Two of America’s largest and most respected law firms accidently released the collateral for a $1.5 billion loan. The debtor, General Motors, was in bankruptcy and its unsecured creditors’ committee successfully resisted attempts to undo the mistake, depriving the syndicate of lenders led by JPMorgan Chase Bank of significant security for its debt including all of the equipment and fixtures at 42 GM facilities. How could this happen? According to the decision of the Court of Appeals, one of the law firms involved delegated too much of the work to an associate and paralegal unfamiliar with the transaction or the purpose of the work being performed. The result was the accidental release of significant collateral that went unnoticed until GM filed for bankruptcy and it was too late to correct the mistake.
On appeal from the bankruptcy court, the United States Court of Appeals for the Second Circuit was asked to determine whether the accidental termination of a UCC financing statement was ineffective because it was filed by mistake and was not authorized by the creditor. (Official Committee of Unsecured Creditors of Motors Liquidation Co v JPMorgan Chase Bank, U.S. Court of Appeals for the Second Circuit, No. 13-2187). The Court of Appeals reversed the bankruptcy court, concluding that although JPMorgan did not intend to terminate its interest in the collateral covered by the financing statement, it authorized the filing and was stuck with the consequence – the loss of its security interest in the collateral securing the $1.5 billion loan.
GM had two loans with two different syndicates of lenders, both led by JPMorgan. There was a $300 million lease financing loan entered into in 2001 and a $1.5 billion term loan entered into in 2006. Both loans were secured by significant GM assets, which security interests were perfected by the filing of various UCC financing statements. In 2008, GM’s $300 million loan was maturing. GM asked its law firm to make arrangements to pay off the loan. A partner at the law firm asked an associate to prepare a closing checklist and draft the necessary documents to pay off the loan and release the collateral securing the loan. The associate, in turn, asked a paralegal to perform a UCC search in Delaware for financing statements filed against GM. The paralegal was not told the purpose of the search. Predictably, the paralegal identified both the financing statements securing the $300 million loan being paid off and the entirely unrelated financing statement for the $1.5 billion loan which was not being paid off. All of the financing statements ended up being identified as needing to be terminated in conjunction with the payoff. GM’s law firm dutifully prepared UCC terminations for each. The closing checklist and closing documents were circulated to JPMorgan and its counsel for approval and were reviewed by GM and its counsel. On October 30, 2008, GM paid off the $300 million loan and the UCC termination statements were filed, including the termination for the $1.5 billion loan. In 2009, GM declared bankruptcy.
The unsecured creditors’ committee asked the bankruptcy court to confirm that the termination statement for the $1.5 billion loan was effective. JPMorgan argued that the termination was ineffective because it was unauthorized. JPMorgan reasoned that it did not intend to terminate its security interest and did not authorize GM or its law firm to terminate it. The committee argued that the only authorization required was JPMorgan’s authorization of the act of filing the termination. The Court agreed, stating “what JPMorgan intended to accomplish, however, is distinct from what actions it authorized be taken on its behalf.” After drafting the erroneous termination, GM’s law firm circulated it to JPMorgan’s managing director and its law firm. Neither JPMorgan nor its law firm objected to the erroneous termination. The Court concluded that JPMorgan may not have intended to terminate the financing statement securing the $1.5 billion loan, but it did authorize the filing of the termination statement that had that effect. “Nothing more is needed,” declared the Court.
Properly documenting loan origination, renewal and termination can involve seemingly mundane tasks, such as performing UCC searches and preparing and filing financing statements and terminations. The temptation is to push the performance of those tasks to the lowest competent level and forget about them. All of the energy instead is spent on the high-level work. But, the best conceived transactions can be undone if the mundane things are not done right. As JPMorgan learned the hard way, it does not do you any good to rely on the largest, most prestigious law firm to perform your work if the little tasks are delegated to people who do not know what they are doing. Delegating the mundane stuff to a paralegal and associate ended up costing the lender its security for a $1.5 billion loan.
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