April 30, 2015 Top Story

Law Firm Mistakenly Wipes Out Security for $1.5 Billion Loan

Court finds intent to release security interest is not required under the UCC

Andrew J. Kennedy

The U.S. Court of Appeals for the Second Circuit has held that a law firm’s mistaken filing of a UCC document was effective—even where there was no intent to terminate the underlying lien. In re Motors Liquidation Co. As a result, the mistakenly filed document eliminated the security that a syndicate of lenders had on a $1.5 billion loan to General Motors. General Motors later went bankrupt. The decision, which suggests strict liability in filing UCC documents, serves as a stark warning for lawyers to thoroughly check the work of others.

The Synthetic Lease and Term Loan

In 2001, General Motors entered into a synthetic lease in which it obtained $300 million from a syndicate of lenders led by JP Morgan. Five years later—in an entirely separate transaction—General Motors entered into a term loan for $1.5 billion. JP Morgan again served as administrative agent for the syndicate for the term loan. Both transactions were secured, which required UCC-1s to be filed.

In 2008, General Motors advised its lawyers that it planned to pay off the synthetic lease. Its lawyers prepared a closing checklist to terminate the lenders’ security interests in property related to the synthetic lease. They prepared UCC-3s in order to terminate the lien created by UCC-1 that had been filed for the synthetic lease. By mistake, they also prepared a UCC-3 to terminate the UCC-1 that had been filed to create a lien for the term loan.

No one at General Motors, JP Morgan, or either of the law firms involved noticed the error, although the draft UCC-3s had been sent to each of them. Indeed, the only comment from JP Morgan’s counsel was to change the references to JP Morgan’s name.

JP Morgan first noticed the mistake after General Motors declared bankruptcy in 2009. JP Morgan argued to the bankruptcy court that since no one had been authorized to file the erroneous UCC-3, it was not effective. The bankruptcy court agreed.

The Unsecured Creditors Committee then appealed to the Second Circuit. The Second Circuit certified a question to the Delaware Supreme Court. It asked whether, in order for a UCC-3 to be effective, a lender must intend to terminate the particular security interest listed on the UCC-3.

Subjective Intent Not Needed for UCC-3 to Be Effective 

The Delaware Supreme Court held that to be effective under Article 9 of the UCC, “it is enough that the secured party authorizes the filing to be made.” Moreover, it held that there is no requirement that the secured party “subjectively intends or otherwise understands the plain terms of its own filing.”

The Second Circuit then turned to the issue of whether General Motors’ counsel had been authorized by JP Morgan to file the UCC-3. JP Morgan’s law firm had multiple opportunities to review the UCC-3s and, at each turn, approved the documents. JP Morgan and its counsel knew that upon closing, General Motors’ counsel was going to file all of the UCC-3s. That was enough: “Nothing more is needed,” reasoned the court. As a result, the mistaken UCC-3 left the $1.5 billion Term Loan unsecured.

A Harsh Lesson?

The unforgiving result concerns some Section leaders. “There was no dispute that this was a mistake,” says Mark A. Platt, Dallas, TX, cochair of the Bankruptcy & Insolvency Litigation Committee of the ABA Section of Litigation. “The Second Circuit could have said, looking at the facts objectively, that the UCC-3 filing was not authorized because the lender did not knowingly approve the filing,” he notes.

Platt also questions JP Morgan’s authority to authorize the filing of the UCC-3. “There is an argument,” he says, “that JP Morgan, acting as agent for a syndicate of lenders, did not have authority to release a lien for a completely different transaction.”

Another observer, though, focuses on how the lender allowed the mistaken UCC-3 to be filed. “In construing what they actually authorized, the courts looked at the UCC-3s that everyone signed off on,” says Michael Brockland, St. Louis, MO, cochair of the Section of Litigation’s Ethics Subcommittee of the Commercial & Business Litigation Committee. “They were filed, and they are presumed to know what is in those UCCs. JP Morgan may have had a stronger argument if it had never seen the UCC-3s,” says Brockland.         

“This case is clearly a cautionary tale that no other lender or outside counsel will want to happen again,” observes Platt. It also serves as a warning about the importance of reviewing the work of others. “This case is a flashing red reminder to check your associates’ work and opposing counsel’s work,” says Brockland.

While the Second Circuit’s opinion focuses mostly on the error that went up the chain of command of the lawyers for General Motors, Brockland observes that “the duty is really on the lawyers who are representing the party who is going to lose an interest.” Here, that duty was on the lawyers for JP Morgan.

Another takeaway, Brockland suggests, is the importance of clear communication with clients. In this instance, JP Morgan had the opportunity to verify the UCC-3. “If a lawyer asks the client to verify information, the lawyer should be clear about the implications of that verification to the client,” says Brockland. That is required by the Rules of Professional Conduct, he explains: “under Rule of Professional Conduct 1.4(b) the lawyer needs to discuss the keys to the transaction, such as here where the client’s security interest would be terminated.”

Secured creditors may wish to change how they approve UCCs. “Unless and until there is a reversal of this case, secured creditors will likely be planning as if this case is generally applicable,” Platt says. “It is clearly a very serious precedent for secured creditors to be mindful of. Lenders and other secured creditors will likely put procedures in place such as making sure that UCC-3s must go through several layers before getting filed.”

Andrew J. Kennedy is an associate editor for Litigation News.

Keywords: UCC, secured party, UCC-3, Article 9, Rules of Professional Conduct 1.4

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