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Error In UCC Termination Statement May Cost Lenders $1.5 Billion

When they terminated the wrong financing statement in filings with the Delaware Secretary of State, a group of secured lenders learned the hard way that proofreading matters. As a result, under a recent decision of the Second Circuit Court of Appeals, the lenders may be forced to turn over $1.5 billion to the unsecured creditors in the General Motors bankruptcy case.

Pre-bankruptcy, a group of lenders, represented by JPMorgan, made two separate loans to GM. Both loans were secured. Before filing bankruptcy, GM repaid the first loan. In connection with the repayment, the attorneys for GM prepared a closing checklist, escrow agreement, and UCC termination statements. Under these documents, which JPMorgan and its attorneys reviewed and approved, the escrow agent would hold the termination statements – statements releasing the lenders’ interest in the collateral for the loan – and file them after the closing. Inadvertently, the escrow agreement and closing checklist provided for the termination of one of the main financing statements relating to the second loan. The erroneous termination statement was filed, but no one discovered the error until after GM filed bankruptcy.

Once in bankruptcy, GM obtained “debtor-in-possession” financing and used $1.5 billion of it to pay the balance due on the second loan. The bankruptcy court authorized GM to make the payment, assuming the lenders were fully secured – i.e., assuming the value of the collateral for the loan was at least $1.5 billion. After GM made the payment, the mistaken filing of the termination statement relating to the second loan came to light. Potentially, the value of the collateral for the loan was now insufficient to cover the $1.5 billion loan payment. The unsecured creditors sued the lender group for return of the unsecured portion of the $1.5 billion payment.

The bankruptcy court was sympathetic to the lenders. There was no question that they never intended to terminate any of the financing statements that related to the second loan. GM, its attorneys, the lenders, and their attorneys all agreed on that. Moreover, the Uniform Commercial Code provides that a secured lender must “authorize” termination of a financing statement, or the termination is not effective. As the bankruptcy court saw it, JPMorgan never authorized the mistaken filing of the termination statement relating to the second loan.

The appellate court was not so understanding. Under the UCC, the Second Circuit Court of Appeals ruled, it makes no difference whether a secured creditor “subjectively intends or otherwise understands the effect of the plain terms of its own filing.” As far as authorizing the filing, JPMorgan and its attorneys reviewed the check list, the escrow agreement, the termination statements, and then assented to the closing. That was authorization enough. The Court admonished: “a secured party . . . ought to review the [termination] 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 ensure the accuracy of the information contained in their UCC filings.”

The Second Circuit has certainly provided that incentive.

About the Author

David Orenstein is former Co-Chair of the Debtor/Creditor Remedies section of the Hennepin County Bar Association. He has been named a “Super Lawyer” by Minnesota Law & Politics ​magazine and has achieved an “AV Preeminent” Martindale Hubbell® rated attorney: the highest level of professional excellence, as determined by his peers.

Contact David by email or phone at 612.305.1494.

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