UCC-3 Termination Statements

The dispute in In re: Motors Liquidation Company arose in the bankruptcy of General Motors. At issue was the treatment of a syndicate of term loan lenders, including JPMorgan Chase Bank, N.A (“JPMorgan”), as agent and lender. After GM filed for bankruptcy, a committee of unsecured creditors filed suit in the New York bankruptcy court for a determination that the filed UCC-3 terminated the term loan security interest in the assets of GM. The bankruptcy court ruled in favor of the term loan lenders, finding that “neither JP- Morgan nor General Motors intended the legal consequences of the UCC-3 termination statement.” Thus, the filing of the termination statement “was not authorized and therefore was not effective.” On appeal to the Second Circuit, the certified question was presented to the Delaware Supreme Court.

The court ultimately ruled that the subjective intent of a secured lender is not relevant to a determination of whether a termination statement was effective under the Delaware Uniform Commercial Code (“UCC”) to terminate the secured lender's perfected security interest. In other words, if a lender authorizes the filing of a termination statement, it does not matter whether the lender reviewed it closely, understood the document, or subjectively intended the legal result of filing the termination statement. It is enough that the secured party authorized its filing.

A Cautionary Tale

The opinion serves as a cautionary tale for agents, lenders and their counsel to closely scrutinize financing statements and termination statements. In In re: Motors Liquidation Company, individuals at Mayer Brown, Simpson Thatcher and Bartlett, as counsel for JPMorgan, and General Motors reviewed the UCC-3 termination statement without recognizing that it purported to terminate the term loan UCC-1 financing statement, according to the Delaware court's opinion.

The Delaware Supreme Court considered the authorization issue as a question certified to it by the U.S. Court of Appeals for the Second Circuit. The Second Circuit is still considering the related issue of whether Mayer Brown, as counsel to General Motors in the related synthetic lease transaction, had authority under agency principles to file the termination statement on behalf of JPMorgan.

The Delaware court's opinion highlights the inconsistency of subjective intent and the UCC Article 9 public notice filing system. “Under the Delaware UCC, parties in commerce are entitled to rely upon a filing authorized by a secured lender and assume that the secured lender intends the plain consequences of its filing.” The court reasoned that it would be “strange and inefficient” to have the effectiveness of a termination statement dependent on whether a secured lender “subjectively understood the terms of its own filing and the effect that the filing would have on the security interests the filings own words address.”

Does a Lender Need to Authorize Mere Filing of the Termination Statement, or the Legal Result of the Filing?

Under the Delaware Uniform Commercial Code (which governed perfection and termination in In re: Motors Liquidation Company), a UCC-3 termination statement may be filed by a person “only if' the secured party of record authorizes the filing.” UCC ' 9-509(d)(1). In addition, “[a] filed record is effective only to the extent that it was filed by a person that may file it under Section 9-509.” UCC ' 9-510(a). Further, “upon the filing of a termination statement with the filing office, the financing statement to which the termination statement relates ceases to be effective.” UCC ' 9-513(d).

The issue before the Delaware Supreme Court and the one argued by the parties was whether it is enough that a secured party authorize the act of filing a termination statement, or is the secured party required to authorize the legal consequences of the filing (i.e., the termination of the subject security interest). That is, is it enough that JPMorgan authorized the filing of the UCC-3 termination statement at issue without ever intending the legal consequences of such filing?

The Bankruptcy Court for the Southern District of New York, the trial court in the matter, focused on agency law as it relates to the fact that GM's counsel made the filing on behalf of JPMorgan. The court concluded that the subjective intent of the secured party, and even more importantly, the subjective intent of the debtor filing the termination statement was dispositive.

While it is undisputed that JP- Morgan knew in advance of GM's counsel's intent to file a UCC-3 which showed the “Initial Financing Statement File #” of a UCC-1 that in fact was the initial financing statement on the Term Loan (and JPMorgan at least arguably consented to the filing), in the absence of belief by GM that actions to terminate the Main Term Loan UCC-1 were authorized, the Court cannot find that JPMorgan authorized the termination of the initial financing statement for that unrelated facility.

The bankruptcy court did find “a grant of authorization to do something,” namely to file the UCC-3 at issue, but that was not enough. JPMorgan was required to subjectively intend to terminate the term loan financing statement in order to provide valid authorization for GM's counsel to do so, according to the Bankruptcy Court. As mentioned above, the agency law issue remains on appeal.

Authorization of UCC Forms in Practice

The issue of intent and authorization is not one that usually receives much attention in a transaction. With respect to financing statements being filed on the “front end” of a transaction, a credit and security agreement or pre-filing letter will often provide clear authority. In fact, comment 4 to UCC ' 9-509 provides that execution of a security agreement ” ipso facto constitutes the debtor's authorization of the filing of a financing statement covering the collateral described in the security agreement.”

