In re Motors Liquidation Co.
In re Motors Liquidation Co., ___ F3d ___, 2015 Westlaw 252318 (2d Cir. 2015): The Second Circuit has held that a lender and its counsel had inadvertently authorized the filing of an erroneous termination statement, thus invalidating the lender’s $1.5 billion security interest. This case is an additional “secured lenders better not make mistakes” case, which is truly terrifying for secured lenders.
Facts: A secured lender intended to file a termination statement (a “UCC-3”) in order to release its lien securing a $300 million synthetic lease. Unfortunately, the termination statement also erroneously included language releasing a lien securing an unrelated $1.5 billion term loan, which was directly contrary to the intent of both the lender and the borrower. The Second Circuit’s vivid recitation of the facts described how this disaster occurred:
A … partner [in the borrower’s law firm] assigned the work to an associate and instructed him to prepare a closing checklist and drafts of the documents required to pay off the Synthetic Lease and to terminate the lenders’ security interests in [the borrower’s] General Motors’ property relating to the Synthetic Lease. One of the steps required to unwind the Synthetic Lease was to create a list of security interests held by [the borrower’s] lenders that would need to be terminated. To prepare the list, the … associate [in the borrower’s law firm] asked a paralegal who was unfamiliar with the transaction or the purpose of the request to perform a search for UCC–1 financing statements that had been recorded against [the borrower] … The paralegal’s search identified three UCC–1s … Neither the paralegal nor the associate realized that only the first two of the UCC–1s were related to the Synthetic Lease. The third [financing statement] related instead to the Term Loan.
When [the borrower’s counsel] prepared a Closing Checklist of the actions required to unwind the Synthetic Lease, it identified the Main Term Loan UCC–1 for termination alongside the security interests that actually did need to be terminated. And when [the borrower’s counsel] prepared draft UCC–3 statements to terminate the three security interests identified in the Closing Checklist, it prepared a UCC–3 statement to terminate the Main Term Loan UCC–1 as well as those related to the Synthetic Lease.
No one at [the borrower], [the borrower’s law firm], [the lender], or [the lender’] counsel … noticed the error, even though copies of the Closing Checklist and draft UCC–3 termination statements were sent to individuals at each organization for review … All three UCC–3s were filed with the Delaware Secretary of State, including the UCC–3 that erroneously identified for termination the Main Term Loan UCC–1, which was entirely unrelated to the Synthetic Lease.
The borrower (General Motors) later filed a bankruptcy petition. Its unsecured creditors’ committee filed an adversary proceeding, seeking a determination that the lender’s $1.5 billion term loan was completely unsecured, as a result of the erroneous termination statement. The bankruptcy court granted summary judgment in favor of the lender. The Second Circuit Court of Appeals certified a question to the Delaware Supreme Court, asking if the subjective intent of the secured creditor was relevant. In Official Committee of Unsecured Creditors of Motors Liquidation Co. v. JPMorgan Chase Bank, N.A., – A.3d -, 2014 Westlaw 5305937 (Del.), the Delaware Supreme Court held that if a secured party authorizes the filing of a UCC–3 termination statement, then that filing is effective to terminate all UCC-1 financing statements covered by the termination statement, regardless of whether the secured party subjectively intends to do so or understands the effect of that filing.
In the wake of that opinion, the Second Circuit held that there was just one remaining question: “Did [the lender] authorize the filing of the UCC–3 termination statement that mistakenly identified for termination the Main Term Loan UCC–1?”
Reasoning: The lender argued strenuously that it never instructed anyone to file the UCC–3 in question, and the termination statement was therefore unauthorized and ineffective. The lender claimed that it authorized the borrower only to terminate security interests related to the synthetic lease; that it instructed its law firm and the borrower’s law firm to take actions to accomplish that objective, and no other; and that therefore the borrower’s law firm exceeded the scope of its authority when it filed the UCC–3 purporting to terminate the main term loan UCC–1.
