Subjective Intent Does Not Save $1.5B Secured Claim Against GM

In September 2008, as the synthetic lease financing was nearing maturity, GM requested its counsel to prepare the documents necessary to repay the lenders and release the security interests in GM's property. After reviewing three public lien filings listing the bank as secured party, GM's outside counsel erroneously prepared three Uniform Commercial Code termination statements (UCC-3s). The error was that only two of the UCC-1s of record related to the collateral securing the synthetic lease, while the third UCC-1 related to collateral securing the completely distinct term loan, which was still in effect. The three UCC-3 termination statements prepared by GM's counsel were later reviewed by the bank and its counsel, but no one noticed the error. It was undisputed that the bank consented to all three UCC-3 termination statements being filed when the synthetic lease was repaid. However, the bank clearly did not knowingly intend to authorize a release of its liens securing the term loan.

The mistake went unnoticed until GM filed for bankruptcy in 2009. The GM Creditors Committee filed an action seeking a declaration that, despite the unintended release of collateral, the UCC-3 was effective to terminate the security interest securing the $1.5 billion term loan. Section 9-509(d)(1) of the UCC provides that a person may file an amendment to a UCC financing statement if the “secured party of record authorizes the filing.” The bankruptcy court concluded that the UCC-3 termination was “unauthorized” under the theory that the bank only intended to terminate its liens securing the synthetic lease and did not intend to terminate its liens securing the separate term loan. (See Christopher M. Winter's article, “UCC-3 Termination Statements; Worth Your Time? A Closer Look” in the January, 2015 issue of this newsletter, available at http://bit.ly/1BCer4P).

An appeal to the U.S. Court of Appeals for the Second Circuit followed, and in January, the court issued its opinion. In re Motors Liquidation (2d Cir. Jan. 21, 2015).

The Second Circuit characterized the question before it as whether the secured lender must “authorize the termination of the particular security interest that the UCC-3 identifies for termination, or is it enough that the secured lender authorizes the act of filing a UCC-3 statement that has that effect?” Delaware law applied, and because the question had never been addressed under Delaware law, the Second Circuit “certified” that question to the Delaware Supreme Court. There the bank argued that there should be an intent requirement in gauging the effects of a UCC filing. The Delaware court was unpersuaded by the bank's arguments, and held that ' 9-509(d)(1) of the UCC is unambiguous and therefore not subject to interpretation. Because ' 9-509(d)(1) clearly states that the filing is effective if a secured party authorizes the filing, the Delaware court refused to read into the statute a subjective intent requirement that the filing party understand the terms and intended effect of the filing. Instead, the court reasoned that it is “fair” to place the burden on sophisticated transacting parties to ensure that a UCC-3 is accurate when filed. Indeed, the court stated that to find otherwise would run directly contrary to the notice mechanism of the UCC and would effectively “disrupt and undermine the secured lending markets.” Moreover, such a system would provide little incentive for secured creditors to ensure the accuracy of their UCC filings.

With that interpretation of the UCC having been made by the highest Delaware state court, the Second Circuit reached the question of whether the bank had “authorized” the filing of the UCC-3 that mistakenly terminated the lien securing the term loan. The Second Circuit noted that “what [the bank] intended to accomplish ' is a distinct question from what actions it authorized to be taken on its behalf.” The court concluded that the bank and its counsel knew that upon the repayment of the synthetic lease, GM's lawyers were going to file the three termination statements, including the one that related solely to the term loan collateral and that the bank “reviewed and assented to the filing of that statement. Nothing more is needed.” Accordingly the bank's liens that had originally secured the term loan were avoided in favor of the unsecured creditors, and the bank's $1.5 billion dollar secured claim will now be treated as a general unsecured claim.

The bank should not have been surprised at the outcome. The Second Circuit's opinion comes on the heels of another circuit court's decision that refused to overlook errors made by secured lenders. In State Bank of Toulon v. Covey (In re Duckworth), (Nov. 21, 2014), the bank's security agreement stated that it secured a note dated Dec. 13, 2008, when the note was actually dated Dec. 15, 2008. Both the bank and the borrower intended that the lien granted under the security agreement would secure the Dec. 15 note. While the bankruptcy court held that the mistaken reference in the security agreement would not defeat the bank's security interest, the U.S. Court of Appeals for the Seventh Circuit disagreed and held that the security agreement would be enforced as written, i.e., securing a non-existent note. Accordingly, like the secured lender in GM, the bank in Duckworth was left with a general unsecured claim.

Conclusion

The implications of the General Motors case are clear and enormous. Under the reasoning of General Motors, the subjective intent of a party making a UCC filing is irrelevant. As long as it authorizes the filing of a UCC document, that party will be bound by the legal effect of the filing. Precision and accuracy are therefore imperative when securing and releasing collateral, as there is no forgiveness in the notice-based UCC filing system. This is especially true with large companies and banks, which typically have voluminous and complex filings in several districts. Attorneys who are filing UCC-1 financing statements or UCC-3 terminations, including in-house counsel who are supervising outside counsel, must be sure that they are acting with the correct instruments, and that there are sufficient checks and balances to review the filings before they are made.

Mark A Salzberg is a partner in Squire Patton Boggs' Washington, DC, office and a member of the firm's restructuring and insolvency practice group. He focuses his practice on bankruptcy litigation, creditors' rights, debtor reorganizations and complex commercial litigation. He is currently a member of the D.C. Bar's Board of Governors. This article also appeared in Corporate Counsel, an ALM sister publication of this newsletter.

The legal principles governing corporate finance often are complex. Sometimes, however, the simplest of errors can be the most costly. Such was the case with a large syndicated secured loan made to General Motors Co. Due to a simple filing error, what the lender and borrower had always intended to be a secured loan will now be treated as a general unsecured claim.

