Canada: When A Secured Loan Turns Into Unsecured Debt: The Irreversibility Of Discharged Registrations

Last Updated: February 11 2015
Article by M. Sandra Appel

A discharge is effective whether or not the secured party intended to discharge that particular registration. That was the decision of the United States Court of Appeals for the Second Circuit,1. which left JP Morgan unsecured for $1.5 billion as a result of a paperwork mix-up. Case law in Ontario and elsewhere in Canada suggests that the decision here would be the same. Consequently, lawyers and law clerks need to exercise extreme care in discharging registrations.

Facts

General Motors ("GM") entered into a syndicated lease financing transaction for about $300 million ("Lease Transaction") with several banks including JP Morgan Chase Bank N.A. (JP Morgan"), as administrative agent. Two registrations were made pursuant to the Uniform Commercial Code ("UCC"), with JP Morgan identified as the secured party on the UCC-1 financing statement.

Several years later GM entered into a term loan facility ("Term Loan Transaction") for about $1.5 billion. Again, JP Morgan acted as the administrative agent for a syndication of lenders. Although there were many UCC filings for the Term Loan Transaction, the major financing statement was registered in Delaware and is referred to as the "Main Term Loan Security".

When the Lease Transaction was nearing maturity, GM instructed its counsel ("GM Counsel") to prepare the documentation to repay JP Morgan and its syndicate and to release the Lease Transaction security. GM Counsel instructed an associate to prepare a closing checklist and the relevant documents. The associate instructed a paralegal to undertake a search for UCC-1 financing statements registered against GM. The paralegal located three such statements, but did not realize that only two related to the Lease Transaction; the third was the Main Term Loan Security.

GM Counsel prepared draft discharge statements (UCC-3 statements) to terminate the UCC-1 filings registered against GM. All three registrations against GM in favour of JP Morgan were discharged. The error went unnoticed until a year later when GM filed for bankruptcy protection.

The United States Bankruptcy Court for the Southern District of New York, in an application, determined that even though the UCC-3 statement for the Term Loan Transaction was filed in error, it was effective. JP Morgan was an unsecured creditor for over $1.5 billion.

JP Morgan argued, in a summary judgment motion, that the UCC-3 filing in respect of the Term Loan Transaction UCC-1 was unauthorized. The Bankruptcy Court agreed and determined that the UCC-3 filing was not effective to terminate the Main Term Loan Security.

The Authorization of Discharges – Does Intention Count?

On appeal to the United States Court of Appeals for the Second Circuit, competing interpretations of the provisions of the UCC in respect of the authorization of discharges were argued. JP Morgan maintained that it did not authorize the discharge of the Main Term Loan Security because it did not intend to discharge that registration. The Committee of Unsecured Creditors argued that intention was not relevant. The only requirement for compliance with the relevant provisions of the UCC was that the secured lender authorize the filing of the UCC-3.2.

The Appeals Court identified two questions to be addressed by it. First, what must a secured lender authorize in order for a UCC-3 termination statement to be effective? Second, was JP Morgan Counsel authorized to file the UCC-3 terminating the Main Term Loan Security?

The Appeals Court delegated the first question to the Delaware Supreme Court. That Court determined that "if the secured party of record authorizes the filing of the UCC-3 termination statement, then that filing is effective regardless of whether the secured party subjectively intends or understands the effect of the filing."3.

JP Morgan argued that it did not instruct the registration of this particular UCC-3. It relied on its counsel to terminate the security only in respect of the Lease Transaction. Both GM Counsel and JP Morgan Counsel agreed that neither intended to terminate the Main Term Loan Security. But the closing checklist and the relevant documents included the UCC-3 to terminate the Main Term Loan Security. The Court determined that although JP Morgan never intended to discharge the Main Term Loan Security, by agreeing to the filing of the UCC-3 the authority was provided and JP Morgan Counsel was authorized.

Cross-border Application: The Personal Property Security Act ("PPSA")

In Ontario, there is currently no requirement in the Personal Property Security Act ("OPPSA") that the secured party authorize the filing of the financing change statement to effect a discharge of a registration.4. In the Minister's Order made under the OPPSA, there is the provision that the name and address of one of the secured parties or of the registering agent be set out. 5. The OPPSA is not as specific as the UCC in requiring that the secured party authorize the filing of the discharge.

There have been a few decisions that have been reported in Ontario dealing with the inadvertent discharge of a registration under the OPPSA. There has not been the type of analysis that was done in Re: Motors. But the result has been the same. In Re Dante Shoe Boutique Shoes Ltd.6., a financing change statement – discharge – was unintentionally registered by the bank. The Court held that the effect of the registration was to discharge the original registration and that once the discharge had been registered, the original registration could not be corrected by the filing of a further financing change statement. In Frankel v. Canadian Imperial Bank of Commerce7. the Ontario Court determined that an unintentionally discharged financing statement cannot be reinstated as it would likely mislead a reasonable person.

In BC there is no comparable provision under the Personal Property Security Act ("BCPPSA") to section 55 of the OPPSA. The BCPPSA contains provisions whereby a debtor can demand the registration of a discharge in certain circumstances.8. Under section 30(7) of the BCPPSA, if a security interest discharged without authorization is re-registered within 30 days, in most instances the priority is unaffected. In a recent BC decision9., the secured party had its registration accidentally discharged by a third party. The secured party registered again, but not for 73 days. The BC Court of Appeal overturned the decision of the BC Supreme Court and determined that in order to protect the integrity of the system, it had to enforce the provisions of the BCPPSA. The secured party could not, after the 30 days, get its position re-instated.

Check, Re-check, and Check Again – Discharged Registrations Are Irreversible

In PPSA jurisdictions, the results should be similar to the decision made by the United States Court of Appeals for the Second Circuit in Re: Motors. Both the UCC-9 and the PPSA are designed to give certainty to secured creditors in respect of priority in collateral of the debtor. If a registration is discharged, whether intentionally by the secured party or inadvertently, the discharge stands. Creditors of the debtor should be entitled to rely upon the registration system. A lesson here for lawyers and law clerks: be extremely careful when effecting discharges. It is critical to ensure that the correct registrations are the ones being discharged.

This publication is intended to provide our general comments on developments in the law. It is not intended to be a comprehensive review nor is it intended to provide legal advice. Readers should not act on information in the publication without first seeking specific advice on the particular matter. The firm will be pleased to provide additional details or discuss how this information is relevant to a specific situation.

Footnotes

1. In Re: Motors Liquidation Company, et al., decided January 21, 2015. Docket No. 13-2187 ("Re: Motors")
2. UCC 9-509(d) : "A person may file an amendment other than an amendment that adds collateral covered by a financing statement or an amendment that adds a debtor to a financing statement only if: (1) the secured party of record authorizes the filing".
3. Supra, page 9
4. Section 55, Revised Statutes of Ontario 1990, c. P.10: "A registration may be discharged or partially discharged by the registration of a financing change statement discharging or partially discharging the registration."
5. Section 19.
6. 2 P.P.S.A.C. 27 (Ont.S.C.)
7. 12 P.P.S.A.C.(2nd) 306
8. Section 50, Revised Statutes of BC 1996, c 359
9. KBA Canada,Inc. v Supreme Graphics Limited (2014) BCCA 117)

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