WurstCaseScenario

Those of you who remember the pre-2001 UCC will remember those long lists of collateral descriptions that usually appeared as attachments to the financing statements filed with the state and local filing offices. Remember that?  And do you remember how those attachments were often lost by the filing office?

The 2001 changes simplified this, not only by eliminating the local filing, but also by allowing the term “all  assets” or similar language to be used on the financing statement in order to do away with those extra pages of collateral descriptions.

Keep in mind, however, that while the UCC allows use of the term “all assets” on financing statements the security agreement must reasonably identify the collateral and supergeneric descriptions, while allowed for use in financing statements, are expressly deemed insufficient for the security agreement.

Use of the supergeneric description on a financing statement is strongly recommended.  A November 1, 2017, well-crafted decision from the Bankruptcy Court for the Eastern District of Kentucky highlights the risk of being specific when generic would have been better.

The issue at hand was in the context of disputed use of cash collateral between a Chapter 11 debtor, Lexington Hospitality Group, LLC, and its lender, PCG Credit Partners, LLC (PCG), and whether hotel room charges were personal property or proceeds of real property.

The Court determined that “room revenue” was personal property and not subject to the mortgage.  The Debtor conceded (and the Court agreed) that PCG was secured in the room revenue but argued that PCG’s position was not perfected in the room revenue.  The Court examined the UCC financing statement which was properly filed and noted that:

The Security Agreement grants a lien on “all right, title and interest” of the Debtor in the “Collateral.” [Security Agreement, Art. III.] “Collateral” in the Security Agreement is broadly defined to include all assets of the Debtor, including accounts, general intangibles and payment intangibles…

The Court addressed the collateral descriptions contained in the financing statement which included:

goods, inventory, accounts, deposits, contracts…tangible personal property…The Financing Statement thereafter becomes more specific…[but] [it] does not identify “general intangibles” or “payment intangibles” in its description of the Collateral

The Court ultimately concluded that the room revenues were “payment intangibles”.  The specific description contained in the financing statement neglected to include intangibles (or even  payment intangibles) although they were included in the granting clause contained in the security  agreement.

It does not matter what the parties intended by the security agreement.  Keep in mind that the security agreement is a private writing between the lender and the borrower but the financing statement is a recorded document that puts the world on notice what collateral is encumbered.

Back in the “old days” we would cut and paste the language from the granting clause and attach it to the UCC-1 financing statement.  Since 2001 that became unnecessary when the use of supergeneric descriptions were authorized by the UCC.

Why anyone would not take advantage of using a supergeneric description is beyond me!

I suspect that PCG has learned a costly lesson.

The April 4, 2016 WurstCaseScenario discussed issues raised in the Chapter 11 of The Sports Authority (“TSA”) and the risks of failing to properly perfect interests in consigned goods under Article 9 of the UCC.  The TSA estate benefitted from the errors of intended consignors when what was intended to be consigned inventory was actually property of the TSA estate.

Today we are looking at another issue in the TSA bankruptcy affecting the rights to goods but this time our attention turns from Article 9 to Article 2.

O2Cool manufactured and distributed consumer cooling products originated in China and sold goods to TSA F.O.B. origin.  TSA utilized a complicated supply, delivery and logistics chain.  O2Cool sent a number of Stop Shipment Notices pursuant to UCC 2-705 to Yusen Logistics (Hong Kong) Inc. (“YLHK”), which provided origin cargo management and customs house brokerage services for TSA as well as to OOCL (USA), Inc., an agent for the carrier, Orient Overseas Container Line Limited.

The UCC states that a seller may stop goods from being delivered to a buyer when the seller discovers that the buyer is insolvent and the goods are still in a carrier’s or bailee’s possession.  This right to stop shipment exists until the buyer receives the goods. “Receipt” occurs when the buyer or the buyer’s designated representative takes actual physical possession of the goods. Goods that are in a common carrier’s possession for delivery to the buyer have not been received by the buyer. A seller’s right to stop goods from being delivered persists until the goods reach their final place of delivery.

TSA’s Bankruptcy Court concluded that because the goods were not yet in the physical possession of TSA when O2Cool sent the Stop Shipment Notices, O2Cool had the right to stop shipment of the goods.