The facts of this matter are relatively straightforward. A major bank served as the agent (the bank) on two distinct credit facilities involving GM. The first was a $300 million synthetic lease entered into in 2001, which was secured by real estate. The second was a $1.5 billion syndicated term loan entered into five years later, which was secured by other GM assets.

Background

In September 2008, as the synthetic lease financing was nearing maturity, GM requested its counsel to prepare the documents necessary to repay the lenders and release the security interests in GM's property. After reviewing three public lien filings listing the bank as secured party, GM's outside counsel erroneously prepared three Uniform Commercial Code termination statements (UCC-3s). The error was that only two of the UCC-1s of record related to the collateral securing the synthetic lease, while the third UCC-1 related to collateral securing the completely distinct term loan, which was still in effect. The three UCC-3 termination statements prepared by GM's counsel were later reviewed by the bank and its counsel, but no one noticed the error. It was undisputed that the bank consented to all three UCC-3 termination statements being filed when the synthetic lease was repaid. However, the bank clearly did not knowingly intend to authorize a release of its liens securing the term loan.

The mistake went unnoticed until GM filed for bankruptcy in 2009. The GM Creditors Committee filed an action seeking a declaration that, despite the unintended release of collateral, the UCC-3 was effective to terminate the security interest securing the $1.5 billion term loan. Section 9-509(d)(1) of the UCC provides that a person may file an amendment to a UCC financing statement if the “secured party of record authorizes the filing.” The bankruptcy court concluded that the UCC-3 termination was “unauthorized” under the theory that the bank only intended to terminate its liens securing the synthetic lease and did not intend to terminate its liens securing the separate term loan. (See Christopher M. Winter's article, “UCC-3 Termination Statements; Worth Your Time? A Closer Look” in the January, 2015 issue of this newsletter, available at http://bit.ly/1BCer4P).

An appeal to the U.S. Court of Appeals for the Second Circuit followed, and in January, the court issued its opinion. In re Motors Liquidation (2d Cir. Jan. 21, 2015).

The Second Circuit characterized the question before it as whether the secured lender must “authorize the termination of the particular security interest that the UCC-3 identifies for termination, or is it enough that the secured lender authorizes the act of filing a UCC-3 statement that has that effect?” Delaware law applied, and because the question had never been addressed under Delaware law, the Second Circuit “certified” that question to the Delaware Supreme Court. There the bank argued that there should be an intent requirement in gauging the effects of a UCC filing. The Delaware court was unpersuaded by the bank's arguments, and held that ' 9-509(d)(1) of the UCC is unambiguous and therefore not subject to interpretation. Because ' 9-509(d)(1) clearly states that the filing is effective if a secured party authorizes the filing, the Delaware court refused to read into the statute a subjective intent requirement that the filing party understand the terms and intended effect of the filing. Instead, the court reasoned that it is “fair” to place the burden on sophisticated transacting parties to ensure that a UCC-3 is accurate when filed. Indeed, the court stated that to find otherwise would run directly contrary to the notice mechanism of the UCC and would effectively “disrupt and undermine the secured lending markets.” Moreover, such a system would provide little incentive for secured creditors to ensure the accuracy of their UCC filings.

With that interpretation of the UCC having been made by the highest Delaware state court, the Second Circuit reached the question of whether the bank had “authorized” the filing of the UCC-3 that mistakenly terminated the lien securing the term loan. The Second Circuit noted that “what [the bank] intended to accomplish ' is a distinct question from what actions it authorized to be taken on its behalf.” The court concluded that the bank and its counsel knew that upon the repayment of the synthetic lease, GM's lawyers were going to file the three termination statements, including the one that related solely to the term loan collateral and that the bank “reviewed and assented to the filing of that statement. Nothing more is needed.” Accordingly the bank's liens that had originally secured the term loan were avoided in favor of the unsecured creditors, and the bank's $1.5 billion dollar secured claim will now be treated as a general unsecured claim.

The bank should not have been surprised at the outcome. The Second Circuit's opinion comes on the heels of another circuit court's decision that refused to overlook errors made by secured lenders. In State Bank of Toulon v. Covey (In re Duckworth), (Nov. 21, 2014), the bank's security agreement stated that it secured a note dated Dec. 13, 2008, when the note was actually dated Dec. 15, 2008. Both the bank and the borrower intended that the lien granted under the security agreement would secure the Dec. 15 note. While the bankruptcy court held that the mistaken reference in the security agreement would not defeat the bank's security interest, the U.S. Court of Appeals for the Seventh Circuit disagreed and held that the security agreement would be enforced as written, i.e., securing a non-existent note. Accordingly, like the secured lender in GM, the bank in Duckworth was left with a general unsecured claim.

Conclusion

The implications of the General Motors case are clear and enormous. Under the reasoning of General Motors, the subjective intent of a party making a UCC filing is irrelevant. As long as it authorizes the filing of a UCC document, that party will be bound by the legal effect of the filing. Precision and accuracy are therefore imperative when securing and releasing collateral, as there is no forgiveness in the notice-based UCC filing system. This is especially true with large companies and banks, which typically have voluminous and complex filings in several districts. Attorneys who are filing UCC-1 financing statements or UCC-3 terminations, including in-house counsel who are supervising outside counsel, must be sure that they are acting with the correct instruments, and that there are sufficient checks and balances to review the filings before they are made.

Mark A Salzberg is a partner in Squire Patton Boggs' Washington, DC, office and a member of the firm's restructuring and insolvency practice group. He focuses his practice on bankruptcy litigation, creditors' rights, debtor reorganizations and complex commercial litigation. He is currently a member of the D.C. Bar's Board of Governors. This article also appeared in Corporate Counsel, an ALM sister publication of this newsletter.