Protecting Perfected Security Interests: JP Morgan’s $1.5 Billion (Lost) Baby

Court of Appeals Second CourtFor Lenders who maintain perfected security interests in collateral and their counsel, the Second Circuit’s recent decision In Re Motors Liquidation Company, et al. will go down in history as a middle of the night sweat inducing source of anxiety. The characters and documents involved are common players in the financial industry: JP Morgan Chase Bank, N.A. was the lender; JP Morgan’s attorney was Simpson Thacher & Bartlett, LLP; General Motors was the borrower; and GM’s attorney was Mayer Brown.

There were two important documents at issue. UCC-1 financing statements are public records perfecting a lender’s secured interest in collateral other than real property. UCC-3 termination statements release of a lender’s secured interest, commonly after a loan is paid in full.

In this recent case, there were three UCC-1 financing statements at play. Two of the three UCC-1 financing statements were to be terminated upon completion of the term of a Synthetic Lease. The third UCC-1 financing statement perfected JP Morgan’s security interest in a second loan, the Main Term Loan, worth $1.5 Billion, or five times the amount of the Synthetic Lease. A series of failures on the part of all parties involved resulted in the release of JP Morgan’s security interest not only in the Synthetic Lease, but also a release of JP Morgan’s perfected security interest in the Main Term Loan.

Here’s a run-down of all the times when the termination error could have been caught. First, the partner in the law firm who had assigned the task of drafting escrow instructions to the associate could have noted the error when reviewing the associate’s escrow checklist. Second, the associate could have noted that one of the UCC-1 financing statements that the paralegal pulled did not relate to the three hundred million dollar Synthetic Lease, but instead applied to a second $1.5 Billion Main Term Loan. Third, upon sending the escrow checklist and termination statements to all parties, any one of them could have noted the error. No one at GM, JP Morgan or their respective attorneys’ offices noted the error. Fourth, JP Morgan could have noted the error when it received the escrow instructions.  Finally, GM could have caught the error before it filed the termination statements.

In light of this inattention to detail, the court found not only that the objective intent of the filed termination statement controlled, but the authority of GM’s counsel extended to filing the termination statement on the wrong loan. The court held that the security interest perfecting the Main Term Loan had been terminated. Had the court found otherwise, it would have rubber stamped actions that showed the parties simply didn’t carefully review their documents prior to filing. In the opinion of the Court, this type of inattention affects the public record and all those who rely on it.

The result isn’t surprising as much as it is attention grabbing. Creditors are responsible for checking and double checking all of the documents that document, perfect, or release secured interests, whether or not those documents are part of the public record. The documents that become routine over time may create a creditor’s greatest exposure to liability. Given that creditors are one of the largest groups to rely on the public record to determine the risk of making a loan, creditors shouldn’t underestimate the importance that a fresh pair of eyes may have in preventing or correcting inadvertent documentation errors. Our Creditor’s Rights and Bankruptcy attorneys would welcome the opportunity to lend a fresh perspective.