United States: Second Circuit To Lenders: Get Your UCC Filings Right

INTRODUCTION

On January 21, 2015, the U.S. Court of Appeals for the Second Circuit issued an opinion regarding a mistaken UCC-3 termination statement that all loan market participants should consider carefully. The Second Circuit held that a secured party's lack of intent to terminate a properly filed UCC-1 financing statement, which perfected its lien granted in connection with a secured financing, is not sufficient to deem ineffective the filing of a UCC-3 termination statement with respect thereto. Even absent the intent to terminate, the actions of the secured party and its lawyers prior to the filing of the UCC-3 termination statement were, in this case, sufficient as a legal matter to form the requisite authority to file under Article 9 of the Uniform Commercial Code (the "UCC"). As a result of the Second Circuit's ruling, a $1.5 billion prepetition financing does not have a perfected security interest on the intended collateral, and the secured creditor may not be repaid in full as part of the debtors' bankruptcy. For general unsecured creditors, the secured creditor's error created a significant source of additional distributable value, potentially improving their recoveries on their prepetition claims.

On February 4, 2015, the secured party filed a petition with the Second Circuit seeking a rehearing en banc. We anticipate that it will take at least one month for the Second Circuit to rule on the secured party's rehearing request.

UNDERLYING COURT DECISIONS

Bankruptcy Court

This matter dates back to the summer of 2009 when the official committee of unsecured creditors (the "Committee") in the Chapter 11 bankruptcy cases of General Motors Corporation et al. (collectively, "GM") commenced an adversary proceeding in the U.S. Bankruptcy Court for the Southern District of New York against JPMorgan Chase Bank, N.A., as agent ("JPM") and members of a term loan lending syndicate. The Committee sought a determination from the Bankruptcy Court that a lien securing a 2006 $1.5 billion syndicated term loan (the "Term Loan") to GM was not perfected as a matter law because the UCC-1 financing statement that perfected JPM's lien granted under the Term Loan had been properly terminated prior to the commencement of GM's bankruptcy cases.¹

Prior to entering into the Term Loan, GM was also a party to a synthetic lease (the "Synthetic Lease"), and JPM was also the administrative agent for the Synthetic Lease and identified on the associated UCC-1s as the secured party of record.² GM paid off the Synthetic Lease in 2008. Two law firms involved in the Term Loan and Synthetic Lease financing reviewed the results of a search of UCC-1 financing statements recorded against GM.³ The search results showed three UCC-1s filed against GM in Delaware, each with a unique filing number. A UCC-3 was prepared for each of the UCC-1s. However, only two of the UCC-1s related to the Synthetic Lease; the third UCC-1 related to the Term Loan (the "Unrelated UCC-3").⁴ The Unrelated UCC-3 was filed, together with the UCC-3s for the Synthetic Lease.

The goal of the Committee's adversary proceeding was to convert the Term Loan creditors' secured claim into an unsecured claim. If successful, the claims of the Term Loan creditors' would not be paid prior to the unsecured creditors with the proceeds of the Term Loan collateral. Rather, proceeds of the Term Loan collateral would be shared pari passu among the Term Loan creditors and the unsecured creditors, thereby significantly increasing the recoveries of the unsecured creditors.

The UCC, as amended in 2001, does not require the execution of a UCC-3 termination statement by the secured party; rather, the filing may be done without a signature by anyone, provided that the filing has been authorized by the secured party. If the requisite authorization is lacking, then the termination is ineffective.⁵ As noted by the Bankruptcy Court, three sections of Article 9 of the UCC are relevant to this dispute: (i) 9-509(d), which provides that a person is entitled to file an amendment to a financing statement if the secured party of record authorizes the filing; (ii) 9-510(a), which provides that a filed record is effective only to the extent that it is filed by a person who may file it under 9-509; and (iii) 9-513(d), which provides that, except as otherwise provided in section 9-510, upon the filing of a termination statement with the filing office, the financing statement to which the termination statement relates ceases to be effective.⁶

Two fundamental facts were undisputed: (i) neither counsel to GM or JPM nor their respective clients knew that the UCC-1 filing number shown on the Unrelated UCC-3 was actually the filing number for the UCC-1 for the Term Loan; and (ii) neither GM nor the lenders under the Term Loan ever intended to affect the UCC-1 filings for the Term Loan in any way. In short, the parties to the adversary proceeding did not dispute that the filing of the Unrelated UCC-3 was an error caused by the failure of JPM and its counsel to realize that the Unrelated UCC-3 related to the Term Loan. Notwithstanding the absence of intent to effect the lien securing the Term Loan, the Bankruptcy Court had to decide whether the UCC-1 perfecting JPM's lien in the Term Loan collateral ended with the filing of the Unrelated UCC-3.⁷ Since GM's counsel filed the Unrelated UCC-3, Judge Gerber's ruling centered on whether GM acted as JPM's authorized agent to complete the filing of the Unrelated UCC-3. JPM argued that the absence of its understanding that one of the UCC-3s to be filed in connection with the termination of the liens for the Synthetic Lease financing would also terminate the lien of the Term Loan meant that it did not give GM the authority to file the UCC-3. On the other hand, the Committee argued that JPM's subjective intent was not relevant to its grant of authority to GM, and therefore, the prepetition lien termination was authorized and valid.

