United States: Costly Mistake: UCC-3 Termination Statements Effective Regardless Of Intent

"Experience is simply the name we give our mistakes" ~Oscar Wilde

Mistakes happen.  But a national financial institution discovered recently that a relatively simple mistake cost about $1.5 billion.  On January 21, 2015, the U.S. Court of Appeals for the Second Circuit ruled that JPMorgan Chase Bank, N.A., as agent, and other members of a syndicated term loan did not hold a perfected security interest in General Motors' collateral because a UCC-3 filed in error terminated the interest, despite the lack of intent to terminate the security interest.  As a result, Chase and other term loan lenders became unsecured creditors, joined the class of other unsecured creditors in the Chapter 11 bankruptcy cases of GM and its subsidiaries, and will share in a pro rata distribution of any assets remaining in the bankruptcy estate.  The Second Circuit denied Chase's petition for reconsideration of the ruling on April 13, 2015.

Background

Prior to the bankruptcy cases, GM entered into two financing transactions with Chase and other lenders.  First, GM was a party to a $300 million synthetic lease facility involving Chase as the administrative agent and identified as the secured party of record.  Second, in 2006 GM obtained a syndicated term loan totaling $1.5 billion where Chase was also the agent.  In 2008, GM repaid the synthetic lease, and GM's legal counsel prepared UCC-3 termination statements to terminate the security interests held by Chase granted under the synthetic lease.  Counsel identified three UCC-1s filed against GM, each with a unique filing number.  However, only two of the UCC-1s were part of the synthetic lease; the third UCC-1 secured the term loan.  Representatives of GM, Chase, and their respective counsel reviewed the prepared UCC-3 termination statements and authorized the filing of the three termination statements.  No one identified the mistake until after GM filed its bankruptcy case.

A committee representing the interests of GM's unsecured creditors filed an adversary proceeding against Chase to claw back amounts paid to the term loan syndicated lenders during the bankruptcy case as a result of its secured status. The committee further sought a declaration that the mistaken termination statement was enforceable, rendering the term lenders unsecured.

The case eventually made its way to the Second Circuit.  As state law determines the property interest of the parties, the Second Circuit sent a single question to the Delaware Supreme Court – is intent to terminate a security interest necessary to render a termination statement effective?  Chase clearly did not intend to release its perfected security interests in the term loan. The Delaware Supreme Court answered in the negative and stated that the termination statement is effective as long as the secured party approves of the filing.  Here, Chase and its counsel reviewed and approved the filing of the termination statements.  Subjective intent – the fact that Chase believed the UCC-3s applied only to the synthetic lease – does not matter.  Thus, the Second Circuit held that the UCC-3 filing on the term loan was effective because Chase approved GM's filing of the UCC-3s.  Chase had multiple opportunities to discover the error in its review but did not.  Chase reviewed the closing checklist with the filing numbers, the termination statements themselves, and an escrow agreement that contained instructions for filing the UCC-3s.  No doubt existed that Chase and its counsel had authorized the filing of the mistaken UCC-3.

The Second Circuit supported its decision by noting that intent was not required under the Uniform Commercial Code ("UCC").  Under Section 9-509(d), the UCC permits a filing of a termination statement without a signature as long as the secured party authorized it.  Further, Section 9-510(a) states that the filed record is effective only to the extent that the person who filed it had the authority to do so.  Since the facts were clear that Chase authorized the filing, the Court held that Chase's intent to retain a security interest in the term loan was not relevant.

Conclusion

The impact of Chase's error was amplified by the fact that Chase was unable to file a corrective statement due to the automatic stay in GM's bankruptcy case that prevents creditors from perfecting unperfected security interests in a prepetition claim.  Absent a bankruptcy filing, lenders should be able to correct the mistake by a new filing, subject to a risk of intervening lien filings.

This case serves as a harsh reminder to lenders to ensure that sufficient operational controls are put in place to prevent the authorization of mistaken termination statements.  Lenders should take care to establish multiple levels of review before approval is given.  The reviews should focus on the UCC filing numbers and the collateral description to confirm that the correct security interest is being terminated.  Lenders should also restrict the authority to file termination statements only to the security interest to be terminated.  These extra precautions may prevent a future costly mistake.

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