The court’s reasoning was that because O2Cool had delivered the goods to YLHK and the goods were still in transit, when O2Cool sent the Stop Shipment Notices a common carrier, and not the buyer, was in possession of the goods.  Thus, O2Cool’s right to stop shipment continued until the goods were in the physical possession of TSA and not when title passed.

The Court next turned to whether notice was given to the proper  party.

The UCC provides that a seller has the right to stop delivery of goods upon discovering that a buyer is insolvent, and that a seller may stop shipment by notifying the bailee so as to “enable the bailee by reasonable diligence to prevent delivery of the goods. The UCC defines a bailee as “a person that by a warehouse receipt, bill of lading, or other document of title acknowledges possession of goods and contracts to deliver them.”

In this case YLHK was not listed as a carrier on the bills of lading and after it received the Stop Shipment Notices, YLHK notified O2Cool that it was neither a carrier nor in possession of the goods.

Article 2 of the UCC states that “a carrier who has issued a non-negotiable bill of lading is not obliged to obey a notification to stop received from a person other than the consignor”.  Consignor is defined as “a person named in a bill of lading as the person from which the goods have been received for shipment”.  Here Orient Overseas issued non-negotiable bills of lading showing another company as “the person from which the goods have been received for shipment.” Thus, the Court concluded that OOCL was not required to obey O2Cool’s Stop Shipment Notices.

Result:  The Stop Shipment Notice was not effective and TSA owns the goods.  Victory for TSA and its secured lenders and a loss to O2Cool and its secured lenders.

Lesson: Secured transactions under Article 9 of the UCC often depend on the workings of other UCC sections such as Article 2.

Some of you may be tired of hearing me run on about the GM-JPMorgan mess.  Remember?  JPMorgan and its counsel authorized the termination of the UCC financing statement securing a $1.5 Billion Syndicated Term Loan.  And despite the General Motors’ bankruptcy judge deciding that JPMorgan did not “intend” to terminate the UCC and that the termination should be void, on appeal the Delaware Supreme Court and the Second Circuit Court of Appeals ruled that the termination statement was “authorized” (even if not intended).  And despite the error the termination statement was effective leaving JPMorgan (and hundreds of co-lenders who invested in that loan) unsecured.

So why am I bringing this up when all of that happened by 2015?

Because the “old” GM Creditors’ Committee is out there trying to collect money that had been paid to JPMorgan and its syndicate prior to the determination that they were unsecured.

But not only is the Committee trying to recover funds from JPMorgan and its syndicate, members of the lending syndicate have brought cross-claims against JPMorgan for having terminated the UCC.  Again by way of reminder, JPMorgan did need to terminate UCCs –  but not for the $1.5 Billion Term Loan.  They needed to release the UCCs securing a much smaller synthetic lease that had gone its term.  It was the error of those who were charged with unwinding the synthetic lease who unknowingly authorized the release of the UCCs securing the $1.5 Billion Term Loan.

And you don’t expect JPMorgan to just sit back and let those cross-claimants walk all over it and stick JPM with the entire $1.5 billion bill, do  you?  Oh no!  JPM is raising defenses that come right out of the standard exculpatory provisions intended to protect agents from claims by syndicate members; those standard provisions that are offered to you on a “take it or leave it” basis if you wish to be part of that club and get your funds employed.

At least one of the answers to cross-claims filed by JPM provides:

The claims asserted in the …Cross-Complaint are barred by provisions of the Term Loan Agreement, including: (a) section 8.04 of the Term Loan Agreement, which provides that JPMCB “shall be entitled to rely, and shall be fully protected in relying” upon “advice and statements of legal counsel (including, without limitation, any counsel to the Borrower)”; (b) section 8.02 of the Term Loan Agreement, which permits JPMCB to execute any of its duties “by or through agents or attorneys-in-fact” and states that JPMCB “shall not be responsible for the negligence or misconduct of any agents or attorneys-in-fact selected by it with reasonable care”; (c) section 8.03 of the Term Loan Agreement, which provides that JPMCB shall not be liable “for any action lawfully taken or omitted to be taken by it or such Person under or in connection with this Agreement or any other Loan Document (except for its or such Person’s own gross negligence or willful misconduct)”; and (d) section 8.06 of the Term Loan Agreement, which provides that each lender “expressly acknowledges” that JPMCB has not “made any representations or warranties to it,” and that each lender “represents that it will, independently and without reliance upon the Agent . . . continue to make its own credit analysis, appraisals and decisions” with respect to the Term Loan.

