A recent opinion issued by the Second Circuit Court of Appeals arising out the General Motors (“GM”) bankruptcy case has illuminated the horrible consequences of overlooking minute details of a loan payoff closing. Practitioners in the banking, secured credit, and bankruptcy fields have been watching this case unfold like a slow motion train wreck. Perhaps it is the significance of the mistake that converted a lending syndicate from being fully secured for $1.5 billion to unsecured in a very public bankruptcy case, or perhaps it’s because two very reputable firms are involved in the center of the mistake. Nonetheless, the case shows that all practitioners and their staff must be attentive to the details.
I. Background Facts
A. The Synthetic Lease Transaction.
In October 2001, GM entered into a synthetic lease (the “Synthetic Lease”), by which it obtained approximately $300 million in financing from a syndicate of financial institutions with JP Morgan (“JPM”) being the administrative agent for the syndicate. The Synthetic Lease was secured by liens on 12 pieces of real estate and by among other filings, UCC-1s filed with the Delaware Secretary of State. In connection with the Synthetic Lease, GM was represented by the law firm of Mayer Brown LLP, and JPM was represented by Simpson Thacher & Bartlett LLP.
B. Documentation of the Term Loan Transaction.
Five years later, in November 2006, GM and its then-subsidiary Saturn Corporation (“Saturn”) entered into a senior secured term loan facility in the amount of approximately $1.5 billion (the “Term Loan”) from a different syndicate of financial institutions with JPM again being the administrative agent. The Term Loan was a transaction wholly unrelated to the Synthetic Lease, and was secured by, among other things, all of GM’s equipment and fixtures at 42 facilities throughout the United States. The liens securing the Term Loan were perfected by, among other filings, the filing of 28 UCC-1 initial financing statements—two of which (one for GM and one for Saturn) were filed with the Delaware Secretary of State. The UCC-1 filed in Delaware for GM was given filing number “6416808 4.”
C. Payoff of the Synthetic Lease and Accidental Termination of the Term Loan Security Interests.
The Synthetic Lease was set to mature on October 31, 2008, and GM was prepared to repay the obligation. In advance of the Synthetic Lease maturing, in early October 2008, GM requested that Mayer Brown prepare the documentation necessary to repay the Synthetic Lease and to release the liens securing the obligation. A partner at Mayer Brown instructed an associate attorney to prepare the necessary documentation to pay off the Synthetic Lease and terminate the liens securing the Synthetic Lease. Specifically, the associate prepared four documents to effectuate the payoff of the Synthetic Lease: (1) a closing checklist that identified the actions required to unwind the Synthetic Lease (the “Closing Checklist”); (2) a termination agreement which acknowledged GM exercised its right to repay the Synthetic Lease and released the liens against the Synthetic Lease collateral (the “Termination Agreement”); (3) a set of UCC-3 termination statements to terminate the liens against the Synthetic Lease collateral; and (4) an escrow agreement governing the title company’s role in closing the transaction (the “Escrow Agreement”).
In preparing the documents to terminate the Synthetic Lease, the associate attorney asked a paralegal unfamiliar with the transaction to perform a search for UCC-1 financing statements that had been recorded against GM in Delaware; the paralegal returned three UCC-1s numbered 2092532 5, 2092526 7, and 6416808 4. Neither the associate nor the paralegal knew that the third UCC-1 related to the Term Loan—and not the Synthetic Lease. Not realizing that the third UCC-1 was related to the Term Loan, the associate identified all three UCC-1s for termination in the Closing Checklist and Termination Agreement. The Closing Checklist and Termination Agreement was circulated to Simpson Thacher who also did not realize that the third UCC-1 related to the Term Loan—and not to the Synthetic Lease. In connection with the Closing Checklist and Termination Agreement, the Mayer Brown associate prepared three draft UCC-3 termination statements to terminate the three UCC-1s identified in the Closing Checklist, including the UCC-1 numbered 6416808 4 relating to the Term Loan. Mayer Brown’s Escrow Agreement provided LandAmerica, the escrow agent and title insurer (“LandAmerica”), with specific instructions to close the payoff of the Synthetic Lease. Pursuant to the Escrow Agreement, LandAmerica would receive funds from GM, disburse the funds to JPM, and the Synthetic Lease would be terminated. Following the disbursement of the funds to JPM, the Escrow Agreement instructed LandAmerica to return the UCC-3s to GM’s counsel, Mayer Brown, who would then file them on GM’s behalf with the Delaware Secretary of State. After receiving drafts of the above-described documents, a partner at Simpson Thacher (JPM’s counsel) replied to the Mayer Brown associate, stating “Nice job on the documents. My only comment, unless I am missing something, is that all references to JPMorgan Chase Bank, as Administrative Agent for the Investors should not include the reference ‘for the Investors.’” 86 B.R. 596, 611 (Bankr. S.D.N.Y. Mar. 1, 2013).