The court disagreed, holding that the lender and its counsel never expressed any concerns about the transaction, even though they had supposedly reviewed it thoroughly:
After [the borrower’s counsel] prepared the Closing Checklist and draft UCC–3 termination statements, copies were sent for review to a Managing Director at [the lender] who supervised the Synthetic Lease payoff and who had signed the Term Loan documents on [the lender’s] behalf. [The borrower’s law firm] also sent copies of the Closing Checklist and draft UCC–3 termination statements to [the lender’s] counsel . . . to ensure that the parties to the transaction agreed as to the documents required to complete the Synthetic Lease payoff transaction. Neither directly nor through its counsel did [the lender] express any concerns about the draft UCC–3 termination statements or about the Closing Checklist. [An attorney in the lender’s law firm] responded simply as follows: "Nice job on the documents …"
After preparing the closing documents and circulating them for review, [the borrower’s law firm] drafted an Escrow Agreement that instructed the parties’ escrow agent how to proceed with the closing. Among other things, the Escrow Agreement specified that the parties would deliver to the escrow agent the set of three UCC–3 termination statements (individually identified by UCC–1 financing statement file number) that would be filed to terminate the security interests that [the borrower’s] Synthetic Lease lenders held in its properties. The Escrow Agreement provided that once [the borrower] repaid the amount due on the Synthetic Lease, the escrow agent would forward copies of the UCC–3 termination statements to [the borrower’s] counsel for filing. When [the borrower’s law firm] e-mailed a draft of the Escrow Agreement to [the lender’s] counsel for review, the same … attorney [acting on behalf of the lender] responded that "it was fine" and signed the agreement.
From these facts it is clear that although [the lender] never intended to terminate the Main Term Loan UCC–1, it authorized the filing of a UCC–3 termination statement that had that effect.
Comment of Loyola Law School Professor Dan Schecter, who wrote this analysis, published in California State Bar Insolvency Committee e-newsletter of 2/11/15: This is the correct result from a legal standpoint, but it is so easy to imagine one’s self in the position of the attorneys who failed to catch this error. As we now know, there were quite a few people who could have fixed the problem, but everyone’s eyes glazed over when confronted with the long checklist of documents to review. There were so many people involved in the process that no one took “ownership” of the end result. This may be a corollary of the well-documented “bystander effect,” a psychological phenomenon in which the greater the number of people present, the less likely any individual is to take responsibility for a problem.
There are two other hidden messages in this tragic fact pattern: first, counsel for a lender should not blindly trust the borrower’s counsel to protect the lender’s interests. Second, when junior staff has been given the task of preparing the first draft of a key document, a senior lawyer with intimate knowledge of the client’s business affairs must carefully review the document before the document is put into final form.
Finally, I [Professor Schecter] will take the liberty of repeating something I wrote in my discussion of the Delaware Supreme Court’s earlier ruling:
This opinion should be required reading for all first year law students, who are often astonished that law professors require them to read long cases, documents, and statutes in excruciating detail. Someone fell asleep at the switch in this case, and did not re-read the termination statement. Roughly $1.5 billion went up in smoke, possibly exposing a major law firm to a ruinous malpractice verdict. (I hope not.) I often tell my students that one key difference between laypeople and lawyers is that we lawyers develop the ability to read, understand, and think carefully about the fine print, hour after hour, day after day, year after year. If that sounds like hard work, that’s because it is.
For a discussion of the Delaware Supreme Court’s opinion, see 2014-44 Comm. Fin. News. NL 89, Lien Securing $1.5 Billion Debt is Invalid Because of Overbroad Termination Statement, Even Though Lender Did Not Intend to Release That Lien.
For discussions of other cases dealing with related issues, see:
- 2011 Comm. Fin. News. 44, Escrow Agent’s Mistaken Filing of Overbroad Amendment to Financing Statement Is Not Binding on Secured Party, When Agent Exceeds Scope of Authority.
- 2012 Comm. Fin. News. 67, Filing of "Correction Statement" Is Insufficient to Revive Security Interest Following Erroneous Filing of Termination Statement; Belated Filing of New Financing Statement Is Avoided As Preferential.