By now, every secured lender and attorney that represents secured lenders should be familiar with the opinion from the Second Circuit Court of Appeals styled Official Committee of Unsecured Creditors of Motors Liquidation Company v. JP Morgan Chase Bank, N.A. (In Re Motors Liquidation Co.) Covered in articles with titles such as “JP Morgan Loses $1.5 Billion Feud with Creditors of GM Forerunner,”[1] the opinion sent a shock wave through the lending community. As our finance colleagues have rightly noted, this case is a stark reminder that best practices require transactional attorneys to “measure twice, cut once.”[2] However, the case also offers important lessons for workout and restructuring professionals, who are often in the position to correct documentation mistakes before a subsequent bankruptcy filing makes the mistakes devastatingly permanent.

Factual Background

To recap the Motors Liquidation/General Motors case, in September 2008, the lender and the borrower entered into a loan repayment and release, which included the termination of certain UCC-1 financing statements in favor of the lender. Both the lender and the borrower retained sophisticated counsel to document the transaction. The errant UCC-3 termination statement was drafted by borrower’s counsel, and it referenced three financing statements to be terminated. One of the referenced financing statements was included by mistake—the parties did not intend to terminate it. Critically, the unintentionally released collateral was “by far the most important” of the collateral securing a separate, $1.5 billion term loan by the lender. Nonetheless, the UCC-3 was filed without either party noticing the error. In March 2009, the term loan was further amended. In June 2009, the borrower filed for bankruptcy protection. Apparently, the lender again did not notice the UCC-3 during both the loan amendment process in March and the presumably extensive pre-bankruptcy negotiations over the terms of the use of cash collateral. Instead, after the commencement of the bankruptcy case, the lender noticed the error in the UCC-3 and brought the error to the attention of the committee of unsecured creditors with the goal of rendering the UCC-3 ineffective. Instead, the committee sought a determination by the bankruptcy court that the UCC-3 was, in fact, effective as filed.

Legal Issues

The Second Circuit, in a per curiam opinion reversing the bankruptcy court, held that the filed UCC-3 was effective to terminate the unintentionally added UCC-1, because lender and its counsel manifested lender’s “assent[] to” its filing.

Under UCC § 9-509(d)(1), a UCC-3 termination statement is effective only if “the secured party of record authorizes the filing.” The UCC-3 was governed by Delaware law and, as readers may remember, the Second Circuit previously asked the Delaware Supreme Court to answer what it means to “authorize” a UCC-3 filing. In response, the Delaware Supreme Court stated:

[F]or a termination statement to become effective under § 9?509 and thus to have the effect specified in § 9?513 of the Delaware UCC, it is enough that the secured party authorizes the filing to be made, which is all that § 9?510 requires.  The Delaware UCC contains no requirement that a secured party that authorizes a filing subjectively intends or otherwise understands the effect of the plain terms of its own filing.[3]

Thus, the Second Circuit was left to determine whether the lender “authorized” the filing of the UCC-3.

The lender argued that it did not authorize the filed UCC-3 because (i) it only authorized borrower to terminate the intended UCC-1s, (ii) it instructed its counsel and the borrower’s counsel only to act in furtherance of that purpose, and (iii) counsel exceeded its authority by filing the over-inclusive UCC-3.

The Court rejected lender’s arguments, instead distinguishing between “what [the lender] intended to accomplish” and “what actions [the lender] authorized to be taken on its behalf.” To determine what the lender authorized, the Court reviewed the exchange of documents and communications between counsel leading up to the filing of the UCC-3. Specifically, when borrower’s counsel provided drafts of the UCC-3 and closing checklist to the lender, the lender’s counsel responded: “Nice job on the documents. My only comment, unless I am missing something, is that all references to [the lender] should not include the reference ‘for the Investors.’” Further, when borrower’s counsel circulated the related escrow agreement for review, lender’s counsel stated that the agreement “was fine” and signed it. The Court concluded that these communications evidenced the lender’s knowledge, review, and assent to the UCC-3, and “[n]othing more is needed” to evidence lender’s authorization.

The Court noted that the mistake in the UCC-3 could be traced to miscommunication, or lack of communication, within borrower’s counsel’s firm. This fact, however, was irrelevant to the Court’s analysis, because outward display of intent prevailed over actual intent.

Lesson for Workout/Restructuring Professionals 

Although the bankruptcy of General Motors followed fairly quickly on the heels of the transaction that led to the errant release of liens in late 2008, the record shows at least two points at which alert workout/restructuring professionals could have caught the perfection issue: first, when the loan was subsequently amended in March 2009, and, second, during the negotiations over the use of cash collateral prior to the bankruptcy filing. Once it is clear that a borrower is preparing to file for bankruptcy, lenders should assume that their liens will be tested by sophisticated creditors’ committees/trustee professionals who have a fiduciary duty to find unencumbered assets for distribution to unsecured creditors. A full perfection review should be completed as early as possible so that the lender can work with its restructuring/workout professionals to address any gaps in its perfection prior to the commencement of the bankruptcy case.


 

[1]           Linda Sandler, JP Morgan Loses $1.5 Billion Feud with Creditors of GM Forerunner, Wash. Post, Jan. 21, 2015.

[2]           Brian Devling and Jeff Chavkin , A $1.5 Billion (Un)Secured Loan, Bank Bryan Cave (Feb. 2, 2015), http://www.bankbryancave.com/2015/02/a-1-5-billion-unsecured-loan/.

[3]           Official Comm. of Unsecured Creditors of Motors Liquidation Co., 2014 WL 5305937, at *5.