United States: Mistakes And Regrets: UCC Filing Error Terminates Security Interest

Last Updated: February 2 2015
Article by Rick Antonoff and Regina Stango Kelbon

Action Item: When a secured loan is being paid off, lenders routinely authorize the borrower's counsel to prepare and file UCC termination statements releasing the lender's security interest in the borrower's property. Lenders and their counsel must carefully review the documents before authorizing the borrower to file them to ensure they match up only with the security interests related to the loan being paid and that are intended to be released. If the termination documents include security interests related to other obligations and that are not intended to be released, the lender can lose its security interest and become an unsecured creditor with respect to those other obligations.

On January 21, 2015, the United States Court of Appeals for the Second Circuit issued an opinion holding that a mistakenly filed Uniform Commercial Code ("UCC") termination statement was effective to terminate JPMorgan Chase's security interest on a $1.5 billion loan on the bases that (a) under Delaware law, an authorized filing of a UCC termination statement is effective to terminate the security interest regardless of the parties' intent, and (b) in this case, the secured party authorized the borrower's counsel to file the termination statement.

Background

JPMorgan Chase ("JPMC") was agent on two secured loans to General Motors Co. ("GM")—a $300 million synthetic lease and a $1.5 billion term loan. In 2008, in connection with GM paying off the synthetic lease and GM releasing its security interest in the collateral securing the synthetic lease, GM's counsel prepared a closing checklist, draft escrow agreement, and UCC termination statements, all of which also erroneously identified JPMC's security interest in collateral securing the term loan. GM's counsel forwarded draft copies of the closing documents to JPMC and its counsel for review. No one noticed that the documents mistakenly included the term loan security interest. JPMC's counsel sent GM's counsel a response saying "nice job" and making a minor change to how JPMC's name appears in the documents.

In June 2009, GM filed for bankruptcy under chapter 11 of the United States Bankruptcy Code in the Bankruptcy Court for the Southern District of New York. Upon learning of the mistakenly filed UCC termination statement, the Official Unsecured Creditors Committee (the "Committee") appointed in GM's chapter 11 case commenced an adversary proceeding in the bankruptcy court for a judgment that JPMC's security interest under the term loan was terminated and, therefore, that JPMC was an unsecured creditor.

Court Rulings

On cross-motions for summary judgment, the bankruptcy court ruled that filing the UCC termination statement releasing security interests in the term loan was unauthorized and therefore not effective to release JPMC's security interest. The Committee appealed directly to the Second Circuit.

On the issue of whether a filing of a UCC termination statement is effective regardless of the parties' intent, the applicable UCC law was Delaware. In June 2014, the Second Circuit certified that question to the Delaware Supreme Court. In October 2014, the Delaware Supreme Court issued its answer, holding that:

[F]or a termination statement to become effective ... 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 a filing subjectively intends or otherwise understands the effect of the plain terms of its own filing.

With the Delaware Supreme Court's ruling in hand, the Second Circuit then had to determine whether JPMC authorized the borrower and its law firm to file the erroneous termination statement.

Based largely on the fact that JPMC and its counsel had opportunities to review the draft documents before they were filed, the Second Circuit concluded, as a matter of law, that JPMC authorized GM's counsel to file the termination statement releasing the security interest in the term loan collateral. The security interest was therefore terminated and the claims of JPMC (and its syndicate lenders) under the term loan are unsecured claims in GM's bankruptcy case.

The Second Circuit remanded the case to the bankruptcy court with instructions to enter partial summary judgment against JPMC. JPMC may file a petition for review with the United States Supreme Court. In view of the fact that both issues in the case—(1) the effect of filing an erroneous termination statement, and (2) GM's counsel's authority to file it—are matters of state law, it is unlikely that the Supreme Court would agree to review the case.

As noted above, when conducting a payoff of a secured loan and releasing collateral, it is critical to make sure that the documents are in order. It is fine to allow the borrower's counsel to prepare the termination documents, but it is not prudent to rely on the borrower's counsel to assure that they only release security interests that are intended to be released and do not include security interests related to other obligations not being paid off.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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