed UCC-1 financing statements with the Delaware Secretary of State to perfect its security interest. In October 2008, the 2001 Facility was scheduled to mature and GM instructed its counsel to prepare the necessary documents to terminate and payoff that facility. In addition to preparing and filing UCC-3 termination statements for the 2001 Facility, GM’s counsel inadvertently prepared and filed (arguably with JPMorgan’s consent) a UCC-3 termination statement releasing liens on the collateral associated with the 2006 Facility.
The erroneous filing went unnoticed until GM filed for chapter 11 reorganization in June 2009. Shortly thereafter, the Official Committee of Unsecured Creditors commenced an action in the Bankruptcy Court seeking a determination that the UCC-3 was effective to terminate the secured status of the lenders in the 2006 Facility. On cross motions for summary judgment, the Bankruptcy Court concluded that the UCC-3 termination statement was unauthorized for the purposes of § 9-509(d)(1) of the UCC and therefore was not effective to terminate the security interest. The Bankruptcy Court certified the case for direct appeal to the Second Circuit Court of Appeals. The Second Circuit held that the effectiveness of the termination turned on two distinct but closely related questions:
- Must a secured lender authorize the termination of the particular security interest that the UCC-3 identifies for termination, or is it enough that the secured lender authorize the act of filing the UCC-3 statement that has that effect?
- Did the administrative agent grant authority to GM’s counsel to file the UCC-3 statement?
The Second Circuit reserved its ruling on the second question and certified the first as a question of law to the Delaware Supreme Court. The Delaware Supreme Court was tasked with determining whether “it is 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 that particular security interest that it listed on the UCC-3.” Del. Op., 2014 Del. LEXIS 491 at *2. JPMorgan argued that there should be an intent requirement. The Delaware Court was unpersuaded by JPMorgan’s arguments and held that the statute is unambiguous and therefore not subject to interpretation. Because the relevant provisions of the UCC clearly state that if a secured party authorizes the filing that filing is effective, the Court refused to read into the statute a subjective intent requirement that the filing party understand the terms and intended effect of the filing. Id. at *10. Instead, the Court reasoned that it is “fair” to place the burden on sophisticated transacting parties to ensure that a UCC-3 is accurate when filed. Id. at *11. Indeed, the Court stated that to find otherwise would run directly contrary to the notice mechanism of the UCC and would effectively “disrupt and undermine the secured lending markets.” Id. at *16-18. Moreover, such a system would provide little incentive for secured creditors to ensure the accuracy of their UCC filings. Id. at *15-16.
It goes without saying that precision is imperative when securing and releasing collateral as there is no forgiveness in the notice-based UCC filing system. Large companies and banks typically have voluminous and complex filings in several districts and attorneys who are filing UCC-1 financing statements or UCC-3 terminations must be sure they are acting against the correct instrument and with the proper authority. This case will now go back to the Second Circuit for the factual determination of whether JPMorgan actually authorized the UCC-3 filing.