Recently, three court cases were published that set forth somewhat contradictory obligations for secured parties. The first case, Roswell Capital Partners LLC v. Alternative Construction Technologies, contradicts both policy and statutory language of Article 9 of the UCC, while creating obligations for secured parties not intended by the statute. The second and third cases, In Re: Charles Clifford McGee, and Deere & Company v. New Holland, are more consistent with the Article 9 policy of “notice filing”.
Over the next three days, we will provide the facts, decisions and implications of these three cases. We think you’ll be surprised by the potential repercussions allowed by Roswell, and the inconsistencies demonstrated by looking at the three cases holistically.
Contributed by Tim Hall, Managing Attorney, CT Corporation
Roswell Capital Partners LLC v. Alternative Construction Technologies (USDC – Southern District of NY). September 1, 2010
Facts: While the facts in Roswell are numerous, the following is a brief summation: JMB Associates provided financing to Alternative Construction Technologies (ACT) via a convertible promissory note dated June 1, 2006. The promissory note contained a provision stating JMB filed a UCC-1 against the assets of ACT, and “ACT shall be required to seek the endorsement of JMB Associates prior to the removal of the UCC-1 upon payment”.
In 2007 and 2008, Roswell Capital provided ACT with two rounds of funding totaling over $6 million. Roswell conditionally expressed it would hold a senior secured priority interest in all of ACT’s assets and the collateral would be free and clear of any liens and encumbrances. On July 2, 2007, ACT filed termination statements against JMB’s financing statements. Three days later, Roswell Capital filed a UCC-1 to perfect its security interest.
JMB disputed the validity of the UCC-3 termination statements, as ACT had not complied with the conditions of the promissory note.
At Issue: Was the UCC-3 termination filed by Roswell ineffective, as it did not authorize the debtor to act, and the promissory note specifically required that debtor “seek the endorsement of” JMB Associates prior to the removal of the UCC-1 upon payment?
The Court Decision: The court held that the termination of the financing statement, even if mistaken, releases the creditor’s lien on the property. Further, potential creditors must be able to rely on termination statements filed in the public record, even if they were filed in error and without authorization. In other words, even if the termination statement was not authorized by JMB, it nonetheless extinguished any perfected security interest it had in the collateral.
According to the court, if an unauthorized termination statement is filed, a secured party may seek damages for the extent of its loss under 9-625. Thus, the only remedy afforded JMB under the statute is to bring suit against the debtor for an unauthorized termination statement. When the firm argued that the UCC has adopted a “notice filing” system which contemplates further inquiry into the scope of the security agreement, which thus would require subsequent secured parties to investigate the filing of the UCC termination statement, the court rejected the argument. The court stated it based its reasoning on the fact that RA9 refers only to “financing statements” and not to termination statements.
In addition, the court stated that “The UCC places a burden on monitoring potentially erroneous UCC-3 filings on existing creditors who are aware of the true state of affairs as to their security interests, rather than potential creditors who will not be in a position to know whether a termination statement was authorized or not”.
Our Analysis
The first incorrect analysis by the court is its misunderstanding of the term “financing statement”. A financing statement is by definition (9-102) “a record or records composed of the initial financing statement and any filed record relating to the initial financing statement”. Thus, the term “financing statement” includes the initial UCC-1 and all subsequently filed records such as attachments, UCC-3 filings, UCC-5 filings, etc.
One of the key concepts under RA9 is that of “authorization to file”, and the fact that an unauthorized UCC filing has no legal effect (primarily found in sections 9-509 and 9-510). 9-509(d) allows a party to file a termination statement only when authorized by the secured party, and under limited circumstances by the debtor as provided in 9-513(c). 9-513(c) allows a debtor-authorized termination only if the secured party has failed to file a termination within 20 days after receiving an authenticated demand from the debtor. As neither of these circumstances existed in this case, the termination statement filed by ACT was clearly ineffective.
The court further errs by ignoring JMB’s position that the UCC adopted a “notice filing” system. Clearly, the intent of the drafters was to adopt a “notice filing” system, and various sections of RA9 contemplate that a party searching the UCC index should NOT rely upon that information without further inquiry.
The court provides no logical basis for its assertion that “the UCC places a burden on monitoring potentially erroneous UCC-3 filings on existing creditors”, nor does the court point to any statutory authority to support such a declaration. The court’s position is also inconsistent with the rest of its opinion. If a secured party were to follow the court’s recommendation and monitor for potentially erroneous UCC-3 filings, the remainder of the opinion indicates that there is nothing a secured party can do if a erroneous/fraudulent UCC-3 filing is uncovered. The filing is nonetheless terminated, and the existing creditor is still unsecured.
What do you think of the court’s decision? Use the “Comments” function of this post to start your own discussions, and check back tomorrow for details on In Re: Charles Clifford McGee.
Tim Hall has been with CT Corporation for more than 13 years. He spent his first three years as a Team Leader for a UCC Service team, and has been with the Government Relations Team for the past ten years. He is a graduate of The Ohio State University and the Northern Illinois University College of Law, and is a frequent speaker on Article 9 of the UCC.
