Restructuring

Contributed by Kyle J. Ortiz
A recent decision out of the United States Court of Appeals for the Second Circuit serves as a powerful reminder of why lawyers are taught to take care in even the most ministerial of tasks. In Official Comm. of Unsecured Creditors of Motors Liquidation Co. v. JPMorgan Chase Bank, N.A. (In re Motors Liquidation Co.), an oversight will end up converting a portion – perhaps a very sizable portion – of JPMorgan’s $1.5 billion secured claim into a general unsecured claim in the General Motors chapter 11 cases.
In September 2008, General Motors was ready to pay off a $300 million synthetic lease under which JPMorgan was the secured party of record. General Motors contacted one of its outside law firms to prepare the necessary paperwork to repay the synthetic lease and have the related liens released. There were two UCC-1s related to the synthetic loan, but when a paralegal at General Motors’ outside law firm did a lien search for UCC-1s recorded by JPMorgan against General Motors in Delaware, the paralegal identified three UCC-1s. Unbeknownst to the paralegal, the third UCC-1 was the financing statement for an entirely unrelated $1.5 billion term loan that General Motors was obligated under and that JPMorgan was again the secured party of record in its capacity as administrative agent. Relying on the lien search, attorneys at General Motors’ outside counsel created a closing checklist of actions needed to terminate the synthetic lease and listed the UCC-1 of the term loan security interest together with the UCC-1s for the synthetic lease needing to be terminated. General Motors’ outside counsel then drafted UCC-3 termination statements for each of those three security interests.
The closing checklist and the UCC-3s were reviewed by General Motors, their outside counsel, JPMorgan, and JPMorgan’s outside counsel and no one caught the errant inclusion of the UCC-1 for the term loan on the closing checklist or the UCC-3 termination statement for the term loan. Consequently, all three UCC-3s were filed with the Delaware Secretary of State.
The filing error went unnoticed until 2009 when General Motors filed its chapter 11 cases. Shortly after the filing, JPMorgan informed the Official Committee of Unsecured Creditors in General Motors’ chapter 11 cases of the filing error. The Committee, in turn, “sought a determination [from the Bankruptcy Court for the Southern District of New York] that, despite the error, the UCC-3 termination statement was effective to terminate the Term Loan security interest and render JPMorgan an unsecured creditor on par with the other General Motors unsecured creditors.” JPMorgan responded that it had not authorized the UCC-3 termination statement because nobody at JPMorgan or General Motors intended to terminate JPMorgan’s security interest in the term loan.
The bankruptcy court agreed with JPMorgan and concluded that the UCC-3 filing was unauthorized because it was filed as part of a transaction the intent of which was to terminate the synthetic lease and not to affect anything else, and, therefore, that filing was not effective to release the security for the term loan. The Committee filed a direct appeal to the Second Circuit.
The Second Circuit identified two related questions to be addressed:

1. Must the secured lender authorize the termination of the particular security interest that the UCC-3 identified for termination, or is it enough that the secured lender authorize the act of filing a UCC-3 statement that has that effect?
2. Did JPMorgan grant to General Motors’ outside counsel relevant authority – that is, alternatively, authority either to terminate the term loan UCC-1 or to file the UCC-3 statement that identified that interest for termination?

To answer the first question, which presented a significant issue of Delaware state law, the Second Circuit enlisted the help of the Delaware Supreme Court and certified to it the following question:

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?

The Delaware Supreme Court answered that the subjective intent of a secured party is not relevant to authorization. Rather, the Delaware Supreme Court held, if the secured party of record authorized the filing of a UCC-3 termination statement, that is all the authority needed. It noted that its answer was essential to the integrity of the UCC filing system because “[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.” It further explained that “consistent with the purpose of setting up a notice system, one of the most important roles the UCC plays is facilitating the efficient procession of commerce by permitting parties to rely in good faith on the plain terms of authorized public filings.”
With the Delaware Supreme Court having answered the question of what is required to authorize a filing, the Second Circuit turned to the second question – whether JP Morgan had authorized General Motors’ outside counsel to file the UCC-3 termination statement for the term loan.
After noting that on at least two occasions JPMorgan’s outside counsel had reviewed the documents related to the synthetic loan termination – including the errant UCC-3 for the term loan – and signed off on them, the Court concluded “that although JPMorgan never intended to terminate the Main Term Loan UCC–1, it authorized the filing of a UCC–3 termination statement that had that effect.” The Second Circuit went on to note that “JPMorgan and [its outside counsel’s] repeated manifestations to [General Motors’ outside counsel] show that JPMorgan and its counsel knew that, upon the closing of the Synthetic Lease transaction, [General Motors’ outside counsel] 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. Nothing more is needed.” Thus, the Second Circuit reversed the Bankruptcy Court’s summary judgment and remanded with instructions to enter partial summary judgment in favor of the Committee with regard to termination of the term loan’s UCC-1.
The Delaware Supreme Court summed up the lesson this case provides in its answer to the certified question when it cautioned secured lenders that, “[b]efore a secured party authorizes the filing of a termination statement, it ought to review the statement carefully and understand which security interests it is releasing and why.” A sobering reminder to lawyers everywhere, to diligently double check everything they do – and then check it again.