Section 8:03 of the Term Loan Agreement provides, in part:

Exculpatorv Provisions. Neither the Agent nor any of its officers, directors, employees or affiliates shall be (i) liable for any action lawfully taken or omitted to be taken by it or such Person under or in connection with this Agreement or any other Loan Document (except for its or such Person’s own gross negligence or willful misconduct) …. [emphasis added]

Gross negligence is very difficult to prove.  New York courts^[1] have addressed this issue stating:

Gross negligence, however, differs in kind as well as degree from ordinary negligence [citations omitted] “It is conduct that evinces a reckless disregard for the rights of others or ‘smacks’ of intentional wrongdoing”

When you sign on to a syndicate you understand the borrower credit risks you are taking on.  But you are not generally taking on the risk that your agent will release the collateral securing the loan.

This case will continue on for a while.  The cross-claim defendants still have until December 31, 2017, to assert their cross claims against JPM.

Whatever comes of this case keep these exculpatory provisions in mind next time you sign off and join a syndicate and understand what your rights are when what can’t go wrong does go wrong.

Stay tuned.  We will continue to update you from time to time as this case further develops.

^[1] Sutton Park v Guerin, 297 A.D.2d 430

Click below to revisit some of my other articles and posts on the GM matter and similar issues click here:

http://www.rmfpc.com//wp-content/uploads/2015/03/ABF-Journal-March-2011-JPMorgan-Chase..pdf

https://wurstcasescenario.com/general-motors-and-the-second-circuitagain/

http://www.rmfpc.com/wp-content/uploads/2013/11/Mutiny-on-the-Agent-TheSecuredLender_Nov13.pdf

https://wurstcasescenario.com/another-erroneous-release-of-a-ucc/

 

Remember the discussions following JP Morgan as agent inadvertently releasing the UCCs securing its liens on a $1.5 Billion loan? Tired of hearing about it? Well, Bank of Nova Scotia (BONS) managed to survive its inadvertent termination of its lien on a motor vehicle in St Thomas, Virgin Islands. It may be a small case (under $20,000) but the lesson is important.

Mr and Mrs Cornelius brought an action against BONS for having wrongfully repossessed their vehicle which was financed by BONS. Mr. Cornelius had received notice from the BONS that it was terminating its lien. He advised BONS that they were in error, however BONS insisted that the loan had been paid by insurance proceeds (even when Mr. Cornelius) assured that the car had not been in any accident). Monthly installments were to be made as deductions from Mr. Cornelius’ salary. As Mr. Cornelius was trying to correct the error installment payments ceased and BONS repossessed the vehicle while Mr. Cornelius was at work, causing him embarrassment. Mr. Cornelius brought an action for damages. At trial Mr. Cornelius testified that it was always his intent to pay the car loan in accordance with its terms. The Court ruled that BONS wrongfully repossessed the vehicle and awarded damages. BONS appealed.

The Superior Court of the Virgin Islands reversed trial court (which prompted me to share this story with you), as follows (with citations removed).

The UCC does not require that a security interest be perfected by filing or otherwise in order to be valid. … Indeed, the requirements of enforceability of a security interest are listed in subsection 9–203(b), and conspicuously absent from these requirements is perfection. 11A V.I.C. § 9–203(b); (“[A]n unperfected security interest is enforceable against all parties unless the holder of a later-acquired interest qualified under some other provision.”); … (explaining that sections 9–501 and 9–503 of the Uniform Commercial Code as adopted in New York, which are analogous to former 11A V.I.C. §§ 9–501 and 9–503, impose no requirement that a financing statement be filed in order to enable the creditor to effect physical repossession of the property that would otherwise qualify as the collateral).