On October 30, 2008, GM repaid the Synthetic Lease to JPM. As set forth in the Escrow Agreement, LandAmerica disbursed the funds to JPM to pay off the Synthetic Lease and returned all three UCC-3s, including the UCC-3 numbered 6416808 4 relating to the Term Loan, to Mayer Brown. Mayer Brown (GM’s counsel) then filed all three UCC-3 termination statements with the Delaware Secretary of State.
D. JPM’s Discovery of the Mistaken UCC-3.
It was not until after GM filed for bankruptcy in June of 2009 that JPM discovered the mistaken filing of the UCC-3 termination statement that related to the Term Loan. Different counsel for JPM, not associated with the payoff of the Synthetic Lease, discovered the error and informed the Unsecured Creditors Committee (the “Committee”) that JPM never intended to terminate any liens securing the Term Loan, but only intended to terminate liens securing the Synthetic Lease. In response to JPM’s explanation regarding the inadvertent termination of the UCC-3 securing the Term Loan, the Committee initiated an adversary proceeding seeking a determination that despite the error pertaining to the erroneous UCC-3, the termination of the security interest in the Term Loan was nonetheless effective. Such a result would convert JPM’s status, under the Term Loan, from a secured creditor to a wholly unsecured creditor.
II. The Bankruptcy Court's Opinion Finding in Favor of JPM
The above described factual background was uncontested and the issue went before Judge Robert Gerber, United States Bankruptcy Judge for the Bankruptcy Court for the Southern District of New York (the "Bankruptcy Court"), on JPM and the Committee's cross-motions for summary judgment. Furthermore, the Committee, JPM, GM, Mayer Brown, and Simpson Thacher each agreed that nobody intended to terminate any liens securing the Term Loan when the Synthetic Lease was paid off.
In a lengthy opinion, the Bankruptcy Court meticulously analyzed whether JPM ever granted Mayer Brown, GM, or Simpson Thacher the requisite authority, pursuant to Section 9-509(d)(1) of the UCC, to terminate its security interest in the Term Loan in any of the Closing Checklist, Termination Agreement, UCC-3s, or Escrow Agreement, by asking two questions: (1) was the document an authorization; and (2) if so, an authorization of what? In response to the first question the Court found that the Termination Agreement and Escrow Agreement were authorizations-to terminate the UCC-1s securing the Synthetic Lease only. However, in response to the second question the Bankruptcy Court found that none of the four documents were a grant of authority to any party to terminate the UCC-1 securing the Term Loan. The Bankruptcy Court adopted JPM's argument that it did not intend to terminate the UCC-1 pertaining to the Term Loan and so the filing of the UCC-3 was unauthorized under Section 9-509(d)(1) of the UCC.
The Bankruptcy Court then disposed of the Committee's remaining theories that JPM authorized the termination of the Term Loan finding that: (1) each of JPM's agents did not subjectively believe that it had the authority to terminate the Term Loan; (2) none of JPM's agents had apparent authority to terminate the Term Loan; (3) JPM did not ratify the filing of the erroneous UCC-3; (4) none of JPM's agents had implied authority; and (5) as applied to the facts in this case, a significant amount of case law holding that a mistaken filing terminating a security interest was nonetheless effective, was distinguishable.
Accordingly, the Bankruptcy Court entered its order granting JPM's motion for summary judgment, holding that JPM "did not authorize the termination of the UCC-1 with respect to the Term Loan, and that anything [JPM] said or did in connection with the payoff of the Synthetic Lease was not effective in bringing the UCC-1 securing the Term Loan to come to an end." Id. at 648. Understanding the significance of its ruling, the Bankruptcy Court certified its opinion on a direct appeal to the Second Circuit.
