For the first four decades in which the Uniform Commercial Code (UCC) was in effect, a financing statement filed in public record to perfect a security interest in a debtor’s assets had to be signed by the debtor and a termination statement extinguishing the security interest had to be signed by the secured lender. However, when Article 9 of the UCC was overhauled in 2001, to facilitate increasingly common electronic filing, the signing requirement was dispensed with as to both financing statements and termination statements and replaced with a requirement that the filing be “authorized.” In a recent series of cases arising from the 2009 Chapter 11 bankruptcy filing by General Motors, the United States Court of Appeals for the Second Circuit and the Delaware Supreme Court examined what constitutes “authorization” under the UCC with an expensive and unfortunate outcome for the syndicate of lenders.
In 2001, GM entered into a $300 million “synthetic lease” transaction with a syndicate of lenders, including JPMorgan Chase Bank. JPMorgan served as administrative agent for the syndicate and filed a financing statement against GM identifying JPMorgan as the secured party and describing the collateral for the synthetic lease transaction.
Five years later, GM obtained a $1.5 billion term loan from a syndicate of lenders for which JPMorgan also served as administrative agent. JPMorgan filed financing statements against GM identifying JPMorgan as the secured party and describing the collateral for the term loan transaction.
In 2008, GM was about to satisfy its obligations to the syndicate under the synthetic lease transaction. GM had not, however, paid off the term loan. GM instructed its lawyers to prepare the documents needed to terminate the security interests securing those obligations. The lawyers prepared termination statements for the financing statements relating to the synthetic lease transaction and the term loan transaction. Drafts of the documents were submitted to JPMorgan’s counsel to review before they were filed. Drafts were also submitted to a JPMorgan Managing Director. GM and JPMorgan entered into an agreement authorizing an escrow agent to file the termination statements that had been circulated for review once JPMorgan confirmed to the escrow agent that GM had satisfied its synthetic lease obligations. After JPMorgan confirmed to the escrow agent that the synthetic lease obligations had been satisfied, the escrow agent filed all of the termination statements.
GM then filed for bankruptcy. As unperfected security interests are not enforceable in bankruptcy, the Official Committee of Unsecured Creditors filed suit against JPMorgan in the bankruptcy court asking it to declare that the syndicate’s claim against GM for the unpaid balance of the term loan was an unsecured claim that had to share pro rata with all of the other unsecured claims. JPMorgan responded that the filing of the termination statements identifying the collateral for the term loan had not been “authorized” because it did not intend to release the collateral for the term loan, but only the collateral for the synthetic lease.
What Happened in the Courts
The bankruptcy court agreed with JPMorgan. Since JPMorgan did not intend subjectively to terminate the security interests in the collateral securing the term loan, the bankruptcy court concluded that the filing of the termination statements terminating those security interests was not “authorized” within the meaning of Article 9 of the UCC.
The Committee appealed to the Second Circuit. In a 2014 opinion, the Second Circuit said that the case presented two closely related issues. The first issue was whether a secured lender had to authorize the termination of a particular security interest for the filing of the termination statement to be “authorized” or whether simply authorizing the filing of a termination statement that had the effect of terminating a security interest, even if that was not intended, was enough. The second issue was whether JPMorgan had authorized the escrow agent to file the particular termination statements in dispute in the case. Because the first issue required an interpretation of the term “authorized” in the UCC as enacted in Delaware that had broad ramifications beyond the GM case, the Second Circuit certified the first issue to the Delaware Supreme Court. The Second Circuit said that it would address the second issue, which depended upon the facts of the specific case before it, after the Delaware Supreme Court addressed the first issue.
The Delaware Supreme Court held that Article 9 only requires that a secured lender authorize a filing to be made, not that it subjectively intend or even understand the effect of the filing. The Delaware Supreme Court said:
Before a secured party authorizes the filing of a termination statement, it ought to review the statement carefully and understand which security interests it is releasing and why…If parties could be relieved from the legal consequences of their mistaken filings, they would have little incentive to insure the accuracy of the information contained in their UCC filings.
The case then returned to the Second Circuit to address the second issue. In a January 21, 2015 opinion, the Second Circuit concluded that since the Delaware Supreme Court had determined that JPMorgan’s subjective intent did not matter, all that mattered was whether JPMorgan had manifested to the escrow agent in a way that the escrow agent reasonably understood to communicate that JPMorgan agreed that the agent was authorized to file the termination statements that the escrow agent was holding. Since the termination statements had been reviewed by both JPMorgan’s lawyers and by a Managing Director of JPMorgan before they were delivered to the escrow agent and JPMorgan had entered into an escrow agreement providing that the escrow agent was to record the termination statements that it was holding once JPMorgan confirmed that GM had satisfied its synthetic lease obligations, the Second Circuit concluded that the filing of the termination statements describing the collateral for the term loan obligation was authorized and that the term loan was no longer secured by GM’s assets.
Implications for Lenders
As is often the case, the decisions of the Second Circuit and the Delaware Supreme Court provide both good news and bad news for lenders. The good news is that a lender contemplating extending secured credit to a debtor who searches the applicable records and finds that termination statements have been filed as to all financing statements previously filed against the debtor can proceed to extend credit safely without having to worry that a competing lender will later contend that it has a superior security interest in the debtor’s assets because it filed its termination statement by mistake. The bad news is that a lender who makes a mistake will lose its security interest. As JPMorgan and the lenders for whom JPMorgan served as administrative agent with respect to the term loan to GM, such a loss can be costly.