Sometimes UCC filing errors can only be described as

Transcription

1 March 2013 Vol. 29, No. 3 CLARKS SECURED TRANSACTIONS MONTHLY Documentation Bankruptcy Regulation UCC TERMINATION STATEMENT COVERING $1.5 BILLION LOAN WAS MISTAKEN, UNAUTHORIZED, AND INEFFECTIVE Sometimes UCC filing errors can only be described as colossal. So it was in a recent New York bankruptcy court decision arising out of the 2009 bankruptcy of General Motors. In re Motors Liquidation Co., 2013 Bankr. Lexis 814 (S.D.N.Y. 3/1/13). The central issue in the case was whether the court should give effect to a mistakenly filed termination statement on a $1.5 billion secured loan. Much to the secured lender s relief, the bankruptcy court ruled that the termination statement was unauthorized under the rules of Article 9, and thus was ineffective to render the security interest unperfected. Just as the secured transaction was huge, Judge Gerber s opinion runs to 74 pages. In light of the big-dollar stakes and the significant legal issues involved, the bankruptcy court certified its judgment for direct appeal to the Second Circuit. The two secured transactions. In 2001 a syndicate of banks agented by JPMorgan Chase extended a $300 million Also in This Issue: Pennsylvania Bankruptcy Court Invalidates Fraudulent Termination Statement and Release of Real Estate Mortgage... 4 Auction Sales of Repossessed Cars Were Private Sales Because All Attendees Had to Pay a $1,000 Refundable Fee... 6 Tenth Circuit Validates Security Interests in the Sale Proceeds of FCC Broadcast Licenses... 7 By: Barkley Clark Stinson Morrison Hecker LLP Washington, DC Barbara Clark Commercial Law Institute Washington, DC & Greenwood, VA synthetic lease facility to GM. The proceeds of the loan were used for the acquisition and construction of several pieces of real estate. The loan was secured by the real estate and related fixtures; the security interest was perfected by local fixture filings, plus a filing with the Delaware secretary of state. The Delaware financing statements were filed in 2001 and continued in The synthetic lease matured in About five years later, in 2006, GM entered into a seven-year senior secured term loan facility with a different syndicate of banks, though JPM Chase was also the agent for the term loan. The amount of the term loan, which was wholly unrelated to the synthetic lease, was $1.5 billion, and it was secured by all of GM s equipment and fixtures at 42 manufacturing facilities throughout the U.S. At the closing of the term loan, 28 financing statements were filed against the term loan collateral, two of which were filed with the Delaware secretary of state (GM was a Delaware corporation). The main financing statement for the term loan, filed in Delaware, bore filing number In 2008, GM told its counsel, Mayer Brown, that it planned to repay the synthetic lease facility, which by then had an unpaid balance of $150 million. A Mayer Brown associate had a paralegal do a UCC search to determine what financing statements needed to be terminated. The exact instructions given to the paralegal are not set forth in the ruling. However, it would not be surprising if the evidence showed that the paralegal was asked to identify all financing statements against GM showing JPM Chase as the secured party. Also unclear from the case is whether anyone advised the associate or paralegal that he or she needed to distinguish between the financing statements for the synthetic lease and the term loan. However it happened, the paralegal produced a list of all JPM Chase financing statements on file against GM, and the associate used that list to put together a closing checklist of required documents related to the properties subject to the synthetic lease, including various UCC-1s that needed to be terminated. The documents on the closing list mistakenly included a reference to financing statement as to equipment, fixtures and related collateral located at certain U.S. manufacturing facilities (file number Need more information on specific topics? Call: info.pratt@aspratt.com Visit:

