ANSWER: AN OVERLOOKED DETAIL ON A ROUTINE DOCUMENT COST CHASE BANK DEARLY!
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An Unforced Error Lost the Game!
JPMorgan Chase Bank (“Chase”) terminated the wrong UCC-1 Financing Statement. That mistake released all of the collateral securing a $1.5 billion Term Loan! In re Motors Liquidation Co., 777 F.3d 100 (2d Cir. Ct., 2015).
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“Don’t sweat the small stuff” may often be good advice. With due respect to Richard Carlson, attention to the detailed “small stuff” is critical with legal documents, however.
How Did a Small Mix Up Become a Game-Changing Error?
Chase and a syndicate of lenders financed $300 million for General Motors in October 2001. Chase provided the financing through a financing lease transaction.
Five years later, on a different deal, General Motors borrowed $1.5 billion from Chase and another group of lenders. This $1.5 billion Term Loan was secured by security interests in a lot of General Motors’ assets, “including all of General Motors’ equipment and fixtures at forty-two facilities throughout the United States.” A key item in perfecting that huge loan was the “Main Term Loan UCC-1,” filed with the Delaware Secretary of State.
General Motors decided to pay off the $300 million lease financing transaction. General Motors told its lawyers to prepare the documents to release the collateral securing that $300 million financing package. The partner at the big law firm told the associate to “prepare a closing checklist” and draft the documents to pay off the $300 million and to terminate the liens securing that financing. The associate told a paralegal to perform a UCC-1 search for financing statements that had been recorded against General Motors in Delaware. The paralegal found three UCC-1 financing statements of record in Delaware, including one that had nothing to do with the lease transaction.
The “Closing Checklist” included preparing a UCC-3 termination statement to terminate the $1.5 billion Main Term Loan UCC-1, as well as the two correct UCC filings. All three of the UCC-3 termination statements were prepared and sent to General Motors, Chase and the lawyers for Chase.
“No one at General Motors, . . . JPMorgan, or its 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.” On October 30, 2008 when General Motors paid the lease financing, the wrong financing statement on the $1.5 billion Term Loan was terminated along with the two correct financing statements.
The Loss of Collateral Was Enforced After Review of the Play on the Field!
No one noticed the mistake until General Motors filed bankruptcy in 2009. The Committee of Unsecured Creditors asked the bankruptcy court to rule that General Motors no longer had any collateral for the $1.5 billion Term Loan. At first, the bankruptcy judge ruled that the termination of the lien was a mistake and that Chase still had a valid lien against most of General Motors’ assets.
The Court of Appeals said the lien was properly terminated, however, and Chase was “an unsecured creditor on par with the other General Motors unsecured creditors.” Oops!
To Err is Human, But to Forgive is Not Found in the Code!
The Court of Appeals said it needed to answer two questions:
First: “Must the secured lender authorize the termination of the particular security interest that the UCC-3 identifies for termination, or is it enough that the secured lender authorize the act of filing a UCC-3 statement that has that effect?” In re Motors Liquidation Co., 755 F.3d at 84.
Second: Did Chase grant General Motors’ lawyers authority “either to terminate the Main Term Loan UCC-1 or to file the UCC-3 statement that identified that interest for termination?” Id.
The Court of Appeals said that the Delaware Supreme Court should answer the first question. The Delaware Supreme Court ruled that if a secured party authorizes the filing of a UCC-3 termination statement, that termination is effective whether or not the secured party actually intended for the lien to be released. The state court said:
Before a secured party authorizes the filing of a termination statement, it ought to review the statement carefully and understand which security interests it is releasing and why. . . . If parties could be relieved from the legal consequences of their mistaken filings, they would have little incentive to ensure the accuracy of the information contained in their UCC filings.
As to the second question, the Court of Appeals stated: “From these facts it is clear that although JPMorgan never intended to terminate the Main Term Loan UCC-1, it authorized the filing of a UCC-3 termination statement that had that effect.” General Motors’ lawyer sent the documents to Chase’s lawyer for review. Chase’s lawyer said “it was fine” and signed the document. Nothing more was needed for Chase to mistakenly lose $1.5 billion.
Moral: Sweat the small stuff! Please let me know if you need help scaring your people into being careful.
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Copyright © 2016 Michael R. King mking@gblaw.com 602-256-4405