By Paul Hodnefield, Esq.
In general, a UCC amendment is only effective to the extent that the filing was authorized by the proper party. With a very narrow exception, the filing of an effective termination statement requires authorization by the secured party of record. But what exactly must the secured party authorize for the termination statement to be effective? Is the secured party’s authority limited to records filed to accomplish a specific legal effect, or is just the authorization to file enough to bind the secured party? The Delaware Supreme Court recently answered those questions in In re: Motors Liquidation Company, 2014 Del. LEXIS 491 (Del. Oct. 17, 2014), an opinion arising out of the ongoing General Motors Corporation (“GM”) bankruptcy litigation.
In 2001, GM borrowed $300 million from a syndicate of lenders to finance the acquisition of properties as part of a synthetic lease arrangement (the “Synthetic Lease”). JPMorgan Chase (“JPMC”) served as the administrative agent for the syndicate participants. JPMC filed several financing statements with various counties and with the Delaware Secretary of State to perfect the syndicate’s security interests. JPMC was listed as the secured party of record on the financing statements.
In November 2006, GM took out an unrelated term loan for $1.5 billion (the “Term Loan”) with an entirely different syndicate of lenders. As with the Synthetic Lease, JPMC served as administrative agent for the lenders in the Term Loan syndicate. JPMC was listed as secured party on the financing statement it filed to perfect the Term Loan syndicate’s security interest.
In 2008, GM notified JPMC that it intended to pay off the outstanding balance of the Synthetic Lease. Lawyers for GM and JPMC drew up the “Synthetic Lease Termination Agreement” and created a closing checklist. The Termination Agreement provided that the administrative agent (JPMC) granted GM the authority to terminate the financing statements related to the Synthetic Lease.
GM’s law firm compiled a list of the Synthetic Lease financing statements to terminate after GM paid off the obligation. Unfortunately, the list mistakenly included the financing statement JPMC filed to perfect the Term Loan security interest. Representatives of GM, its law firm and the law firm representing JPMC all reviewed the termination list, but no one caught the error.
The law firm then prepared a batch of UCC3 termination statements for the Synthetic Lease and had them filed by a vendor. The batch included a termination statement for the Term Loan financing statement. None of the parties involved in the transaction, nor their attorneys or vendors, ever intended to authorize any filing related to the Term Loan.
Only after GM filed for bankruptcy in 2009 did the parties realize that a termination statement had been filed for the financing statement related to the Term Loan. The Official Committee of Unsecured Creditors (the “Committee”) then filed an adversary action against the Term Loan syndicate of lenders asking the court to determine that the debt should be treated as unsecured.
The bankruptcy court ruled that JPMC had not authorized the termination statement. Therefore, the termination statement was ineffective and JPMC remained perfected. However, the bankruptcy court certified the case for direct appeal to the United States Court of Appeals for the 2nd Circuit.
On appeal, The Circuit Court realized that it could not resolve the case without further guidance on the state law issue of authority, so it certified the following question to the Delaware Supreme Court:
Under UCC Article 9, as adopted into Delaware law by Del. Code Ann. tit. 6, art. 9, for a UCC-3 termination statement to effectively extinguish the perfected nature of a UCC-1 financing statement, is it enough that the secured lender review and knowingly approve for filing a UCC-3 purporting to extinguish the perfected security interest, or must the secured lender intend to terminate the particular security interest that is listed on the UCC-3?
The Delaware Supreme Court issued its opinion on the certified question on October 20, 2014. As a threshold issue, the Court noted that the question was precise and that it would answer the question exactly as the 2nd Circuit framed it.
The Court found that the applicable statute was unambiguous—it was enough for the secured party to authorize the filing of a termination statement. The argument that the record is effective only if the authorizing party understands the substantive terms of the filing and intends their effect runs contrary to the clear language of the statute.
Further, the Court found that it was fair to place the burden on the sophisticated parties to the transaction to ensure that the termination statement was accurate when filed. Before a secured party authorizes the filing of a termination statement, it must carefully review the record and understand what financing statements the record will terminate and why. According to the Court, “A secured party is the master of its own termination statement.” A party that causes a record to be filed on its behalf is expected to understand what the record says and what effect the filing will have. The court concluded that for a termination statement to be effective under Delaware law, it is enough that the secured party authorized the filing to be made.
This case is not over. The Delaware Supreme Court will transmit the opinion back to the 2nd Circuit for further review. Nevertheless, there is an important takeaway for secured parties. The courts will hold the secured party responsible for a mistakenly authorized termination statement, even if doing so will produce a harsh result.
CSC will continue to monitor this case after it goes back to the 2nd Circuit and provide updates on any further developments.
Paul Hodnefield is Associate General Counsel for CSC and a frequent speaker/writer on UCC due diligence issues. Please feel free to contact him with questions or comments at firstname.lastname@example.org or 800-927-9801, ext. 62375.