Article 9 and the Life of a UCC Financing Statement
Article 9 of the Uniform Commercial Code (UCC) provides the process by which a secured lender obtains, perfects and enforces a security interest in a debtor’s assets and also sets forth the effectiveness of the perfection of that security interest. The life of a UCC financing statement can be divided into three stages: (1) the initial filing of a financing statement by which the security interest is perfected, (2) any amendments or continuations of that financing statement, and (3) its termination either through expiration or through the filing of a termination statement. Section 9-515 of the UCC provides that a financing statement is effective for a period of five years for most types of personal property, but there are exceptions for public-financed, manufactured-home and cooperative interest transactions. The third stage of this life cycle, and specifically the question of whether an unauthorized termination statement is effective, has been the subject of some controversy.
The Enactment of Revised Article 9
The current controversy can be traced back to 2001 with the enactment of the “Revised Article 9.” Prior to 2001, all termination statements required an actual signature by the secured party to acknowledge the intent of the secured party to have the termination statement filed. If such a termination statement lacked the required signature, it was rejected for filing because it was deemed unauthorized. However, any signature would suffice as there was no additional certificate required to authenticate the signature or any method in place to prove that the person was actually authorized by the secured party to make such a filing.
In recognizing that the signature requirement did not offer much protection, and also in light of the increasing reliance on electronic filings in secured lending, Revised Article 9 removed the signature requirement. However, Revised Article 9 does not specifically address the authorization requirement as it pertains to the effectiveness of filed termination statements, leaving open the room for the controversy. Rather, the query falls on the specific documentation between the parties, namely the underlying security agreement and/or the payoff letter, and the particular facts of each case. The subject of what happens when a termination statement is filed in error and without the knowledge and authorization of the secured party is the source of the commentary below.
The Roswell Case & Impact on Secured Lenders
In 2010, the United States District Court for the Southern District of New York held that all such termination statements were effective, even if filed by mistake or without authorization from the secured party. Roswell Capital Partners LLC v. Alternative Constr. Techs., No. 08 Civ. 10647(DLC), 2010 WL 3452378 (S.D.N.Y. Sept. 1, 2010), aff’d sub nom., Roswell Capital Partners LLC v. Beshara, 436 F. App’x 34 (2d Cir. 2011). This holding made secured lenders uneasy because it meant that they did not have complete control over their own filings. The Roswell court’s holding opened up the door for termination statements filed by unrelated third parties to be effective even if filed in complete error and without any notice to the secured party. The holding went further and placed the burden on secured lenders to monitor their own filings to ensure that a third party has not erroneously terminated the secured party’s lien.
In its decision, the Court in Roswell reasoned that the public record is an integral part of the entire secured lending process, and if a termination statement is filed, irrespective of authorization, it must be given full effect because third parties have the ability to rely on it. Furthermore, the Court pointed out that if it were to start setting aside erroneously filed termination statements, it could create a chain reaction by which an unrelated secured party’s collateral would be jeopardized because they relied on the public record. Of particular frustration to secured lenders, the majority of the cases relied upon by the Roswell court involve secured parties filing the termination statements themselves, and not the filing by a designated third party. Also, the Roswell court seemed to interpret the statutory language of the UCC based on cases that were decided prior to Revised Article 9, which of course dealt with cases where the secured party signed a termination statement and then later objected to its filing based on error. Neither of these scenarios seemed to correspond with the circumstances in the Roswell case,
Setting the Record Straight
In March 2013, the United States Bankruptcy Court for the Southern District of New York held that termination statements have no effect unless the secured party properly authorizes the filing. See generally In Re Motors Liquidation Co., f/k/a Gen. Motors Corp., 486 B.R. 596 (Bankr. S.D.N.Y. 2013). In the Motors Liquidation case, General Motors Corporation (“GM”) was paying off the outstanding balance of a synthetic lease obligation owed to JPMorgan Chase (“JPMC”). The synthetic lease obligation was secured by a set of corresponding financing statements in various jurisdictions and JPMC granted GM the authority to terminate the respective financing statements upon receipt of the payoff. In connection with preparing the termination statements, GM erroneously identified and prepared a financing statement that was unrelated to the lease obligation being repaid and involved a different set of syndicate lenders with JPMC as the administrative agent. GM filed this termination statement via a third party vendor service company on July 2, 2007. The error went undetected by all parties.
When GM filed for bankruptcy in 2009, the parties realized the mistake when a creditors’ committee filed an adversary proceeding asking the Court to determine that the financing statement had been terminated rendering the underlying debt unsecured. In making their argument, the creditors’ committee relied upon the following: (1) the Roswell holding, (2) the line of cases which involve a secured party erroneously filing the statement itself and which pre-date Revised Article 9, and (3) cases which arose after Revised Article 9 that which applied the previous interpretation.
The Court did not agree with any of the creditors’ committee’s arguments and instead held that, to be effective, a termination statement must be properly authorized by the secured party. The Court reasoned that the same rules for determining whether the filing of an amendment was authorized by a secured party (which is addressed in the UCC) should apply to determining whether the filing of a termination statement was authorized. Specifically, the Court referred to the following three Sections of the UCC: (1) Section 9-509 (d), which provides that a person is entitled to file an amendment if the secured party of record authorizes the filing, (2) Section 9-510 (a), which provides that a filed record is deemed effective if authorized, and (3) Section 9-513 (d), which provides that except as otherwise provided in Section 9-510, an original financing statement is no longer effective upon the filing of a related termination statement. The Court pointed out that the totality of these Sections require all filings to be authorized to be effective.
In support of its decisions, the Court quoted Harry Sigman, one of the members of the drafting committee of Revised Article 9, as saying, “Revised Article 9 makes explicit another concept that is implicit under current law—the fact that a filing is on the public record doesn’t guarantee that it is effective.” The quote went on to point out that similar logic was applied prior to Revised Article 9 by stating, “a termination statement that bears a forged secured party signature is not effective simply because it gets onto the public record. Revised Article 9 states that a filed record is ‘effective’ only to the extent that its filing is authorized.”
In addition, the Court acknowledged that encouraging secured parties to continually monitor their existing filings to detect and correct erroneously filed termination statements is good practice, but it pointed out that such diligence may not be enough. Even if a secured party were to discover an erroneously filed termination statement, it could possibly be too late as a new lender could have already filed an intervening lien.
Something to Remember
An important distinguishing factor in the Motors Liquidation case was that a third party filed the termination statement, and not the secured party itself. JPMC first granted the authority to GM to terminate the existing filings and GM then contracted a third party vendor to actually file the termination statements with the State. Although JPMC was given the opportunity to review the proposed termination statements before they were filed, the Court was unwilling to consider the erroneously filed termination statement authorized. The determination of whether a termination statement (filed by a third party) is authorized by the secured party hinges upon the particular facts of a case.
Secured lenders can breathe much easier after the Motors Liquidation case. Although unauthorized termination statements are not effective, they can lead to expensive legal fees in the event a debtor defaults on the underlying loan or files for bankruptcy. If a secured lender discovers such an unauthorized statement, it should immediately file a correction statement form to put potential lenders on notice that the termination statement was unauthorized (and filed in error) and that the security interest remains effective. This type of diligence can avoid having to challenge a dispute in court.