The Honorable Robert E. Gerber, U.S.B.J., disagreed with the Committee and held that the Unrelated UCC-3 was ineffective because it was not authorized under the common law doctrines of actual authority, apparent authority, ratification or implied authority.

Actual Authority

"Actual authority exists when an agent has the power 'to do an act or to conduct a transaction on account of the principal which, with respect to the principal, he is privileged to do because of the principal's manifestation to him.'"⁸ The four documents considered by the Bankruptcy Court to determine the scope of authority given by JPM to GM were: (i) the Synthetic Lease Termination Agreement,⁹ (ii) the Synthetic Lease Closing Checklist, (iii) the Unrelated UCC-3, and (iv) the Synthetic Lease Escrow Agreement. The Bankruptcy Court found that, through the Synthetic Lease Termination Agreement, JPM authorized GM to file terminations of existing financing statements only with respect to the specific properties that were the subject of the Synthetic Lease.¹⁰ GM's counsel prepared the Synthetic Lease Closing Checklist – a six-page listing of several dozen documents to be executed in connection with the Synthetic Lease payoff. While JPM and its counsel reviewed the document, and even though the document included the unique filing number of the UCC-1 for the Term Loan, the Bankruptcy Court did not find that any element of the document provided authorization to file the Unrelated UCC-3, especially as the document made no mention of the Term Loan.¹¹ With regards to the Unrelated UCC-3, the Bankruptcy Court found that, even though JPM's counsel reviewed and approved (or failed to object to) it, the Unrelated UCC-3 was not itself an authorization to terminate the Term Loan UCC-1 because it did not call for the signature of the secured party's principal or contain any sort of express granting clause.¹² The Bankruptcy Court then found that, while the Synthetic Lease Escrow Agreement was an authorization to implement the letter's joint directions with respect to the Synthetic Lease, it did not give express instructions or authority to GM's counsel to do anything, including anything affecting the Term Loan.¹³ When considering these documents together with all of the relevant circumstances, Judge Gerber viewed this as nothing more than a "payoff of a real estate financing under which parties intended to bring the real estate financing liens to an end, without any intention to affect anything else."¹⁴

Judge Gerber also noted that he could not find the filing of the Unrelated UCC-3 to have been authorized under the doctrine of actual authority because GM did not have the requisite understanding. According to the Bankruptcy Court, "[a]n agent does not have actual authority to do an act if the agent does not reasonably believe that the principal has consented to its commission,"¹⁵ and this was affirmed by the evidence that no one at GM actually believed that it had been authorized to terminate JPM's financing statement with regards to the Term Loan.

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Footnotes

*Geoffrey R. Peck is a Partner in the New York office of Morrison & Foerster LLP and Jordan A. Wishnew is an Of Counsel in the New York office of Morrison & Foerster LLP.

1. See Off. Comm. of Unsecured Creditors of Motors Liquidation Co. v. JPMorgan Chase Bank, N.A., et al. (In re Motors Liquidation Co.), 486 B.R. 596, 602-03 (Bankr. S.D.N.Y. 2013).

2. See Official Committee of Unsecured Creditors of Motors Liquidation Company v. JPMorgan Chase Bank, N.A., et al. (In re Motors Liquidation Co.), 755 F.3d 78, 79 (2d Cir. 2014).

3. Id. at 80.

4. 486 B.R. at 603.

5. Id. at 617.

6. Id. at 618, notes 68-70.

7. Id. at 604.

8. Id. at 621, quoting Hidden Brook Air, Inc. v. Thabet Aviation Int'l, Inc., 241 F. Supp. 2d 246, 260 (S.D.N.Y. 2002) (citations omitted).

9. The Termination Agreement provided, in pertinent part, "[T]he Administrative Agent [JPMorgan] and the Lessor do hereby (x) release all of their Liens ...against the Properties created by the Operative Agreements [of the Synthetic Lease], (y) acknowledge that such Liens and Lessor Liens are forever released, satisfied and discharged and (x) [sic] authorize Lessee to file a termination of any existing Financing Statements relating to the Properties [of the Synthetic Lease]." 755 F.3d at 81.

10. Id. at 624.

11. Id. at 625.

12. Id. at 625-26.

13. Id. at 626-27.

14. Id. at 629.

15. Id. at 630.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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