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26 RegisteRNowfoRCfA’s5thANNuAliNteRNAtioNAlleNdiNgCoNfeReNCe,JuNe13-15,loNdoN,www.CfA.Com.
Unauthorized UCC Terminations May Extinguish Secured Lenders’ LiensYou Thought You Had a Priority Lien:
The due diligence is complete, the loan documents are signed and the UCC financing statement has been filed and recorded in the proper jurisdiction. A lender should therefore reasonably anticipate that its priority position will continue to be secured, right? According to a recent case in the Southern District of New York, this expectation may be completely wrong. • By Jason I. Miller, Esq.
theseCuRedleNdeR mAY/JuNe201127
Roswell Capital Partners LLC v.
Alternative Construction Technolo-
gies, 2010 LEXIS 90695 (S.D.N.Y. Sept. 1,
2010) contradicts both the policy and
statutory language of Article 9 of the
Uniform Commercial Code (UCC) and
creates obligations for secured parties
of active oversight of post-closing
UCC filings not intended by statute.
Because this case involves issues of
perfection and priority, lenders and
their counsel are rightly taking notice.
In Roswell, JMB Associates (JMB)
provided financing to Alternative
Construction Technologies (ACT) under a
convertible promissory note dated June
1, 2006. The promissory note permitted
the conversion of ACT’s debt obligation
into ACT equity at JMB’s option. The
promissory note also provided that if
the price of ACT’s shares fell below $2.00,
JMB would have the option to unwind
the transaction and convert the equity
back into debt. The loan closed, JMB
filed a UCC financing statement and JMB
exercised its option to convert the debt
into shares of ACT stock.
Subsequently, Roswell Capital
Partners LLC, as collateral agent for
a group of lenders, negotiated with
ACT in connection with a proposed
additional financing for ACT. Roswell
and the lenders conducted due dili-
gence prior to the funding, and their
inquiries revealed that the prior loans
from JMB to ACT had been converted
into equity.
On June 30, 2007, Roswell and ACT
entered into security agreements un-
der which ACT granted Roswell a sup-
posed first lien on its assets. On July 2,
2007, without prior authorization from
JMB as required by the JMB promis-
sory note, ACT filed a UCC termination
statement terminating JMB’s financing
statement. Three days later, Roswell
filed a UCC financing statement to
perfect its security interest.
In July 2008, ACT’s stock price
dropped below $2.00 per share and
JMB exercised its option to convert
its equity back to debt. JMB asserted
that these actions reconstituted the
original debt evidenced by the June 1,
2006, promissory note. Meanwhile, ACT
defaulted on its loan from Roswell and
Roswell initiated a suit to foreclose
on ACT’s collateral. JMB joined the suit
and disputed the seniority of Roswell’s
security interest, as well as the valid-
ity of the UCC termination statement.
Roswell moved for summary judgment
and the court granted its request.
The court held that the debt-to-
equity conversion extinguished
JMB’s security interest, and therefore
Roswell had a prior perfected security
interest in ACT’s assets. Though it
acknowledged that its decision on the
conversion issue alone was sufficient
to grant Roswell summary judgment,
the court went on to address a second
issue at length: whether the filing of
the UCC termination statement was
effective, despite ACT filing it without
JMB’s express authorization. The court
found for Roswell again.
Although the determination regard-
ing the extinguishment of the security
interest may raise a number of issues,
the court’s holding with respect to
the UCC termination statement is
particularly troublesome. The court
decided that there is a “clear rule” that
filing a termination statement, even
if done so mistakenly, extinguishes a
secured creditor’s lien on the debtor’s
property. The court extended this rule
even further by explaining that “[p]
otential creditors must be able to
rely on termination statements, even
if they were filed in error or without
authorization.”
According to the court, if an un-
authorized termination statement is
filed, the only remedy available to a
secured party is to sue the debtor for
damages and noncompliance under
UCC § 9-625. JMB stressed to the court
that the UCC is a “notice filing” sys-
tem, and it therefore argued that after
becoming aware of the termination
statement, Roswell (like all prospec-
tive lenders in the same situation)
had the duty to investigate further to
ascertain the full state of affairs. The
court rejected this argument on the
grounds that the duty of further inqui-
ry expressed in the Official Comment
to UCC § 9-502 only applies to financ-
ing statements and not to termination
statements. In addition, the court
pronounced that “[t]he 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 in-
terests, rather than potential creditors
who will not be in a position to know
whether a termination statement was
authorized or not.”
The troublesome implications
of this decision are clear. Roswell
supports the proposition that an
unauthorized termination statement
is fully effective in undermining a se-
cured party’s perfection. It also explic-
itly imposes a burden on the secured
party of record to monitor the public
records periodically for unauthorized
and erroneous filings. This new burden
will impose administrative hardships
for lenders and may increase transac-
tion costs for borrowers.
Fortunately, there are reasons se-
cured parties need not panic over the
Roswell decision. The case is flawed
and it will prove difficult for other
courts to follow the reasoning and
conclusions of the court. Moreover,
no other court has previously adopted
the court’s interpretations of Article 9
and the policies underlying it.