III. The Second Circuit’s First Opinion Punting to the Delaware Supreme Court
Upon a direct appeal from the Bankruptcy Court, the Second Circuit narrowly framed the question on appeal as whether the UCC-3 filing—relating to the Term Loan—effectively terminated the UCC-1 relating to the Term Loan even though the intent of both GM and JPM was to terminate only the UCC-1s relating to the Synthetic Lease.
The Second Circuit began its inquiry by examining the three relevant provisions of Article 9 of the UCC pertaining to the termination of financing statements. First, Section 9-513(d) provides that a financing statement ceases to be effective once a UCC-3 termination statement has been filed. See 9-513(d) (“Except as otherwise provided in Section 9-510, upon the filing of a termination statement with the filing office, the financing statement to which the termination statement relates ceases to be effective.”). Second, Section 9-510(a) sets forth that a termination statement is ineffective if it is filed by a person who is not authorized to do so. See 9-510(a) (“A filed record is effective only to the extent that it was filed by a person that may file it under Section 9-509.”). Third, Section 9-509(d) sets forth who may file a termination statement. See 9-509(d) (“A person may file an amendment other than an amendment that adds collateral covered by a financing statement or an amendment that adds a debtor to a financing statement only if (1) the secured party of record authorizes the filing …”). According to the Second Circuit, “whether the UCC-3 filing effectively terminated the [UCC-1 related to the Term Loan] depends on whether the secured party of record, JPMorgan authorized the filing.” 755 F.3d 78, 83 (2nd Cir. 2014).
JPM argued that the erroneous UCC-3 was not authorized because the Termination Agreement only granted Mayer Brown and GM authority to terminate the Synthetic Lease, and because nobody at Mayer Brown, Simpson Thacher, or GM, ever subjectively thought they were authorized to terminate the UCC-1 relating to the Term Loan. Alternatively, the Committee argued that the analysis should be focused upon whether JPM authorized the mere filing of the erroneous UCC-3, and not whether it authorized termination of the UCC-1 relating to the Term Loan. The Second Circuit struggled in deciding the issues at hand, finding that there was no controlling Delaware legal authority on point, so it certified the following question to the Delaware Supreme Court:
“Under UCC Article 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?”
Id. at 86.
The Second Circuit’s quandary under Section 9-509(d)(1) was whether authorization is sufficient where the secured party authorized the act of filing a particular UCC-3, or whether the secured party must authorize the termination of the particular security interest identified for termination in the particular UCC-3. Obviously, the Committee argued in favor of the former broad view—authorization is needed only for the act of filing the particular UCC-3—and JPM argued in favor of the narrow view—authorization is needed to accomplish the legal result of the filing of the UCC-3 to be filed and the secured party must intend those particular consequences.
In certifying the issue to the Delaware Supreme Court, the Second Circuit held that once the Delaware Supreme Court answered the question, the Second Circuit would be able to answer the remaining issue swiftly of whether “JPMorgan grant[ed] to Mayer Brown the relevant authority—that is, alternatively, authority either to terminate the [Term Loan UCC-1] or to file the UCC-3 statement that identified that interest for termination?” Id. at 84.
IV. Deleware Supreme Court: Section 9-509(D)(1) Only Requires a Secured Party to Authorize the Filing of a UCC-3.
In addressing the certified question, the Delaware Court held that Section 9-513(d) of Delaware’s UCC is unambiguous and dictates that “‘it [is] enough that the secured lender review and knowingly approve for filing a UCC-3 purporting to extinguish the perfected security interest.’” 103 A.3d 1010, 1012 (Del. Oct. 17, 2014).
In its analysis, the Delaware Court started by reviewing the plain language of the three sections of the UCC applicable to the issues at bar, Sections 9-509(d)(1), 9-510(a), and 9-513(d). The Delaware Court found that the plain language of these sections of the Delaware UCC were unambiguous and “make clear that if a ‘secured party of record authorizes the filing [of a termination statement],’ then the filing is ‘effective’ ‘upon the filing of a termination statement with the filing office.’ At that time, ‘the statement to which the termination statement relates ceases to be effective.’” Id. at 1014 (citing 6 Del. C. §§ 9-509(d)(1), 9-510(a), and 9-513(d)).