2 Clarks Secured Transactions Monthly Vol. 29, No. 3, March ), file date 11/30/06. Unfortunately, this financing statement related to the term loan, not the lease. No one at Mayer Brown (representing GM), at JPM Chase, or at Simpson Thacher (representing JPM Chase) caught the colossal error. A copy of the original financing statements referred to in the termination statements, which would have called attention to the error, was not attached. Based on the description in the closing checklist, a Mayer Brown paralegal used an outside vendor to file a UCC-3 form with the termination box checked. The UCC-3, on line 1, referred to initial financing statement file # on The mistaken termination statement was duly filed with the Delaware secretary of state on the day the synthetic lease facility was paid in full by GM. It was undisputed that neither GM nor its counsel (who drafted and filed the unrelated termination statement), nor JPM Chase and its counsel (who were provided draft documents before the termination statement was filed) realized that the UCC-3 related to the term loan rather than to the payoff of the synthetic lease. None of the players for either the lease or the term loan intended to affect the term loan in any way much less render the banks security interest unperfected. In fact, a Simpson Thacher lawyer congratulated the Mayer Brown lawyers for a nice job on the documents. The problem came to light only after GM filed bankruptcy in June 2009 and a JPM Chase lawyer from Morgan Lewis discovered the 2008 termination of the term loan financing statement. A DIP financing order authorized full repayment of the $1.5 billion term loan. One month later, the Unsecured Creditors Committee filed an adversary proceeding seeking a determination that the banks security interest was unperfected on the date of bankruptcy and thus was voidable under the strongarm clause, Section 544 of the Bankruptcy Code. The three key UCC rules governing termination statements. Both the Unsecured Creditors Committee and JPM Chase agreed that the Delaware UCC determined whether the banks security interest was still perfected by the original Delaware financing statement. UCC and UCC They also agreed that there were three key UCC provisions regarding the effect of termination statements: (1) Under UCC 9-509(d), a person may file a termination statement only if the secured party of record authorizes the filing; (2) under UCC 9-510(a), a filed termination statement is effective only to the extent it was authorized; and (3) under UCC 9-513(d), upon the filing of a termination statement in the correct filing office, the original financing statement to which the termination statement relates ceases to be effective if filing of the termination statement was authorized by the secured party of record. The argument of the unsecured creditors. The Unsecured Creditors Committee contended that the filing of a termination statement could be authorized even if the filing were mistaken and irrespective of the intent of the parties. In the present case, the debtor and its counsel were authorized by the banks to file a termination statement referring to original financing statement # , even though a review of other loan documents would reveal that the filing number referred to the term loan rather than the synthetic lease. The intent of the parties was to terminate that particular financing statement, based on the filing number. This wasn t a case where the termination statement was filed by a total stranger, such as a disgruntled unsecured creditor. The filing of the termination was authorized, albeit mistakenly. In the present case, if the filed termination statement were given no effect, the record could mislead third parties because the terminated financing statement would not show up on any UCC search. It would be a form of secret lien. Under the Article 9 notice filing principle, it was appropriate that the termination statement identify the prior financing statement by filing number alone, without the need to identify by name the lease transaction that was intended to be terminated. In terms of fault, Article 9 leaves the loss on the party that made the mistake, particularly when the mistake could have been revealed if the original financing statement bearing the filing number had been attached to the termination statement as a matter of due diligence at closing. The unsecured creditors relied heavily upon a leading Fourth Circuit decision, In re Kitchin Equip. Co. of Virginia, Inc., 960 F2d 1242, 17 UCC Rep.2d 322 (4th Cir. 1992), where the secured creditor mistakenly checked the termination box on the UCC-3 rather than the partial release box. The court ruled that the filing was effective to render the lender s entire security interest unperfected, not just to release specific items of collateral that were identified in the filing. It was a mistake, and it was not the lender s intent to terminate, but the termination was dramatic and final under the Article 9 filing scheme. The unsecured creditors also cited other cases that gave effect to a mistaken termination statement. In re Negus- Sons, Inc., 2011 Bankr. LEXIS 2378 (Bankr. D. Neb. 2011), aff d on opinion of BAP, 701 F.3d 534 (8th Cir. 2012); In re Pacific Trencher & Equipment, Inc., 735 F2d 362, 38 UCC Rep (9th Cir. 1984); Roswell Capital Partners LLC v. Alternative Construction Technologies, 2010 U.S. Dist. LEXIS (S.D.N.Y. 2010), aff d on other grounds, 436 Fed. Appx. 34 (2d Cir. 2011); In re Cox Enterprises, Inc., 2009 Bankr. LEXIS 4573 (Bankr. E.D. Ky. 2009); In re Hickory Printing Co. Group, Inc., 479 B.R. 388, 78 UCC Rep.2d 314 (Bankr. W.D.N.C ) (bank 2

