The Second U.S. Circuit Court of Appeals recently held that a secured creditor’s $1.5 billion security interest was invalidated due to an error in the preparation of its UCC-3 termination statement. A disastrous result which could have been prevented had the creditor proof read the termination statement.
The facts of this matter are straightforward. General Motors entered into a synthetic lease financing transaction by which it obtained approximately $300 million in financing from a syndicate of lenders including JP Morgan Chase Bank, N.A. (“JPMorgan”). Five years later, General Motors entered into a separate term loan facility for approximately $1.5 billion from a different syndicate of lenders. Although JP Morgan was the administrative agent for the term loan facility, the term loan facility was completely separate from the synthetic leasing financing transaction.
The term loan facility was secured by security interests in a large number of General Motors’ assets. JPMorgan was listed as the secured party of record and caused twenty-eight (28) UCC-1 financing statements to be filed around the country. One such financing statement (the “Main Term Loan Financing Statement”) covered all of General Motors’ equipment and facilities at forty-two (42) General Motors facilities, and was the most important financing statement filed in connection with the term loan.
In connection with the pay-off on the synthetic lease financing transaction, the attorney representing the debtor General Motors in the synthetic lease financing transaction included, in error, the Main Term Loan Financing Statement in the UCC-3 termination statement. The draft UCC-3 termination statement was sent to JPMorgan and its counsel for review, but no one spotted the error. Thereafter, the UCC-3 termination statement that erroneously identified for termination the Main Term Loan Financing Statement was filed with the Delaware Secretary of State.
The error in the UCC-3 termination statement went unnoticed until General Motors bankruptcy filing the following year. After General Motors filed for bankruptcy relief, the unsecured creditors committee appointed in the General Motors bankruptcy case filed an action to terminate the term loan security interest.
Although many legal arguments were raised in the case, the central issue boiled down to whether the subjective intent of the secured creditor in terms of the anticipated legal effect of the termination statement is relevant. Put another way, is it fair to strip the creditor’s $1.5 billion lien when no party in the transaction, including the debtor General Motors, intended to release the Main Term Loan Financing Statement.
Relying on Uniform Commercial Code, the Second Circuit ruled that the subjective intent of the parties is entirely irrelevant so long as the secured creditor authorized the filing of the particular termination statement, even with the mistaken information. As a result, because it was undisputed that JPMorgan authorized General Motors to file the termination, the fact that JPMorgan did not intend to release the Main Term Loan Financing Statement did not prevent the loss of its lien.
This matter may not be over. I have been advised by an attorney working on this matter that this decision may be reviewed by the Second District sitting en banc which could potentially reverse this decision. I will keep you posted if I am aware of any new developments on this matter. However, the message from this case is quite clear. All UCC termination statements as well as UCC financing statements (and all other loan documentation) should be closely reviewed. Never entrust borrower or borrower’s counsel to prepare these documents. Although in limited instances common law principles such as agency can be applied to minimize a harsh result under the Uniform Commercial Code, this should not be relied on and cannot take the place of careful preparation and review of all loan related documentation.
