The holdings of two recent decisions from the Bankruptcy Courts of the Western District of Pennsylvania and the Southern District of New York, handed down within three days of each other in March, both affect the amount of reliance prospective lenders can place in what appear to be validly filed and recorded UCC-3 termination statements.  Both decisions appear to counsel that very limited reliance upon such statements is warranted.

On March 1, 2013, Bankruptcy Judge Robert E. Gerber released his decision in Official Committee of Unsecured Creditors of Motors Liquidation Co. v. JPMorgan Chase Bank, N.A. (“Motors Liquidation”).  This was followed only three days later by Bankruptcy Judge Carlota M. Bohm’s decision in Primerock Real Estate Fund, LP v. Rag East, LP (“Primerock”).

In Motors Liquidation, a syndicate of lenders led by JPMorgan Chase Bank, N.A. (the “Lenders”) made a $1.5 billion term loan in November of 2006 (the “Term Loan”) to General Motors Corporation (“GM”), well before that company’s chapter 11 petition was filed.  (GM was subsequently known as Motors Liquidation Company.)  To perfect the Lenders’ security interest in the collateral for the Term Loan, UCC-1 financing statements were properly filed and recorded in the appropriate recording offices.

In October 2001, the same parties had also entered into a synthetic lease, whose outstanding balance was less than one-tenth the size of the Term Loan (the “Synthetic Lease”).  In October 2008, UCC-3 termination statements were prepared and recorded (the “Termination Statements”), with the intention of terminating the Lenders’ security interest in the Synthetic Lease only.   Unfortunately, because of an error contained in the Termination Statements, they also served to terminate the UCC-1 financing statement which had perfected the Lenders’ security interests with respect to the $1.5 billion Term Loan.[1]

GM later filed for bankruptcy, and the Official Committee of Unsecured Creditors (the “Committee”) sought a determination that, as a result of the Termination Statements, the Lenders’ security interest was unperfected, and its debt under the $1.5 billion Term Loan unsecured.

Judge Gerber made clear from the outset that neither the Lenders nor GM had intended this result.  The Committee argued that, as a matter of law, the intent of GM and the Lenders did not matter.  Judge Gerber analyzed Article 9 as it was amended in 2001.  The Judge found the 2001 amendments to be relevant to the outcome of the decision.  Those amendments, among other things, did away with the requirement that a UCC-3 statement contain an actual signature.  That provision was replaced by one which required that the UCC-3 termination statement be authorized by the secured party (with certain exceptions not relevant here).  Judge Gerber found that whether “an initial statement came to an end” depended upon whether the proper authorization was present.

On a superficial level, one could argue that because GM and its counsel prepared the Termination Statement, and counsel for the Lenders reviewed and approved them before their filing, the Lenders had “authorized” the Termination Statements.

The court noted that UCC §§ 9-509 and 9-510 require that a termination or amendment be authorized in order to be effective.  The issue became what exactly constituted an “authorized” statement?  Here, the Lenders and or their counsel reviewed and approved the Termination Statements prior to their recordation.  Did that not constitute “authorization”?

Because the terms “authorizes” and “authorization” are not defined in Article 9, or anywhere else in the Uniform Commercial Code, the court turned to agency law.  In short, Judge Gerber relied upon the Restatement (Third) of Agency for the propositions that (i) an agent “acts with actual authority when the agent reasonably believes, in accordance with the principal’s manifestations to the agent, that the principal wished the agent so to act”, and (ii) the “focal point for determining whether an agent acted with actual authority is the agent’s reasonable understanding at the time the agent takes action.”

The court found that, based upon these principles of agency law, the Lenders did not give, and GM did not have, actual authority to terminate the security interests with respect to the Term Loan; but that they did have actual authority to terminate the Lenders’ security interest with respect to the Synthetic Lease.

The court noted that the Committee based many of its arguments on case law addressing the pre-2001 Article 9. The court also noted the existence of post-2001 amendment UCC case law which stood for the proposition that “[p]otential creditors must be able to rely on termination statements filed in the public record even if they were filed in error or without authorization.”  Judge Gerber declined to follow this line of reasoning. He held that this proposition was at odds with the amended UCC §§ 9-509, 9-510 and 513(d), which all stand for the proposition that a “filing has legal effect only to the extent that it is authorized.”  As a result, the Motors Liquidation court held that the Termination Statements had no legal effect upon the UCC-1 financing statement which perfected the Lenders’ security interest with respect to the Term Loan.

Judge Gerber granted summary judgment to the Lenders, but took the somewhat unusual step of certifying the court’s judgment for direct appeal to the Court of Appeals for the Second Circuit, finding that the three prongs of 28 U.S.C. § 158 had been met.

Three days after the Motors Liquidation decision, Primerock was published.  Primerock was a real estate lender which held a properly recorded first mortgage on real property, and a validly perfected security interest in the personal property, of RAG East, LP.  The Primerock financing was used by RAG East, LP to purchase a vacant commercial property in Philadelphia.  The same borrower then went on to obtain two subsequent layers of construction financing on the property.

However, at approximately the time of the first round of construction financing, (following the recordation of Primerock’s mortgage and financing statement), a forged UCC-3 termination statement, and “satisfaction piece,” were filed in the proper recording offices, purporting to terminate Primerock’s mortgage on the real property, and its security interest in the personal property of RAG East, LP.

Judge Bohm noted that Primerock, as well as the two subsequent lenders to RAG East, LP, were innocent victims of the forged termination statement and satisfaction piece.

The Primerock court made note of case law standing for the propositions that an innocent mortgagee for value is not bound by secret liens, and that even a bona fide purchaser, or mortgagee for value, will not always prevail despite reliance on public records.  However, Judge Bohm did not find that these rules were relevant in Primerock, as the validity of forged documents, not secret liens, were central to the case.  As a result, Primerock’s mortgage was deemed entitled to priority status, despite the forged satisfaction piece.

As for the forged, and therefore unauthorized, termination statement, Judge Bohm found that Primerock was the only party authorized under these facts to file a termination statement, and had not done so in this case.  Therefore, the forged termination statement was ineffective, and Primerock’s original UCC-1 financing statement continued to be of full legal force and effect.

The Primerock court noted the need for reliance on public records, and stated that the court did not “seek to weaken reliance on public records in any way.”

Judge Gerber may have hit the mark with respect to reliance on the notice filing regime upon which Article 9 of the UCC is based, in a footnote near the end of the lengthy Motors Liquidation decision.  Judge Gerber quoted from Official Comment 2 to UCC § 9-502:

The notice itself indicates merely that a person may have a security interest in the collateral indicated.  Further inquiry from the parties concerned will be necessary to disclose the complete state of affairs.

Judge Gerber did not hesitate to use this Official Comment as a starting point to extrapolate from UCC-1 financing statements to UCC-3 termination statements.  He opined that because the authorization of a previously filed termination statement will usually matter to a prospective lender, that lender “can simply include any necessary further inquiry as part of its due diligence.”

And that may be the central message of both the Motors Liquidation and Primerock decisions: simply ordering an official search of your state’s financing statement records may not be sufficient.  If there are any termination statements, or other amendments to UCC-1 financing statements, in those records, further investigation may be warranted.  Under the new Motors Liquidation regime, UCC-3 termination statements may serve as only an invitation to due diligence on the part of prospective lenders; unless, of course, the Second Circuit Court of Appeals takes up the direct appeal certified by the Motors Liquidation court, and rules differently.