In a payoff or restructuring, a payoff letter, or acknowledgment or ancillary letter, should also provide requisite authority to file a termination statement with respect to liens expressly released in or by such letter. In addition to any such letter, drafts of UCCs are usually circulated to lawyers on both sides for review and approval which also apparently constitutes an authorization.

UCC Forms Are Deceptively Simple

UCC forms can be deceptively simple. They are set up in a check-the-box format and require very little information. A UCC-3 termination statement ' which is really an amendment form that provides for amendment, continuation, assignment or termination ' is no different. It is the very simplicity of the document that requires caution. A party completing a form UCC-3 statement must first identify an existing prior filed financing statement. The party does this only by identifying the filing number and date. The party then checks a box for “Termination,” “Continuation,” “Assignment” or “Amendment.” On its face, someone reviewing the UCC-3 would have no way of knowing whether the document purports to effect the proper existing financing statement. This can only be verified by review of the existing financing statement and confirmation of its filing number.

It may be tempting in some cases to rely on the diligence and care of the individual who originally prepared the UCC-3. But that could be a shortcut with dire consequences. Best practices should include reviewing draft UCC-3 termination statements with a copy of the UCC lien report and/or the underlying financing statement with the stamped-on filing number.

Conclusion

A party reviewing the public filing record should know that there is a risk that a public filing may be invalid due to fraud or a true lack of authorization. But to require a party reviewing a record to wonder about the secret subjective intent of a secured party in a case where the secured party authorized the filing? The Second Circuit will ultimately decide whether authorization occurred and the unintended termination statement is valid as a matter of law in In re: Motors Liquidation Company. In the meantime, the case highlights for lenders and practitioners the importance of close review and deliberate action with respect to UCC-3s. UCC-3 termination statements (and UCC-1 financing statements) are documents with powerful legal effect and are worthy of our close attention.

Christopher M. Winter is a partner in the Wilmington, DE, office of Duane Morris LLP. He focuses his practice on Chapter 11 bankruptcy law and proceedings, commercial finance and transactions, and Delaware corporate and alternative entity law. Mr. Winter can be reached at [email protected].

Preparation of UCC-3 termination statements may be thought of as ministerial work best left to paralegals or administrative staff. After long days and nights of negotiating and documenting a financing transaction, lenders, lawyers and business people may be too willing to rely on the diligence of others and not closely review the UCCs themselves. They do this at their peril. In a recent case, two large law firms and a major corporation failed to scrutinize a UCC-3 termination statement and may have inadvertently allowed $1.5 billion in indebtedness to become unsecured.

In that case, In re: Motors Liquidation Company, 755 F.3d 78, 86 (2d Cir. 2014), the Delaware Supreme Court considered the payoff of a “synthetic lease” by General Motors Corporation (“General Motors” or “GM”), which required several UCC-3s to be filed to terminate liens on synthetic lease collateral. However, inadvertently included in that batch of UCC-3 termination statements was one that terminated a UCC-1 financing statement ' referenced only by its eight-digit filing number ' that was the principal UCC-1 securing a General Motors term loan that was 10 times the size of the synthetic lease and wholly unrelated to it.

Background

The dispute in In re: Motors Liquidation Company arose in the bankruptcy of General Motors. At issue was the treatment of a syndicate of term loan lenders, including JPMorgan Chase Bank, N.A (“JPMorgan”), as agent and lender. After GM filed for bankruptcy, a committee of unsecured creditors filed suit in the New York bankruptcy court for a determination that the filed UCC-3 terminated the term loan security interest in the assets of GM. The bankruptcy court ruled in favor of the term loan lenders, finding that “neither JP- Morgan nor General Motors intended the legal consequences of the UCC-3 termination statement.” Thus, the filing of the termination statement “was not authorized and therefore was not effective.” On appeal to the Second Circuit, the certified question was presented to the Delaware Supreme Court.

The court ultimately ruled that the subjective intent of a secured lender is not relevant to a determination of whether a termination statement was effective under the Delaware Uniform Commercial Code (“UCC”) to terminate the secured lender's perfected security interest. In other words, if a lender authorizes the filing of a termination statement, it does not matter whether the lender reviewed it closely, understood the document, or subjectively intended the legal result of filing the termination statement. It is enough that the secured party authorized its filing.

A Cautionary Tale

The opinion serves as a cautionary tale for agents, lenders and their counsel to closely scrutinize financing statements and termination statements. In In re: Motors Liquidation Company, individuals at Mayer Brown, Simpson Thatcher and Bartlett, as counsel for JPMorgan, and General Motors reviewed the UCC-3 termination statement without recognizing that it purported to terminate the term loan UCC-1 financing statement, according to the Delaware court's opinion.

The Delaware Supreme Court considered the authorization issue as a question certified to it by the U.S. Court of Appeals for the Second Circuit. The Second Circuit is still considering the related issue of whether Mayer Brown, as counsel to General Motors in the related synthetic lease transaction, had authority under agency principles to file the termination statement on behalf of JPMorgan.

