A lot of the business owners we talk to at Delancey Street have pulled a UCC search on their own company and found a stack of filings they don’t recognize. Part of the reason business owners are confused about UCC’s has to do with their names. A UCC-1 financing statement is what a lender files to perfect its security interest in your collateral, and a filing that continues a UCC-1 keeps that claim alive on the public record. A UCC-3 termination statement does the opposite. It notifies the world that the prior UCC-1 financing statement is invalid or no longer in effect. Typically, a UCC-3 statement is filed when the lender no longer has a security interest in the collateral. That usually means the debtor has paid off the loan.
The General Motors Bankruptcy
That sounds like simple paperwork, but a case out of the General Motors bankruptcy shows how much can ride on a single termination form. Read it closely, because you’ll see how these forms can get you deep into trouble.
In October 2001 GM borrowed $300 million in a synthetic lease loan from a group of lenders who took security interests in 12 of its pieces of real estate. In 2006 GM borrowed $1.5 billion in a term loan from a new group of lenders who took a security interest in a big variety of GM assets. JPMorgan Chase was administrative agent on both. One of the term loan filings was a UCC-1 covering all of GM’s equipment and fixtures at 42 facilities, filed in Delaware, and it was considered by far the most important filing on that loan.
In 2008 GM set out to repay the synthetic lease and release its lien. A paralegal unfamiliar with the deal did a UCC search in Delaware to get this done. The paralegal found three UCC-1s, including the UCC-1 for the main term loan. The closing checklist included it for termination. Counsel prepared a UCC-3 for the UCC-1. The closing checklist and draft UCC-3s were sent to a managing director at JPMorgan, and to JPMorgan’s counsel, and they all approved them. The wrong UCC-3 was filed, with the correct UCC-3s. In short, nobody questioned the paralegal’s list. If GM and JPMorgan are to blame, then the question is why the lawyers approved the wrong termination statements. Or, more likely, why they failed to notice the mistake.
Fast forward to 2009. GM files for bankruptcy, and only now does the mistake come to light. JPMorgan tells the unsecured creditors’ committee that the termination was not intentional, nor authorized, and that it is not effective. On July 31, 2009, the committee sues to have the court find that the termination was effective. This would make JPMorgan an unsecured creditor like the others. One day, it’s a secured lender. The next, it’s an unsecured claimant in a massive bankruptcy. That must have hurt.
The timing made it worse. A bankruptcy filing gives the trustee or debtor-in-possession the status of a hypothetical lien creditor with a blanket lien on all of the debtor’s assets. Because the termination was filed before GM’s petition and discovered after it, JPMorgan was barred from re-perfecting its interest in the collateral. In other words, JPMorgan went from secured to unsecured in the blink of an eye.
JPMorgan Authorized the Filing
On the cross-motions, the bankruptcy court determined the erroneous termination filing was ineffective. The committee appealed to the Second Circuit, and the fight turned on Section 9-509(d)(1) of the UCC, which says the UCC-3 is effective only if the lender of record authorizes the filing. JPMorgan and its lawyers say: We never intended to terminate the lien. In their view, the lender did not intend to terminate the lien on the term loan; therefore, it did not authorize it. The committee said intent was irrelevant: JPMorgan had told its lawyers to file the documents, and that was authorization.
The Second Circuit sent the question of what exactly must be authorized to the Delaware Supreme Court, which answered that a filing the secured party authorizes is effective regardless of what the secured party intends or understands it to do. Nothing in the Delaware UCC requires you to understand what a filing that you authorize will do. Applying that rule, the Second Circuit held that JPMorgan chose to file the termination statement when they reviewed the closing documents and consented to their filing. It’s easy to feel sympathy but the law is also clear: JPMorgan authorized the filing. JPMorgan failed to see the implications of a UCC-3 termination, even with help from two law firms. It should ring a bell for anyone who’s ever had to sign an escrow delivery or a disbursement schedule of funds without remembering every last detail. If you approve the filing, it’s effective. If you sign something, and someone files it, you’re stuck with that filing.
So here is the difference in plain terms. A UCC-1, and any continuation of it, keeps a lender’s claim on the record. A UCC-3 termination takes it off, and once it is filed with the secured party’s authorization, it works even if nobody meant it to.
Do Your Homework
For a business owner paying off or settling a debt, the lesson is to understand every document you sign and deliver. And you should not assume that a lender will correctly file an initial financing statement, a continuation of an existing filing, or a termination statement. The error may not be glaringly obvious. At GM it sat unnoticed until the bankruptcy, when it could no longer be fixed. A mistake by your lawyer won’t be an excuse for filing an improper document, especially if all parties and their lawyers got the opportunity to review and sign off on the documents. It looks like everyone was depending on the diligence of the other parties, and the secured party lost badly as a result. You and your lawyer need to pay close attention to every document filed on your behalf. Do your homework before you file anything. Double- and triple-check it. Let’s face it, we are all just humans and mistakes can be made.
At Delancey Street, we negotiate with merchant cash advance funders, lenders and other business creditors for less than the full balance owed. For the business, the focus should be on negotiation, payment and documentation. We are not a law firm, so when litigation or bankruptcy is the better path, we refer owners to a vetted independent attorney. A first consultation is free and confidential.