A security interest attaches when it becomes enforceable against the debtor. 11A V.I.C. § 9–203(a). Therefore, a secured party may take possession of collateral pursuant to a security agreement if the property may be repossessed from the defaulting debtor without a “Breach of Peace.” 11A V.I.C. § 9–609(b) (“A secured party may proceed under subsection (a): … (2) without judicial process if it proceeds without breach of the peace.”). Those portions of Article 9 of the UCC in the form enacted in the Virgin Islands, 11A V.I.C. § 9–201 et seq., are devoid of any language indicating that a security agreement is only effective if perfected. … (“A security agreement is generally effective according to its terms between parties even when it is unperfected.”); … (“A security agreement is not invalid between the parties merely because it was not perfected. Perfection of an interest is important only to insure priority of the lien over intervening third-parties[.]” … (Article 9 “do[es] not require that the secured interest of the creditor be perfected in order to foreclose”).

So why did BONS earn a “get out of jail free card” when JP Morgan and its co- lenders took a $1.5 Billion loss? We need to look at the Bankruptcy Code for that. GM filed for Bankruptcy. Cornelius did not file for bankruptcy. If he had, I suspect there would have been a different outcome. Pursuant to Section 544 of the Bankruptcy Code, upon the filing of a bankruptcy the Trustee becomes a lien creditor. Once its UCC was released (it appears that St. Thomas does not treat motor vehicle liens differently from other personal property) BONS retained its unperfected security interest. Absent an intervening bankruptcy filing, and absent the filing of another lien, BONS was able to enforce its security interest.

Consider if Mr. Cornelius had been less scrupulous and refinanced the vehicle leaving him with a windfall.

Although not as dramatic as the GM situation, an error in terminating a UCC has serious implications. BONS got lucky.

Cornelius v. Bank of Nova Scotia, 2017 WL 3412202 (V.I.).

Let me start with an apology to my readers. I am long overdue for a post. My “day job” has been busy and I have just been unable to set time aside to share my observations on the state of Commercial Finance Law. I will try to catch up. The courts have been busy with both good and bad decisions.

Today, we look at a July 19, 2017, decision from the United States District Court for the District of Kansas. Ericsson Inc., the plaintiff and an account debtor of Stutler Technologies, brought the action against Corefirst Bank &Trust after Ericsson made an erroneous overpayment to Stutler. As you might imagine, after the payment was made and deposited into Stutler’s account at Corefirst, Corefirst applied the payment to debts owed to Corefirst by Stutler.

Stutler sold Ericsson’s goods and services and Ericsson paid Stutler commissions for its sales. Those commissions were deposited into Stutler’s accounts at Corefirst. Stutler was indebted to Corefirst for loans and credit card debts which were secured by a security agreement that, amongst other things, gave Corefirst a right of setoff against funds that came into its possession.

At some point Ericsson realized that it had overpaid Stutler over $120,000 and Stutler notified Corefirst of this occurrence. Ericsson made demands for repayment against both Stutler and Corefirst and subsequently brought an action against Corefirst for money had and received and unjust enrichment.

Corefirst argued that it was a bona fide payee under the Restatement (Third) of Restitution and Unjust Enrichment Section 67. The Court noted that it was clear that Ericsson was entitled to restitution for its mistaken overpayment to Stutler (who was not a party to the lawsuit) BUT did not have rights against Corefirst.

The Court noted that the Restatement (Third) provides a defense to a restitution claim to a payee who takes a payment without notice of any facts underlying a claim for restitution so long as the payee used the funds in satisfaction or reduction of the payee’s valid claim as a creditor of the payor or for another person.

It must be noted that the various Restatements are not “law” but instead serve as guidance. The Court noted that Kansas has not adopted the Restatement but the motion pointed out that Ericsson provided no authority to the contrary. The Court went on to distinguish Ericsson’s situation from a Michigan case where General Motors had erroneously made overpayments to a supplier.

The Michigan Court noted that under Article 9 of the UCC a party’s security interest does not attach to collateral unless “the debtor acquires rights in the collateral” ruling in favor of GM. However, the Kansas Court noted that the GM case predated revisions to Section 67 of the Restatement, and Corefirst was a bona fidepayee of Stutler’s.

The Kansas Court ruled in favor of Corefirst, allowing it the windfall resulting from Ericsson’s erroneous overpayment.

Lesson – Kansas may have applied the childhood rule of “finders keepers – losers weepers” but don’t count on that rule being applied in all of the other 49.

Ericsson v Corefirst 2017 WL 3053646