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What Else Can a Creditors Committee Do? Maybe Reap $1.5 Billion for Unsecured Creditors (Lender Beware)

JPMorgan Chase & Co. and others (“JPM”) lent $1.5 billion to General Motors Corporation (“Old GM”) under a term loan agreement (the “Term Loan Agreement”).  JPM was the senior secured creditor of Old GM.  Old Gm went into chapter 11 bankruptcy.  Under the terms of the DIP financing approved by the bankruptcy court, proceeds of the DIP loan were used to pay $1.5 billion to JPM for its claims under the Term Loan Agreement.  The unsecured creditors committee formed in the Old GM chapter 11 case (the “Committee”) wants that money back, on the grounds that JPM’s lien is unperfected and that the “strong-arm powers” provided by the Bankruptcy Code thus effectively deprive JPM of any lien at all. The JPM litigation dramatically illustrates how committees can challenge the validity, priority, and extent of liens of secured parties in order to bring (or keep) large amounts of money into the debtor’s estate for the benefit of unsecured creditors.

In 2006, JPM lent the $1.5 billion and Old GM gave JPM a senior security interest on all of its assets to secure repayment of the Term Loan.  Upon execution of the security agreement component of the loan documents, the lien of JPM “attached” to the collateral.  At that point, JPM’s rights to the collateral could be enforced against Old GM.  JPM also caused the filing of a UCC-1 financing statement in the Secretary of State’s office in Delaware (the state of Old GM’s incorporation) with respect to the debt and the collateral.[i]  Thus, the lien of JPM was “perfected” and enforceable against any junior liens on the assets of Old GM: JPM would be paid in full first.

On June 1, 2009, Old GM filed a chapter 11 bankruptcy case in the United States Bankruptcy Court for the Southern District of New York.[ii]   Most of the assets of Old GM were sold shortly thereafter to a new company now known as General Motors Company (“New GM”). [iii]  To finance the sale and liquidation of Old GM, the DIP successfully sought court approval of the United States Department of the Treasury and the Canadian government as DIP lenders under a post-petition DIP lending facility.  From the proceeds of the DIP lending facility, the DIP paid $1.5 billion to JPM to pay off the indebtedness under the Term Loan Agreement.

The DIP paid JPM, but theoretically could have challenged and sought to avoid JPM’s senior lien.  Under Bankruptcy Code section 544(a), the so-called “strong-arm powers,” a bankruptcy trustee or DIP (like Old GM) is deemed to have obtained a judicial lien on all of the debtor’s assets as of the beginning of the case.  That status would not disturb the interests of the holder of a prior perfected lien, for a prior perfected lien will be paid in full before a subsequent judicial lien.  The DIP’s status, however, spells doom for the holder of a prior unperfected lien, because a judicial lien creditor stands ahead of a prior unperfected lienholder with respect to the same collateral.  So, Old GM as DIP had the power to try to show that JPM’s lien is unperfected, and if successful could keep the $1.5 billion (to be distributed to unsecured creditors, where there are no other prior perfected secured creditors).

But Old GM did not have much incentive to do so.  Aware of that, the Committee (as committees do in many cases) worked to have the order approving DIP financing of the debtor also provide that the Committee would have a period of time to investigate the validity, priority and extent of liens on the debtor’s assets (including those of JPM), as well as provide the Committee with the DIP’s power to seek avoidance of those liens under the DIP’s strong-arm powers.[iv]  Without those powers, a successful effort by the Committee to prove that a lien was unperfected would change nothing, for the merely attached lien of a secured creditor would remain enforceable against the collateral.  With the strong-arm powers, however, the successful effort of the Committee, given that the judicial lien creditor status of the DIP trumps that of an unperfected lien-holder, would mean that the collateral (or proceeds from its sale) remains in or is returned to the debtor’s estate for the benefit of unsecured creditors.

Shortly after the bankruptcy case began, counsel for JPM informed the Committee that on October 30, 2008 a UCC-3 termination statement had been filed with respect to UCC-1s that had perfected JPM’s security interests in Term Loan collateral.  A UCC-3 termination statement, usually filed after indebtedness is satisfied, ends the perfected status of any lien to which it applies by terminating the UCC-1 financing statement.  JPM presented affidavits in support of its insistence that it never intended to terminate its security interests in Term Loan collateral.

But how could the unintended UCC-3 filing have happened in the first place?  Simple, really.  JPM and Old GM had respectively retained immense international law firms to handle the Term Loan as well as other loans, called “synthetic leases,” to Old GM..  Old GM indebtedness related to the synthetic leases got satisfied.  GM’s lawyers undertook to prepare UCC-3s to terminate the UCC-1s that JPM had caused to be filed with respect to collateral for the synthetic leases.  GM’s immense international law firm designated a busy associate to handle.  Associate ordered paralegal to identify UCC-1s filed by JPM, and, with the information in hand, prepared UCC-3s that terminate the UCC-1s pertaining to JPM security interests in the synthetic lien collateral and the Term Loan collateral.[v]  No-one at either immense international law firm or GM or JPM caught the error.  The Term Loan-related UCC-3 got filed.

The Committee sued JPM in an adversary proceeding within the chapter 11 case, seeking avoidance of JPM’s lien as unperfected, avoidance and recovery of the transfer of $1.5 billion in proceeds made to JPM after the sale of Old GM assets, and disallowance of any claim of JPM against Old GM until the $1.5 billion is returned to the Old GM bankruptcy estate.

Discovery and summary judgment motions ensued.  The bankruptcy court ruled in JPM’s favor, holding that even though JPM caused the UCC-3 to be filed, it did not mean to terminate its security interests, and therefore that UCC-3 is deemed not to have terminated JPM’s secured status.  More to come in future articles on that decision and subsequent events as the case makes its way through an appeal (of course it was appealed – we are talking $1.5 billion dollars!) to the Second Circuit Court of Appeals.

[i]     Actually, JPM caused 28 separate UCC-1 financing statements to be filed with respect to collateral securing the Term Loan.  We simplify for clarity of this discussion.

[ii]   General Motors Corporation filed one chapter 11 case and affiliated companies filed other chapter 11 cases at the same time.  All of these cases were jointly administered.  We shall refer to the “Old GM case” in the singular for simplicity’s sake.

[iii]   Old GM was renamed Motors Liquidation Company.  We will nevertheless call the debtor “Old GM” throughout our discussion.

[iv]  Granting the committee such powers is  a way of purchasing committee acquiescence to the other terms in a DIP loan facility.  See here for potential objections a committee may make to a DIP loan facility.  A committee may acquire the DIP’s strong-arm powers by other means, such as by requesting the DIP to exercise them with respect to a particular matter, and then moving successfully to be granted such powers based upon the DIP’s unjustified refusal to exercise the power.

[v]    The paralegal had been unfamiliar with the transaction or the purpose of the associate’s request, which was to search for UCC-1 financing statements filed against Old GM in Delaware.  Note to self and to everyone else: to treat a paralegal like a cog can destroy the value sought from his or her services.

About Christopher M. Cahill

Mr. Cahill is a Senior Counsel at Dykema, in Chicago, Illinois. In addition to a wide variety of corporate work, including with respect to digital assets, he guides secured lenders, creditors, debtors, creditors’ committees, potential purchasers and others through bankruptcy cases, out-of-court workouts, assignments for the benefit of creditors, and receiverships. Mr. Cahill has substantial…

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Christopher M. Cahill