In order to highlight the court’s
fundamental errors, below is a discus-
sion of the court’s flawed holdings,
which are central to its opinion, and a
comparison of each error with the text
of Article 9.
Roswell Decision: The provisions of
Article 9 that reference a secured party’s
obligation to conduct further inquiry
apply only to “financing statements” and
not termination statements.
Article 9: The court misinterpreted
the duty of further inquiry here. UCC
9-102(93) defines a “financing state-
ment” as “a record or records com-
posed of the initial financing state-
ment and any filed record relating
to the initial financing statement.”
Accordingly, the term “financing state-
28 RegisteRNowfoRCfA’s5thANNuAliNteRNAtioNAlleNdiNgCoNfeReNCe,JuNe13-15,loNdoN,www.CfA.Com.
full-pAgeAdpAge29
ment” includes the initial UCC financ-
ing statement and all subsequently
filed records, such as attachments,
UCC amendments and terminations,
and UCC information statements. It
is noteworthy that the drafters of
Article 9 generally used the phrase
“initial financing statement” when the
intent was to limit the application of
a certain provision to a UCC financing
statement. Thus, even if the duty of
further inquiry applies to “financing
statements,” it must also apply to
related termination statements.
Roswell Decision: “Even if the termi-
nation statement was not authorized by
[the secured party of record] it, nonethe-
less, extinguishes any perfected security
interest [the secured party] had in the
Collateral . . . This clear rule accords with
the policy of the UCC. Potential credi-
tors must be able to rely on termination
statements filed in the public record,
even if they were filed in error or with-
out authorization.”
Article 9: Putting aside the fact
that the court ignores the specific
requirement in the underlying security
agreement that JMB had to endorse
any termination of its UCC financing
statement for such termination to be
authorized, one of the key concepts
under Article 9 of the UCC is that of
“authorization to file” and the fact
that an unauthorized UCC filing has no
legal effect. Section 9-510(a) provides
that a filed record is effective only to
the extent it was filed by someone au-
thorized to do so under Section 9-509.
Section 9-509(d), in turn, squarely ad-
dresses the filing of UCC amendments
other than those adding collateral
or debtor names (e.g., terminations)
and provides that “a person may file
an amendment . . . only if the secured
party of record authorizes the filing,”
except in certain limited circumstanc-
es not applicable in Roswell. A mistak-
enly filed but authorized termination
statement is effective; however, an
unauthorized termination statement
is not effective.
Roswell Decision: “The UCC there-
fore places the burden of monitoring
for potentially erroneous UCC-3 filings
on existing creditors, who are aware
of the true state of affairs as to their
security interest, rather than potential
creditors who will not be in a position
to know whether a termination state-
ment was authorized or not.”
Article 9: 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
explain how its statement squares
with the text of Article 9. Moreover,
the court’s recommendation to
monitor the public record is intellectu-
ally inconsistent with the rest of its
opinion because, based on the court’s
earlier holding, even if a secured party
discovers an erroneous or fraudu-
lent UCC termination filing, it would
always be too late. The unauthorized
termination statement would have
rendered the UCC financing statement
ineffective upon its filing.
The court erred in dismissing JMB’s
argument that the UCC has adopted
a “notice filing” system. Official Com-
ment No. 2 to UCC § 9-502 makes this
abundantly clear. The filing system
provides searchers merely with inqui-
ry notice. Once the 2010 Amendments
to Article 9 are adopted by the states,
a new Official Comment to Section
9-518 will make this even clearer.
The Roswell case is currently on ap-
peal, but unless the courts withdraw,
overturn or otherwise reject the deci-
sion, the case could cause problems
for secured parties. Competing lend-
ers, bankruptcy trustees and debtors
may cite this case as their authority to
terminate a secured party’s security
interest without authorization.
Until Roswell is reversed, what
should a prudent lender do to protect
itself? First, in any debt-to-equity
reconversion scenario and upon
reconstitution of the debt obligation,
the lender should promptly conduct
a search and file a new UCC financing
statement. As the court suggested,
secured parties should consider taking
steps to monitor their filed financing
statements for unauthorized termina-
tion filings. Many search providers cur-
rently provide such a service and charge
a nominal fee for each filing monitored.
If an unauthorized filing is de-
tected, then a secured party may wish
to evaluate whether to discontinue
funding and freeze any further exten-
sions of credit until the situation is
resolved. Although Article 9 does not
require that a secured party take any
action to remain perfected, a prudent
secured party may want to file a new
financing statement as a precaution-
ary measure and file a UCC Informa-
tion Statement explaining the situa-
tion. The UCC will put any subsequent
searchers on notice of the dispute.
Finally, if any junior creditors stand
in line to receive a windfall as a result
of the unauthorized termination, the
secured party may want to seek sub-
ordination agreements quickly from
such junior creditors. These measures
may prove unnecessary if Roswell is
reversed, but until then, this case pres-
ents an increased risk for lenders. TSL
Jason I. Miller is an associate in Blank Rome
LLP’s New York office. He advises secured
lenders, syndicated loan agents, international
banks, finance companies, creditors, debtors
and equity holders in connection with a wide
range of matters. He can be reached at