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When a Billion Dollars has Eight Digits; Taking Authorization Seriously

posted by Melissa Jacoby

CloudytitleMove over, two ships Peerless. Even in legal regimes that prioritize substance over form, errors in the execution of formalities can produce significant consequences and the risk of transactional failure. And even chapter 11 cases featuring quick asset sales can generate litigation over such formalities for years to come. A recent example illustrates both points.  

On March 1, 2013, the United States Bankruptcy Court for the Southern District of New York issued and certified a judgment for direct appeal to the United States Court of Appeals for the Second Circuit. The decision grants summary judgment in Official Committee of Unsecured Creditors of Motors Liquidation Company v. JPMorgan Chase Bank, N.A. et al, adversary proceeding 09-00504, in the GM bankruptcy. The decision already has received in-depth summaries, at least in some law firm bulletins. If the Second Circuit accepts a direct appeal, I aspire to watch the oral arguments, but hope it will be easier to find a seat in the courtroom than in NML v. Argentina.   

A short, crude, stylized version of the facts, all of which happened well before the bankruptcy: the debtor was paying off a $300 million synthetic lease obligation, and a document (UCC-3) was supposed to be filed in the public record terminating the effectiveness of the financing statement perfecting that interest. One of the filed termination statements erroneously referred to a financing statement number relating to a $1.5 billion term loan, not the synthetic lease. Counsel for the debtor had prepared and filed the statement with the wrong number. But it had been shared in advance with counsel for JPMorgan, the administrative agent for secured parties in both deals. No one caught the mistake until after the bankruptcy case was filed. 

But if the document was effective to terminate the financing statement relating to the term loan, the interest securing the term loan would be unperfected unless another method of perfection happened to be in place. And to the extent unperfected, the security interest interest could be avoided in the debtor's bankruptcy under the so-called strong-arm clause (see this prior post for a visual). The potential billion dollar consequences of an eight-digit clerical error should give a jolt to any law school secured transactions class - especially useful during the month of March.

This post is about to digress further here. A perhaps more commonplace authorization issue in the secured transactions world is when secured parties file initial financing statements against debtors that may not be fully authorized, or authorized at all, even though they are not the stereotypical bogus filings. Lenders might "pre-file" financing statements against potential borrowers without their consent, on the theory that a subsequently executed security agreement will authorize them. Article 9 makes crystal clear that such filings require contemporaneous or preexisting debtor authorization, but apparently not all lenders play the game this way. Or, as my colleague Lissa Broome has explored, a lender might be authorized to file a financing statement because the debtor has authenticated a security agrement, but files a statement with a broader collateral description.

These scenarios are entirely different from the GM litigation. But these contexts also deserve rigorous policing of the boundaries of authorized filings. Well beyond the rather unusual facts captured in the judgment certified for appeal, how to construe authorization to cloud, or uncloud, title in the current Article 9 filing system is extremely important to the integrity of commercial law. 

Back to the actual case: applying the law of agency to the GM dispute, the bankruptcy court held that the secured party did not authorize the termination of the financing statement relating to the term loan. The termination statement was therefore ineffective, the security interest associated with the term loan was perfected at the time of bankruptcy, and thus the security interest is not avoidable on these grounds. The opinion granting summary judgment in favor of JPMorgan analyzes the authorization issue in great depth and this Credit Slips post can't do the reasoning justice; interested readers can and should examine it for themselves. As noted above, though, the court certified the decision for direct appeal to the Second Circuit, and the creditors' committee has filed an appeal, with a statement of issues here. Surely I will not be alone in staying tuned.    

Cloud and signature image courtesy of Shutterstock.

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