From a policy perspective, the Delaware Court reasoned that sophisticated parties should bear the burden of ensuring that filed documents are correct. Imposing a requirement that the secured party subjectively understand the nature of its filing—as urged by JPM—would be extremely inefficient given the plain text of the secured party’s filing. The Delaware Court admonished JPM that “[b]efore a secured party authorizes the filing of a termination statement, it ought to review the statement carefully and understand which security interest it is releasing and why… [i]f parties could be relieved from the legal consequences of their mistaken filings, they would have little incentive to ensure the accuracy of the information contained in their UCC filings.” Id. at 1016. Additionally, the Delaware Court acknowledged that the UCC is a system of notice filing, and “[t]o hold that parties cannot rely upon authorized filings unless the secured party subjectively understood the effect of its own action would disrupt and undermine the secured lending markets.” Id. at 1017. Accordingly, the Delaware Court answered the certified question that, under Section 9-509 of the UCC, “it is enough that the secured party authorizes the filing to be made, which is all that § 9-510 requires… [t]he Delaware UCC contains no requirement that a secured party that authorizes a filing subjectively intends or otherwise understand the effect of the plain terms of its own filing.” Id. at 1018.
With these principles in mind from the Delaware Court, the Second Circuit then had the straightforward task of answering whether “JPMorgan grant[ed] to Mayer Brown the relevant authority—that is, alternatively, authority either to terminate the [Term Loan UCC-1] or to file the UCC-3 statement that identified that interest for termination?” 755 F.3d at 86-87.
V. The Second Circuit’s Controversial Opinion
Following the Delaware Court’s affirmative statement that “‘it [is] enough that the secured lender review and knowingly approve for filing a UCC-3 purporting to extinguish the perfected security interest’” the Second Circuit’s remaining task was to determine whether JPM granted Mayer Brown the requisite authority to file a UCC-3 termination statement. 2015 U.S. App. LEXIS 859 at *9 (2nd Cir. Jan. 21, 2015). Unsurprisingly, the Second Circuit’s answer to the remaining question was easy: JPM authorized the act of filing of the UCC-3 in question, its intent to terminate the UCC-3 pertaining to the Term Loan is immaterial for purposes of Section 9-509. In reaching its conclusion, the Second Circuit stated that:
JPMorgan and Simpson Thacher’s repeated manifestations to Mayer Brown show that JPMorgan and its counsel knew that, upon the closing of the Synthetic Lease transaction, Mayer Brown was going to file the termination statement that identified the Main Term Loan UCC-1 for termination and that JPMorgan reviewed and assented to the filing of that statement. Nothing more is needed.
Id. at *14.
Accordingly, the Second Circuit—with input from the Delaware Court—reversed the Bankruptcy Court’s grant of summary judgment and it’s ruling that the filing of the UCC-3 pertaining to the Term Loan was ineffective because it was without authority.
VI. The Story Continues: JPM’s Petition for Rehearing En Banc.
Unsurprisingly, on February 10, 2015, following entry of the Second Circuit’s reversal of the Bankruptcy Court, JPM filed its Petition for Rehearing En Banc (the “Petition”). (See 2nd Cir., Case No. 13-2187, Docket No. 151.) In its Petition, JPM asserted the same argument it has set forth before every court in this proceeding—the filing of the UCC-3 that pertained to the Term Loan was ineffective because JPM never intended to authorize Mayer Brown to terminate its interest in the Term Loan. In its latest attempt, JPM pleads that the Second Circuit’s ruling “has triggered a seismic shift in agency law with profound—and profoundly troubling—consequences’ and that the “opinion upends agency law by obliterating the key prerequisites to actual authority”. (See id. at 1-2.) JPM suggests that “[t]he takeaway for future litigants and courts is this: The scope of authority the principal explicitly granted does not matter; an agent for a limited purpose can bind the principal for all purposes.” (Id. at 13.) The Committee has not yet filed its response to the Petition.
Originally published by The Colorado Bar Association Business Newsletter.