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Edward J. Levin: A tale of two inadvertent releases

Consider the following (not so) hypothetical cases.

No. 1. A lender made two loans to the same borrower. The borrower wanted to pay off one of the loans (Loan 1), but not the other (Loan 2). The lender agreed that it would release the financing statements that related to Loan 1. The borrower’s counsel performed a search of financing statements against the borrower and in favor of the lender.  It prepared termination statements to release all of the financing statements it found – inadvertently including a termination statement for the financing statement relating to Loan 2 which was still outstanding.  Lender’s counsel and lender were shown copies of the termination statements before they were filed, and they approved filing them. A year later, after the borrower had filed for bankruptcy, the lender first realized that the financing statement relating to Loan 2 had been released of record even though that loan had not been repaid.

No. 2. A husband and wife sold real property in Maryland and obtained a purchase money mortgage from the purchasers.  The husband and wife assigned that mortgage to a bank as collateral for their own loan.  When that loan was repaid in full, the bank mistakenly filed a release of the mortgage when it intended to re‑assign the mortgage to the husband and wife.

Wouldn’t it seem that the results should be the same in both cases – that inadvertent releases of termination statements either are effective or ineffective – especially if third parties are not adversely affected?  Actually, the answer provided by a recent 2nd Circuit case under the Uniform Commercial Code (the “UCC”) is dramatically different from the decisions that courts have issued under Maryland real property law.

The 2nd Circuit decision in the GM bankruptcy

Case No. 1 above outlines the facts in In re Motors Liquidation, 777 F.3d 100 (2d Cir. 2015).  General Motors Corporation entered into a $300 million synthetic lease transaction (essentially a financing) with JPMorgan Chase Bank, N.A. as administrative agent in 2001. In 2006 General Motors borrowed $1.5 billion under a term loan, also with JPMorgan as administrative agent. The two transactions were not related.

In September 2008, shortly before the maturity of the synthetic lease and in anticipation of paying the final amount due thereunder, General Motors requested that its counsel, Mayer Brown, prepare the documents that would release the relevant collateral for the synthetic lease. Mayer Brown searched the Delaware UCC records to find what financing statements were outstanding showing General Motors as debtor and JPMorgan as creditor, and it found financing statements that were filed in connection with each of the transactions described above – two for the synthetic lease transaction and one for the term loan.

We know where this is going. A Mayer Brown paralegal who did not know that there were two distinct transactions prepared a termination statement (a “UCC-3”) for each of the financing statements (sometimes called “UCC-1s”) that were of record. No one at that firm, no one at Simpson Thacher & Bartlett LLP (counsel to JPMorgan), and no one at JPMorgan noticed the error before all of the UCC-3s were filed. To the contrary, counsel at Simpson Thacher sent notes to Mayer Brown indicating satisfaction with the UCC-3s.

Realizing a mistake

JPMorgan first realized that there was a mistake after General Motors filed for bankruptcy in 2009. Upon discovering the error, JPMorgan advised the Committee of Unsecured Creditors in the General Motors Bankruptcy (the “Committee”) of the unauthorized termination statements. The Committee commenced an action to determine the rights of the parties.

It must be noted that pursuant to the last major revision of Article 9 of the UCC, which has been adopted in all 50 states and the District of Columbia and which became effective in Maryland in 2001, a termination statement does not need to be signed by anyone. However, it must be authorized by the secured party. See UCC §9-509.

In response to motions of the Committee and JPMorgan, the bankruptcy court held that the termination statement for the term loan was unauthorized and therefore ineffective to terminate JPMorgan’s security interest that related to the term loan.

The Committee appealed to the 2nd Circuit, and the 2nd Circuit certified to the Delaware Supreme Court the question of what is necessary for a lender to authorize the filing of a termination statement. Specifically, it asked: Is it enough for a lender to authorize the filing of a particular termination statement that has been filed, or must the lender have intended to terminate the applicable financing statement that the UCC-3 purported to release?

The Delaware Supreme Court opined that “for a termination statement to become effective . . . it is enough that the secured party authorizes the filing to be made.” Official Comm. of Unsecured Creditors of Motors Liquidation Co. v. JPMorgan Chase Bank, N.A., 103 A.3d 1010, 1017-18 (Del. 2014). The Delaware Supreme Court held that this result is consistent with the literal wording of the UCC and that a secured party should be charged with the responsibility of carefully reviewing any termination statement that it authorizes to be filed.

Before the 2nd Circuit, JPMorgan contended that its authorization was only that the financing statements relating to the synthetic lease transaction should be released and that it did not authorize the filing of the mistaken UCC‑3 pertaining to the term loan. However, the 2nd Circuit held that JPMorgan did authorize the filing of the UCC-3 that related to the term loan. The 2nd Circuit found that JPMorgan’s and Simpson Thacher’s communications to Mayer Brown indicated that JPMorgan and its counsel knew that the term loan UCC-3 would be recorded and that JPMorgan assented to the filing of that UCC-3. The 2nd Circuit concluded simply, “Nothing more is needed.”

Therefore, instead of having a secured interest in the collateral described in the financing statement filed for the term loan, JPMorgan will be an unsecured creditor on its $1.5 billion loan.

Maryland cases on inadvertent releases of mortgages

The facts of Case No. 2 stated above are those of Van Schaik v. Van Schaik, 35 Md.App.19 (1977).  In that case, Marie Van Schaik and her husband sold a farm to their son and his wife and took back a purchase money mortgage. Marie and her husband assigned the mortgage to Provident State Bank of Preston, Maryland as security for their own loan. When that loan was paid off, the bank released the mortgage even though it intended to release only the assignment of the mortgage to the bank. Marie Van Schaik filed suit in the Circuit Court for Caroline County for a determination of the rights of the parties. After a hearing the court ordered that the inadvertently released lien of the purchase money deed of trust be restored.

On appeal, the Court of Special Appeals affirmed. The appellate court cited two cases by the Court of Appeals from the 19th century for the proposition that “if a release of mortgage is mistakenly recorded, that release is effective as to subsequent bona fide purchasers, but the mortgage remains valid as between the parties and equity will enforce it.”  The Court of Special Appeals also noted two other Court of Appeals decisions which held that mistakenly released mortgages should be restored so long as junior creditors as of the time of the releases were not adversely affected by the restoration.

Two recent bankruptcy cases follow the holding of Van Schaik.  In In re Hughes, No. 12-14427-DER, 2013 WL 1327119, at *5 (Bankr. D. Md. Mar. 29, 2013), Judge David Rice stated, “In Maryland, it is well settled that “[i]t is black letter law that a certificate of satisfaction recorded by mistake does not release a mortgagee from a lien or from the obligations that the lien secures,” citing Simpson v. Levitsky (In re Levitsky), 401 B.R. 695, 721 (Bankr.D.Md.2008).

Learning from these cases

As the Christmas song goes, when it comes to preparing a termination statement or a release, make a list and check it twice. Better yet, with respect to UCC-3s, review them and the applicable financing statements several times and have someone else check them as well to be sure that the UCC-3 is correct. If a mistaken termination statement is filed, there may be considerable negative consequences.  Some banks are now instructing their outside counsel that whenever their firm files a termination statement or a release, a partner in the law firm must certify to the bank that those documents (a) relate solely to the original filings in the applicable transaction and (b) affect only collateral for that transaction.

Edward J. Levin is chair of the Real Estate Practice Group at Gordon Feinblatt LLC. He may be reached at [email protected] or (410) 576-1900. Sara J. Witman, director of research services at Gordon Feinblatt, contributed to this column.