Updated: Jul 21, 2020
By Dick Lieberman, Consultant and Retired Attorney
Although this blog deals with government contracting, the author couldn’t resist writing about a huge quality control problem, where a huge bank and two big law firms all made a $1.5 billion mistake. This incident demonstrates how crucial a quality control process can be—especially at a bank or a law firm. Government contractors should never short-change their quality program. The incredible story is recounted in In Re Motors Liquidation Co., et al v. Official Committee of Unsecured Creditors v. JP Morgan Chase Bank, No. 13-2187 (2d Cir., Jan. 21, 2015).
In 2001, General Motors (“GM”) obtained a $300 million loan from a group of lenders headed by JPMorgan Chase Bank. The loan was known as the “Synthetic Lease” and JPMorgan was identified in the Uniform Commercial Code (“UCC”) UCC-1 financing statements as the secured party of record. In 2006, GM entered into an unrelated loan for $1.5 billion, known as the “Term Loan,” from a different group of lenders led by JPMorgan Chase. The loan was secured by security interests including all of GM’s equipment at 42 locations throughout the U.S., and JPMorgan perfected the lenders’ security interests in that collateral through the filing of UCC-1 forms.
In September 2008, as the Synthetic Lease was nearing maturity, GM contacted Mayer Brown, LLP, its counsel, and explained that it planned to repay the amount. GM asked Mayer Brown to prepare the documents necessary for JP Morgan and the lenders to be repaid and to release the Synthetic Lease security interests held in GM property. A Mayer Brown partner assigned the work to an associate to prepare the documents to terminate the Synthetic Lease. In order to do so, the associate asked a paralegal who was unfamiliar with the transaction or its purposes to perform a search for UCC-1 financing statements that had been recorded against GM in Delaware. The paralegal found three such UCC-1s. Neither the paralegal nor the associate realized that only the first two UCC-1s related to the Synthetic Lease. The third UCC-1 related to the $1.5B Term Loan.
Mayer Brown prepared the papers to terminate the security interests, but included all three filings, which terminated the Term Loan as well as those in the Synthetic Lease. No one at Mayer Brown, JPMorgan, or its counsel, Simpson Thacher & Bartlett, noticed the error, even though copies of the closing checklist and draft UCC-3 termination statements were sent to individuals at each of these organizations for review. The documents were approved and then filed in Delaware—including the Main Term UCC-3 extinguishing the $1.5 billion security interest.
This issue came up when GM went into bankruptcy, and JPMorgan informed the Unsecured Creditors Committee that the UCC-3 termination statement relating to the Main Term Loan had been “inadvertently filed.” The Committee began an action to state that the loan was no longer secured, and JPMorgan was now an unsecured creditor for the $1.5 billion loan, because the termination statement had been filed. JPMorgan asserted that the filing was inadvertently wrong (they didn’t mean to do it), or was unauthorized, and therefore ineffective.
The Bankruptcy Court held that the termination statement was unauthorized and therefore ineffective because no one at JPMorgan, GM or their law firms had intended that the Term Loan security interest be terminated. On appeal, however, the Second Circuit Court of Appeals reversed, concluding that “although the termination statement mistakenly identified for termination a security interest that the lender did not intend to terminate, the secured lender authorized the filing of the document, and the termination statement was effective to terminate the security interest.” The Court noted that even though there was a mistake in the documents, JPMorgan authorized them to be filed after it and its counsel had reviewed them—so JPMorgan and its counsel knew that the documents were going to be filed, and JPMorgan “reviewed and assented to the filing of the [$1.5 billion UCC-3 termination] statement.”