This post, written by Dana S. Katz, was originally published in the American Bar Association Young Lawyer Division Bankruptcy Committee Winter 2015 Newsletter. (c) 2015 by the American Bar Association.
The Second Circuit Court of Appeals recently determined that JPMorgan released its security interest on a $1.5 billion term loan by virtue of the mistaken filing of a UCC-3 termination statement. After concluding that both the borrowers and lenders had reviewed drafts, including review by their counsel, the Second Circuit concluded that erroneous termination statement was filed with actual authority. Official Committee of Unsecured Creditors v. JPMorgan Chase Bank, N.A. (In re Motors Liquidation Co.), Appeal No. 13-2187 (2d Cir. Jan. 21, 2013)(Second Circuit Decision). A copy of the decision can be found here.
In October 2011, General Motors (GM) entered into a “synthetic lease financing transaction” (the Synthetic Lease) by which it obtained approximately $300 million of financing from a syndicate of lenders for which JPMorgan was the administrative agent and secured party of record listed on the UCC-1 financing statements. The Synthetic Lease was secured by liens on real property. Id. at 3. Five years later, GM entered into an unrelated term loan facility (the Term Loan) for approximately $1.5 billion in financing from a syndicate of lenders for which JPMorgan was again the administrative agent and secured party of record. The Term Loan was secured by a large number of GM’s assets, including its equipment and fixtures. Id. at 3-4. In connection with the Term Loan, twenty-eight UCC-1 financing statements were filed across the country to perfect the lenders’ security interests, including one filed with the Delaware Secretary of State (the Main Term Loan UCC-1). Id. at 4.
In September 2008, GM contacted Mayer Brown LLP, its counsel for the Synthetic Lease, in order to facilitate repayment of the Synthetic Lease and release of the lenders’ interest in the GM collateral. Id. at 4. A paralegal at Mayer Brown performed a search and prepared a list of financing statements for termination that inadvertently included the Main Term Loan UCC-1 despite that it was not related to repayment of the Synthetic Lease and should not be terminated. Id. at 5.
Copies of the closing checklist and draft UCC-3 termination statements were circulated to GM, Mayer Brown, JPMorgan and JPMorgan’s counsel Simpson Thatcher & Bartlett LLP, but the error went unnoticed. On October 30, 2008, GM repaid the Synthetic Lease and the erroneous UCC-3 identifying the Main Term Loan UCC-1 was filed with the Delaware Secretary of State. Id. at 6. The mistake was not uncovered until GM filed for bankruptcy in 2009 in the U.S. Bankruptcy Court for the Southern District of New York (the Bankruptcy Court). After GM filed its chapter 11 petition, JPMorgan informed the Unsecured Creditors Committee that a UCC-3 termination statement was inadvertently filed in October 2008, but termination of the security interest was unauthorized and therefore ineffective. Id. The Committee then initiated litigation against JPMorgan seeking a determination that the UCC-3 termination was effective, and JPMorgan was therefore an unsecured creditor. Id. at 6-7.
On cross motions for summary judgment, the Bankruptcy Court found the termination statement unauthorized and not effective to terminate JPMorgan’s Term Loan security interest. Id. at 7. See Official Committee of Unsecured Creditors v. JPMorgan Chase Bank, N.A. (In re Motors Liquidation Co.), 486 B.R. 596, 647-48 (Bankr. S.D.N.Y. 2013). The Committee appealed directly to the Second Circuit, and on appeal, the parties offered competing views of UCC § 9-509(d)(1), under which a termination statement is effective if “the secured party of record authorizes the filing.” Second Circuit Decision at 7.
The Second Circuit certified a question to the Delaware Supreme Court regarding whether the filing of a termination statement is effective to terminate the security interest regardless of the filer’s intent. In October 2014, the Delaware Supreme Court provided its answer: “it is enough that the secured party authorizes the filing to be made . . . the Delaware UCC contains no requirement that a secured party that authorizes filing subjectively intends or otherwise understands the effect of the plain terms of its own filing.” Id. at 9-10 (quoting Official Committee of Unsecured Creditors of Motors Liquidation Co. v. JPMorgan Chase Bank, N.A., __ A.3d __, 2014 WL 5305937, *5 (Del. Oct. 17, 2014) (the Delaware Decision)). The Delaware Supreme Court reasoned that “[i]f 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.” Second Circuit Decision at 10 (quoting Delaware Decision, 2014 WL 5305937 at *3-4).
Having heard from the Delaware Supreme Court, the Second Circuit considered the remaining question, “Did JPMorgan authorize the filing of the UCC-3 termination statement that mistakenly identified for termination the Main Term Loan UCC-1?” Second Circuit Decision at 11. Although JPMorgan argued that Mayer Brown must have exceeded the scope of its authority and that JPMorgan “never instructed anyone to file the UCC-3 in question, and the termination statement was therefore unauthorized and ineffective,” the Second Circuit considered the facts at issue – namely that both JPMorgan and Simpson Thatcher received copies of the draft UCC-3 termination statement at issue and neither party expressed any concerns about it or the closing checklist. Id. at 11-13. Moreover, JPMorgan’s counsel had approved an Escrow Agreement providing that once GM repaid the Synthetic Lease, the escrow agent would forward the termination statements to GM’s counsel for filing. Id. at 13-14.
With these facts, the Court cited only the Restatement (third) of Agency to find that actual authority existed here, where “JPMorgan and its counsel knew that, upon the closing of the Synthetic Lease transaction, Mayer Brown was going to file the termination statement that identified the Main Term Loan UCC-1 for termination and that JPMorgan reviewed and assented to the filing of that statement.” Id. at 14.
Often, when a secured loan is paid off, the lenders rely on the borrower’s counsel to prepare and file UCC termination statements. The Second Circuit’s decision in this case illustrates the importance of a detailed review of draft termination statements by lenders prior to filing as well as the importance of the Creditors’ Committee’s post-petition review of secured liens which can reveal errors or issues with the liens or their perfection. In this case, the mistaken filing of the termination statement resulted in JPMorgan and the syndicate of lenders for the $1.5 billion Term Loan releasing their security interests. Time will tell the full scope of damages to these lenders and whether further litigation will ensue.
Dana S. Katz is an associate in Fox Rothschild’s Philadelphia office. As a member of the firm’s Financial Restructuring and Bankruptcy and Litigation Departments, Dana’s practice focuses on all facets of chapter 11 and chapter 7 bankruptcy matters as well as commercial and business-related litigation, with a particular emphasis on bankruptcy litigation.