Delaware Supreme Court Rules Mistakenly Filed UCC Termination Statement Is Effective in $1.5 Billion Secured Loan Transaction
Lenders need to exercise great caution when filing a UCC-3 termination statement. They must make sure that the list of security interests terminated is accurate and that the statement does not mistakenly include other, unrelated loans and security interests. A recent ruling by the Delaware Supreme Court in a dispute arising out of the GM bankruptcy case gave effect to the literal terms of a mistaken termination statement and accordingly a $1.5 billion loan could be rendered unsecured.
On October 17, 2014, the Delaware Supreme Court interpreted the termination provisions in UCC Article 9 in a way that should force lenders and their counsel to put greater scrutiny on what might be considered a simple, ministerial procedure. In Official Comm. of Unsecured Creditors of Motors Liquidation Co. v. JP Morgan Chase Bank, N.A., 2014 Del. LEXIS 491 (Oct. 17. 2014), the Delaware court held that an indisputably mistaken termination statement nevertheless was effective as to a security interest in collateral securing a $1.5 billion syndicated term loan from a lender group, because the lenders had “authorized” the filing. The lender group was not permitted to refute the apparent effect of the mistaken filing by arguing that both it and GM (the debtor) had made an obvious mistake and that the lenders did not subjectively intend to terminate that particular security interest.
Before the GM bankruptcy, with the permission of its lender group, GM filed a termination statement (UCC 3) which had been prepared by GM’s own counsel and then reviewed by the lender representative and its counsel and which, in addition to correctly terminating a security interest relating to a different and much smaller loan by the lender group to GM, mistakenly and inadvertently also purported to extinguish a security interest in an unrelated $1.5 billion term loan by the lender group to GM. Neither GM nor the lender intended to terminate that term loan security interest, but no one at GM, the lender, or either of their law firms caught the mistake before the termination statement was filed.
After GM filed bankruptcy, the Official Creditors Committee brought an action to declare the security interest terminated, and effectively render the lender group unsecured. The bankruptcy court held for the lender group, finding that the erroneous termination statement mistakenly prepared by GM’s law firm was not “authorized” by the lender. On appeal, the Second Circuit certified to the Delaware Supreme Court the question whether “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 court opted for the first of the two choices: it held that the plain meaning of UCC 9-509, 9-510, and 9-513, as well as the need to protect the integrity of secured lending markets, dictated answering the certified question that it was enough for the lender to review and knowingly approve the termination statement, irrespective of its subjective intent.
Under Revised Article 9, no signatures are required to file a financing statement or an amendment such as a termination statement. Instead, to be effective the filing simply need be “authorized,” although the UCC does not define that term. Counsel for the lender had reviewed the proposed termination statements prepared by GM’s counsel but did not catch that one of them related to the unrelated loan.
The lender group argued that despite the fact that it and its counsel had reviewed the UCC-3 and approved it, and that it had authorized GM to file the termination statement, nevertheless it had no subjective intention to terminate the secured interest in a totally unrelated loan, and that it should not be bound by what it argued was a mere mistake which was acknowledged by the borrower and lender. The other side, the Official Creditors Committee, whose constituency hugely benefits from the mistake, argued for the plain meaning of the language and that the lender’s intent, even if admittedly mistaken, is immaterial as a matter of law.
The Delaware Supreme Court agreed with the Committee and ruled against the lender group, although the time for filing a motion for rehearing has not expired. The court held that a UCC-3 filing was effective when reviewed and approved by the creditor, and that to allow a creditor to argue after-the-fact that it did not intend such a consequence would undermine the secured lending markets, which depend on a trustworthy filing system to operate efficiently. The court relied upon the “unambiguous” language of the statue and cases that say a party is bound by the terms of the contract it has read. The court also rejected the applicability of the concept of “mutual mistake.” It agreed with the Committee’s argument that the drafters of the UCC could have included “intent to terminate” language in the termination provision if it wished to provide protection for unintentional filing.
Notably, the Delaware Supreme Court refused the invitation to address the principal-agency relationship and noted the Second Circuit can address that fact-laden issue upon receipt of its answer to the certified question. Thus, all is not necessarily yet lost for the lender group, which now must argue to the Second Circuit that GM’s law firm exceeded the scope of its agency when it included unrelated security interests in the termination statement. The Delaware court put the responsibility on the lender and its counsel to insure that a UCC filing is correct.
We note that neither the Second Circuit Court nor the Delaware Supreme Court mentioned the Article 1 general provision of the Uniform Commercial Code that that says the law of mistake is not eliminated under the UCC unless displaced by another provision. See 1-103(b). The failure of either court to address this long-established exception is puzzling to these authors. There was no ruling the Revised Article 9 termination provisions that did away with the signature requirement and did not define the term “authorized” displaced the survival of the UCC- recognized doctrine of mistake. The Delaware Supreme Court concluded, apparently, that the law of mistake did not survive, without reflecting on the important Article 1 doctrine which applies to all articles of the Uniform Commercial Code. The court still might reach the same conclusion, but certainly a discussion of 1.103(b) seems missing.
This case should remind lender and their counsel that when terminating UCCs to double check the financing statement targeted for termination. Matching original financing statement filings or registration numbers to particular loans is critical. It also might be helpful, at least for commercial loans, to add to the initial filing statement in the miscellaneous or other space the lender’s loan or note number (getting the borrower’s okay to do so in the loan or security agreement). While perhaps more difficult to implement, a lender might obtain from its borrower in the loan or security agreement the borrower’s agreement to execute upon repayment of the loan an acknowledgment that the termination statement only applies to the collateral pledged for the specific loan being paid off. Perhaps the lender group will prevail upon further proceedings, but in the meantime and regardless of the results of the particular GM case, lenders and their counsel should be fine-tuning their UCC termination practices.
Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and our colleagues. If you have any questions about this update or would like to discuss this topic further, please contact your Foley attorney or the following:
Mark J. Wolfson
Tampa, Florida
813.225.4119
[email protected]
Charles Tabb
Chicago, Illinois
312.832.5169
[email protected]
