To err may be human, but at what cost? How about $1.5 billion? On Wednesday, the United States Court of Appeals for the Second Circuit declined to save a secured creditor who, as part of the payoff and termination of a $300 million financing, mistakenly also permitted the filing of a UCC3 termination statement pertaining to $1.5 billion in unrelated secured debt.
General Motors ("Borrower") was obligated under two unrelated financing transactions, a $300 million syndicated synthetic lease financing and a $1.5 billion syndicated term loan facility. Although the members of the lender groups differed between the two credit facilities, the same bank ("Bank") served as administrative agent for both. In both financings, UCC1 financing statements were filed to perfect each respective lender group's security interest in the applicable collateral.
In 2008, as the synthetic lease financing was nearing maturity, Borrower instructed its outside counsel to prepare documentation for the repayment of that financing and the release of all attendant liens. As part of that process, Borrower's counsel performed a search for UCC financing statements filed against Borrower in its jurisdiction of incorporation (Delaware), which revealed three UCC1 financing statements showing Bank as secured party. Unbeknownst to the lawyers representing Borrower, only two of the financing statements related to the synthetic lease financing, with the third being the primary financing statement perfecting the security interest in collateral for the unrelated term loan facility.
Borrower's counsel prepared UCC3 termination statements for all three of the underlying financing statements, and circulated drafts of the termination statements to Bank and Bank's outside counsel for review. None of Bank's lawyers or bankers noticed that one of the termination statements pertained to the unrelated term loan facility. Upon payoff of the synthetic lease financing, all three termination statements were filed in Delaware.
A few months later, Borrower entered bankruptcy. Soon thereafter, Bank informed the creditors' committee about the mistaken filing of the termination statement relating to the term loan facility, asserting that such filing was unauthorized and therefore ineffective. The creditors' committee took issue, and brought an action in the bankruptcy court to resolve the issue. The bankruptcy court agreed with Bank, concluding that filing the termination statement was not authorized and therefore such filing was ineffective to terminate perfection of the security interest supporting the term loan facility.
On appeal, the Second Circuit framed a two-part question. First, what precisely must a secured party of record "authorize" for a termination statement to be effective? Second, did Bank provide the necessary authorization?
The Second Circuit certified the first question to the Delaware Supreme Court, as a question wholly governed by Delaware state law. The Delaware Supreme Court's answer was that the secured party of record had to authorize the filing of the applicable termination statement, whether or not the secured party of record subjectively intended, or even understood, the effect of that filing, explaining that to hold otherwise would be contrary to the unambiguous language of the applicable Uniform Commercial Code provisions and inconsistent with the sound policy consideration of requiring that parties ensure the accuracy of the information contained in their UCC filings.
The first question now answered, the Second Circuit next considered the second question. In doing so, the court noted that the closing checklist and draft termination statements had been sent for review to the Bank officer overseeing the payoff of the synthetic lease transaction (and who had also signed documents relating to the term loan facility on Bank's behalf), and to Bank's outside counsel (who had provided minor comments not relevant here). Borrower's counsel also prepared an escrow agreement providing, among other things, that upon payoff of the synthetic lease financing, the escrow agent would release the termination statements to Borrower's counsel for filing. Bank's outside counsel reviewed the draft escrow agreement and signed it on Bank's behalf.
The Second Circuit determined that Bank, directly and through its outside counsel, made repeated manifestations to Borrower's counsel assenting to the filing of all three termination statements upon the payoff of the synthetic lease financing, even though Bank never actually intended to terminate perfection of the security interest securing the term loan facility. Those manifestations constituted sufficient actual authority for Borrower's counsel to file all three termination statements and for those filings to be effective.
The Second Circuit's decision is not surprising, given longstanding case law placing responsibility on secured creditors for the consequences of their mistakes. Nor would the doctrine of mutual mistake help Bank in this situation, as the intervening bankruptcy created a new constituency – the bankruptcy trustee – that was untainted by the mistake and would be severely adversely impacted by any attempt to correct it judicially.
The parties briefs in the case, and the Second Circuit's decision, focus extensively on agency principles as they relate to the authorization granted by the principal (Bank) to its agent (the law firm). Curiously, neither the briefs nor the court seem to have considered how Bank, while acting in its capacity as administrative agent for the synthetic lease syndicate, was able to authorize the filing of a termination statement relating to the separate term loan financing, which presumably only could have been authorized by Bank while acting in its capacity as administrative agent for the term loan syndicate. Despite Revised UCC Article 9's innovation in allowing a financing statement to be effective where the secured party of record is acting in an agency capacity, whether or not such agency is disclosed in the financing statement, it does not necessarily follow that the particular "hat" a party is wearing is so obviously irrelevant to the granting of an authorization by that party.
Of course, the errant termination of a financing statement in a $1.5 billion transaction was entirely avoidable. It serves as a clear reminder that, even in sophisticated, big-ticket financings, it really does pay to sweat the small stuff.
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