The Delaware court's opinion highlights the inconsistency of subjective intent and the UCC Article 9 public notice filing system. “Under the Delaware UCC, parties in commerce are entitled to rely upon a filing authorized by a secured lender and assume that the secured lender intends the plain consequences of its filing.” The court reasoned that it would be “strange and inefficient” to have the effectiveness of a termination statement dependent on whether a secured lender “subjectively understood the terms of its own filing and the effect that the filing would have on the security interests the filings own words address.”

Does a Lender Need to Authorize Mere Filing of the Termination Statement, or the Legal Result of the Filing?

Under the Delaware Uniform Commercial Code (which governed perfection and termination in In re: Motors Liquidation Company), a UCC-3 termination statement may be filed by a person “only if' the secured party of record authorizes the filing.” UCC ' 9-509(d)(1). In addition, “[a] filed record is effective only to the extent that it was filed by a person that may file it under Section 9-509.” UCC ' 9-510(a). Further, “upon the filing of a termination statement with the filing office, the financing statement to which the termination statement relates ceases to be effective.” UCC ' 9-513(d).

The issue before the Delaware Supreme Court and the one argued by the parties was whether it is enough that a secured party authorize the act of filing a termination statement, or is the secured party required to authorize the legal consequences of the filing (i.e., the termination of the subject security interest). That is, is it enough that JPMorgan authorized the filing of the UCC-3 termination statement at issue without ever intending the legal consequences of such filing?

The Bankruptcy Court for the Southern District of New York, the trial court in the matter, focused on agency law as it relates to the fact that GM's counsel made the filing on behalf of JPMorgan. The court concluded that the subjective intent of the secured party, and even more importantly, the subjective intent of the debtor filing the termination statement was dispositive.

While it is undisputed that JP- Morgan knew in advance of GM's counsel's intent to file a UCC-3 which showed the “Initial Financing Statement File #” of a UCC-1 that in fact was the initial financing statement on the Term Loan (and JPMorgan at least arguably consented to the filing), in the absence of belief by GM that actions to terminate the Main Term Loan UCC-1 were authorized, the Court cannot find that JPMorgan authorized the termination of the initial financing statement for that unrelated facility.

The bankruptcy court did find “a grant of authorization to do something,” namely to file the UCC-3 at issue, but that was not enough. JPMorgan was required to subjectively intend to terminate the term loan financing statement in order to provide valid authorization for GM's counsel to do so, according to the Bankruptcy Court. As mentioned above, the agency law issue remains on appeal.

Authorization of UCC Forms in Practice

The issue of intent and authorization is not one that usually receives much attention in a transaction. With respect to financing statements being filed on the “front end” of a transaction, a credit and security agreement or pre-filing letter will often provide clear authority. In fact, comment 4 to UCC ' 9-509 provides that execution of a security agreement ” ipso facto constitutes the debtor's authorization of the filing of a financing statement covering the collateral described in the security agreement.”

In a payoff or restructuring, a payoff letter, or acknowledgment or ancillary letter, should also provide requisite authority to file a termination statement with respect to liens expressly released in or by such letter. In addition to any such letter, drafts of UCCs are usually circulated to lawyers on both sides for review and approval which also apparently constitutes an authorization.

UCC Forms Are Deceptively Simple

UCC forms can be deceptively simple. They are set up in a check-the-box format and require very little information. A UCC-3 termination statement ' which is really an amendment form that provides for amendment, continuation, assignment or termination ' is no different. It is the very simplicity of the document that requires caution. A party completing a form UCC-3 statement must first identify an existing prior filed financing statement. The party does this only by identifying the filing number and date. The party then checks a box for “Termination,” “Continuation,” “Assignment” or “Amendment.” On its face, someone reviewing the UCC-3 would have no way of knowing whether the document purports to effect the proper existing financing statement. This can only be verified by review of the existing financing statement and confirmation of its filing number.

It may be tempting in some cases to rely on the diligence and care of the individual who originally prepared the UCC-3. But that could be a shortcut with dire consequences. Best practices should include reviewing draft UCC-3 termination statements with a copy of the UCC lien report and/or the underlying financing statement with the stamped-on filing number.

Conclusion

A party reviewing the public filing record should know that there is a risk that a public filing may be invalid due to fraud or a true lack of authorization. But to require a party reviewing a record to wonder about the secret subjective intent of a secured party in a case where the secured party authorized the filing? The Second Circuit will ultimately decide whether authorization occurred and the unintended termination statement is valid as a matter of law in In re: Motors Liquidation Company. In the meantime, the case highlights for lenders and practitioners the importance of close review and deliberate action with respect to UCC-3s. UCC-3 termination statements (and UCC-1 financing statements) are documents with powerful legal effect and are worthy of our close attention.

Christopher M. Winter is a partner in the Wilmington, DE, office of Duane Morris LLP. He focuses his practice on Chapter 11 bankruptcy law and proceedings, commercial finance and transactions, and Delaware corporate and alternative entity law. Mr. Winter can be reached at [email protected].