Beware!! The story brought to us today courtesy of the Second Circuit Court of Appeals (In re: Motor Liquidation Co., 13-2187) is one that should strike fear into the hearts of all bankers and lawyers. It is a cautionary tale of how lack of attention to detail may lead to huge potential losses when dealing with bank releases of collateral.

The Facts

1.  The 2001 Financing. In 2001, JP Morgan acted as the agent on a $300 million financing to General Motors. The 2001 Financing was secured by both real and personal property, and the personal property security interest was perfected by the filing of UCC-1 financing statements in Delaware. 

2.  The 2008 Financing. In 2008, JP Morgan again served as agent on a financing to GM, although this time for $1.5 billion and with a different lender pool. The 2008 Financing was secured by equipment and fixtures, and JP Morgan’s security interest was also perfected by the filing of a UCC-1 financing statement in Delaware. 

3.  The Payoff and Improper UCC termination. In late 2008, GM decided to pay off the 2001 Financing and directed its lawyers to prepare the documents necessary to release JP Morgan’s security interests from the 2001 Financing. GM’s law firm prepared UCC-3 termination statements to release the security interests, but an associate inadvertently included a release of the UCC-1 financing statement related to the 2008 Financing. Neither GM, JP Morgan, nor any of the lawyers for either party noticed the error, and the UCC-3 termination statements (including the termination related to the 2008 Financing) were filed upon JP Morgan’s approval. 

4.  GM Bankruptcy and Litigation. In 2009, GM filed for bankruptcy and the improper termination was discovered. The Unsecured Creditors Committee filed a lawsuit asking the bankruptcy court to hold that JP Morgan was unsecured on the 2008 Financing due to the filing of the termination statement. JP Morgan argued that the filed termination statement was void and invalid because it never authorized the filing of a termination statement related to the 2008 Financing. In other words, JP Morgan argued that its subjective intention should govern regardless of the facial validity of the termination. 

The Second Circuit disagreed. In its January 21, 2015 opinion, the court relied upon an opinion of the Delaware Supreme Court and held that subjective intent was irrelevant since JP Morgan had authorized the filing of the termination statement, even though it was mistaken as to what it was releasing. 
 

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.

5.  The Outcome. It appears that JP Morgan’s $1.5 billion claim in the GM bankruptcy will be treated as unsecured, an outcome that may be hard to explain to the lender pool which thought its lending risk was protected by collateral security.  
 

The Moral

While this case involved outside counsel review, the vast majority of collateral releases are handled internally by banks. It is essential that banks institute proper procedures and oversight protection to ensure that collateral releases are handled properly. As the GM case illustrates, particular caution needs to be paid in situations involving multiple loans to the same borrower. It may be the rare case indeed which involves a mistaken release on a billion dollar loan, but for most lenders, a similar mistake on a much smaller scale will be more than sufficient to ruin the day (or the quarter).   
 

Questions regarding this case update or financial services litigation in North Carolina can be addressed to Will Esser at willesser@parkerpoe.com. This legal update does not constitute the provision of legal advice or the creation of an attorney/client relationship with any party.