It’s an old saying that lessons are expensive and good lessons are really expensive. A recent 2nd Circuit Case provides a good lesson on attention to detail and, unfortunately, it is also a really expensive lesson to JPMorgan and their attorneys. In the 2nd Circuit’s recent opinion, the Court determined that a UCC3 (termination statement) which “accidently” was filed served to unsecure a $1.5 billion (“BB”) loan which could not be re-secured because of GM’s bankruptcy filing.
A Quick Background
By now you have likely heard about the recent opinion out of the GM bankruptcy case (which is now called “Motors Liquidation”) regarding JPMorgan Chase Bank. However, I will briefly recap for those of you who have not received the emails circulating around.
Before I get into the case, it is helpful to be familiar with two legal concepts. They are the bankruptcy code’s strong arm provisions and perfection and termination of a personal property lien.
- Strong Arm Provisions: This is a legal concept that exists under the Bankruptcy Code. While it is a little complex, the crux of the law is that if there is a defect in a secured creditor’s perfection at the time of the bankruptcy filing, the secured creditor will generally be deemed unsecured. Thus, the bankrupt debtor (and often unsecured creditors) will scour the perfection documents of creditors to determine if any collateral can be un-secured and thereby made free and clear.
- Perfection and Termination: In order to ensure that a secured creditor maintains its secured position to the exclusion of third parties, the secured creditor must perfect its lien. For personal property, this usually means filing a form UCC1 with the state secretary of state. When the secured loan is paid off (or released for some other reason), the secured creditor will file a form UCC3, which terminates the UCC1.
A Tale of Two Loans
In the case, two loans to GM pre-bankruptcy are relevant. One was a secured term in the amount of $1.5BB which was secured by substantially all of GM’s U.S. equipment. The other loan was a loan (a “synthetic lease”) in the amount of $300MM, which had other security. JPMorgan was the agent on both the loans. Both of the loans’ secured interest was perfected by the filing of a UCC1. The $300MM loan had two UCC1s filed and the $1.5BB loan had one UCC1 filed.
Apparently, what happened was GM informed JPMorgan it was going to pay off the $300MM secured obligation. GM instructed its attorney, a Meyer Brown partner, to prepare the documents. The Meyer Brown partner assigned an associate to prepare the closing checklist. The associate assigned a paralegal to run the UCC search to determine which UCC1 to terminate. Unfortunately, the paralegal was not aware of the $1.5BB loan. So, when the Delaware UCC search came up with 3 hits, the paralegal did not know that the 3rd UCC1 secured the $1.5BB loan and only two secured the $300MM loan.
Apparently, no one noticed that all three UCC1 were listed on the closing checklist to be terminate. Apparently, no one checked to be sure that they had the correct UCC1s after the checklist was created and approved by all parties, including the attorneys for JP Morgan. Thereafter, the closing company dutifully filed all UCC3s thereby un-securing the $1.5BB loan.
GM filed bankruptcy without anyone catching the errant UCC3 filing. JPMorgan (who now had bankruptcy counsel) quickly realized there was a problem in light of the strong arm provisions. JPMorgan was promptly sued by the creditors to declare them unsecured. In bankruptcy court, JPMorgan essentially said, “we never meant to release the $1.5BB so therefore the $1.5BB UCC3 was filed without authority and not effective.” (my language, not theirs). The Bankruptcy court agreed.
However, the decision was appealed directly to the 2nd circuit. After certifying a portion to the Delaware Supreme Court, the 2nd Circuit held that JPMorgan authorized the filing of the UCC3 document, even if it didn’t intend the content to release the lien. Thus, the $1.5BB lien was released.
The Request for Rehearing
Unsurprisingly, JPMorgan has recently requested a re-hearing on the matter and seeks to have the entire 2nd Circuit hear why they should not lose their $1.5BB lien.
In their request, JPMorgan frames the issue as a “seismic shift in agency law…”. As part of their argument, JPMorgan infers that the volume of document precluded holding JPMorgan and its attorneys responsible for authorizing the filing of the errant UCC3. Additionally, JP Morgan maintains that up and down the chain of command, no one on the JPMorgan side had any authority to release the liens on the 1.5BB loan.
Whether or not this is a seismic shift in law or the work-a-day application of law to an extremely large amount of money is, for now, an ongoing dispute.
Regardless, the attorneys’ fees alone in this case will make this an extremely expensive lesson for everyone involved. If the loan remains unsecured, the cost of the lesson will be staggering.
Official Committee of Unsecured Creditors of Motors Liquidation Company v. JPMorgan Chase Bank, N.A. (In re Motors Liquidation Company, et al.), cause no. 13-2187 in the United States Court of Appeals for the Second Circuit.