For lenders who maintain perfected security interests in collateral, the Second Circuit’s recent decision in In Re Motors Liquidation Company, et al. will go down in history as a middle-of-the-night, sweat-inducing source of anxiety. For business owners and others who rely on lenders to fund their ventures, the decision reveals the mechanics of a transaction. The characters and documents involved are common players in the financial industry: JP Morgan Chase Bank, N.A. was the lender; JP Morgan’s law firm was Simpson Thacher & Bartlett, LLP; General Motors was the borrower; and GM’s law firm was Mayer Brown.
There were two important documents at issue in the Court’s decision. UCC-1 financing statements are public records perfecting a lender’s secured interest in collateral other than real property. (Real property is perfected by recording in county land records.) UCC-3 termination statements release a lender’s secured interest in the personal property, commonly after a loan is paid in full. In this recent case, there were three UCC-1 financing statements involved. Each UCC-1 financing statement was part of a complex loan structure involving the same parties, JP Morgan and GM. JP Morgan, GM, and their counsel commonly referred to the loans based on the collateral used to secure the loans. One was identified as the “Synthetic Lease” and the other as the “GM Main Term Loan.” Upon completion of the term of a Synthetic Lease held by JP Morgan, two of the three UCC-1 financing statements were to be terminated. However, the third UCC-1 financing statement perfected a security interest in the GM Main Term Loan for $1.5 Billion, or five times the amount of the Synthetic Lease. JP Morgan was the nominated lender for a syndicate of lenders for the GM Main Term Loan. A series of failures on the part of JP Morgan, GM, and their counsel resulted in the filing of UCC-3 termination statements and subsequent release of JP Morgan’s security interest not only in the Synthetic Lease, but also a release of the lending syndicate’s perfected security interest in the GM Main Term Loan. Filing the UCC-3 Termination Statement left the $1.5 Billion GM Main Term Loan unsecured. The termination error and resulting unsecured status in GM’s bankruptcy could have been caught a number of times along the way. First, the partner in the law firm who had assigned the task of drafting escrow instructions to the associate attorney could have discovered the error when reviewing the associate’s escrow checklist. Second, the associate could have noticed that one of the UCC-1 financing statements that the paralegal identified did not relate to the $300 Million Synthetic Lease, but instead applied to the second $1.5 Billion GM Main Term Loan. Third, upon sending the escrow checklist and termination statements to all parties, any one of them could have discovered the error. Fourth, JP Morgan could have discovered the error when it received the escrow instructions. Finally, GM could have discovered the error before it filed the termination statements. Because of this inattention to detail, the 2nd Circuit found: (1) that the objective intent of the filed termination statement controlled; and (2) that the authority of GM’s counsel extended to filing the termination statement, albeit on the wrong loan. The court held that the security interest perfecting the GM Main Term Loan had been terminated. Had the court found otherwise, it would have rubber stamped actions showing that the parties simply failed to carefully review their documents prior to filing. In the opinion of the Court, this type of inattention affects the public record and all those who rely on it.
The result is a wake-up call for those working in the lending industry. Creditors are responsible for checking and double checking all of the documents that document, perfect, or release secured interests, whether or not those documents are part of the public record. The documents that become routine over time expose creditors to liability. Careful and clear drafting can avoid these issues by identifying the parties and specifically describing the collateral. Finally, parties should take the time to cross reference their drafting with loan documentation to ensure accuracy and ability to locate information in the future, such as when it is time to renew or terminate a security interest.
Creditors are one of the largest groups relying on the public record to identify the risk of making a loan, or to determine the equity of assets to be used as collateral. For this reason, creditors shouldn’t underestimate the importance of documentation. Often all that is required is a fresh pair of eyes to provide the scrutiny required to prevent or correct inadvertent documentation errors. Our Creditor’s Rights and Bankruptcy attorneys would welcome the opportunity to confirm the accuracy of UCC-1 financing statements, or lend a fresh perspective on a complex loan transaction that you fear has become routine and more prone to errors.