3 Vol. 29, No. 3, March 2013 Clarks Secured Transactions Monthly conceded that, while its employee s termination statement was a mistake, it was still authorized). New York bankruptcy court sides with secured lenders. The New York bankruptcy court rejected the unsecured creditors arguments and ruled that the termination statement in the present case was not effective because it had not been authorized by JPM Chase, as required by Article 9. The court conceded that it was initially tempting to doom the lenders to the consequence of their folly or, to speak in general terms, of parties living with their mistakes. But in the court s view it was oversimplistic to conclude that the termination statement filed in the present case was authorized, based on nothing more than its reference to the filing number of the financing statement for the term loan. The key was the meaning of authorization for purposes of Article 9. Although that term is not defined in the statute, UCC incorporates common-law principles of agency law which fill holes left in the statute. The court relied primarily on the Restatement of Agency to analyze the present case in terms of actual authority, apparent authority, and ratification. Applying these principles, the court concluded that there was no authorization given to GM and its counsel by JPM Chase and its counsel to terminate any financing statement related to the term loan. The court looked at a number of the loan documents but relied primarily on a document entitled Synthetic Lease Termination Agreement. Under that document, JPM Chase authorized [GM] to file a termination of any existing Financing Statement relating to the Properties. The terms Financing Statement and Properties were capitalized because they were expressly defined elsewhere in the documents to mean the financing statements filed for the synthetic lease and the properties covered by that lease. They did not refer in any way to the term loan. In short, the secured lender gave authority to the debtor and its counsel to terminate only the filings relating to the synthetic lease, not the term loan. Based on the record, the court could find no facts to support a broader grant of actual, implied or apparent authority, or ratification. The New York court exhaustively analyzed the case law on unauthorized termination statements. It distinguished the cases relied on by the unsecured creditors on two grounds: (1) Some of these cases were decided under the pre-2001 version of Article 9, which does not focus on the principle of secured party authorization in the same detailed way that current Article 9 does. (2) In many of these cases, the filing error was made by employees of the secured lender rather than by third-party agents such as the debtor or debtor s counsel. In the present case, by contrast, the error was made by GM and its counsel, not by the secured lender and its counsel. In the court s view, once authority to document the termination of a loan is delegated by the secured lender to a third party agent, the principle of authorization as found in the rules of Revised Article 9 comes into greater focus and requires a more fact-specific analysis. In reaching its conclusion, the New York court relied on two cases governed by Revised Article 9, where the error was not made in house by the secured lender. In In re A.F. Evans Co., 2009 Bankr. LEXIS 2473 (Bankr. N.D. Cal. 2009), aff d 2011 U.S. Dist..LEXIS (N.D. Cal. 2011), the California bankruptcy court engaged in a factdriven analysis to ascertain whether the requisite authority had been granted. It ultimately concluded that authority to terminate the liens on two items of collateral did not extend to a third, even though a termination statement that covered the third was prepared by third-party agent. In AEG Liquidation Trust v. Toobro N.Y. LLC, 932 N.Y.S.2d 759, 2011 WL (Sup. Ct. N.Y. Co. Comm. Div. 2011), the New York court refused to give effect to a termination statement that was filed by an unknown party. Some thoughts about the New York case: Although this is a close case, we think the bankruptcy court got it right. Lenders like JPMorgan Chase (and their counsel) need to carefully review all financing statements on file when authorizing the filing of any termination statement. A single financing statement may perfect a security interest for multiple loans, or different financing statements by the same secured party may perfect a security interest for different loans. The best practice to accomplish this is debatable. Options to minimize this risk include attaching copies of original financing statements to termination statements for comparison before filing, checklists that require the lender s initials on termination statements (or at least next to a list of termination statements), opinion letters from counsel (which presumably would cause counsel to more carefully review these issues), and UCC insurance (which presumably would cause the insurance company to more carefully review these issues). As the Fourth Circuit has warned, the impact of a mistaken termination can be dramatic and final. In the New York case, the secured creditor ultimately prevailed in the bankruptcy court, but at a huge cost of litigation. Moreover, the Second Circuit looms. Every one of the high-powered lawyers who was involved in the termination of the synthetic lease transaction missed the colossal mistake. There was no procedure in place to identify the synthetic lease financing statements versus the term loan financing statements. 3

4 Clarks Secured Transactions Monthly The most significant aspect of the bankruptcy court s decision is its ruling that Revised Article 9 requires a fact-intensive analysis of the law of agency as it applies to termination of a secured transaction, at least when the documents are prepared by a third-party agent. How would the New York decision have come out if the error had been made by employees of JPM Chase? As the court points out, the case law is unanimous that an in-house mistake is always authorized as a matter of law. Conversely, if the termination statement is filed by a total stranger, or a rogue fraudster, it is clear that it is unauthorized and thus ineffective to wipe out the original financing statement. The New York case was in between these two polar scenarios. Based on this precedent, lenders should consider never filing termination statements but, instead, only authorizing borrowers to file termination statements under clear instruction letters only for the paid-off loan and not any other loan. Another idea in this area is for secured parties to start using box 10 on the UCC amendment form to routinely fill in a description of the reason the termination statement is being filed (e.g., payoff of loan XYZ ). What is a searcher to do in this circumstance? The public record would show that the term loan financing statement had been terminated. Clearly, this case cautions that searchers must circle back with secured parties to verify that all termination statements have been authorized. The UCC search results are only the starting point for an inquiry, not the ending point for analysis. The New York court did a good job of distinguishing the many cases that give effect to a mistaken termination statement where the mistake is made in house by the secured creditor. We do, however, disagree with the court s assumption that the 2001 amendments to Article 9 changed the law in this area. The court cited an article by Harry Sigman, who was on the Revised Article 9 drafting committee. That article states that the current UCC rules requiring that a termination statement be authorized by the secured party don t change prior law, but make explicit what was implicit under the old version of Article 9. Sigman, The Filing System Under Revised Article 9, 73 Am. Bankr. L.J. 61, 71 (1999). Therefore, contrary to the court s suggestion, the pre-2001 case law is not automatically disqualified as precedent in this area. The editors want to thank Paul Hoffmann, a bankruptcy specialist at Stinson Morrison Hecker LLP, for his contributions to this story and our third story. Vol. 29, No. 3, March 2013 PENNSYLVANIA BANKRUPTCY COURT INVALIDATES FRAUDULENT TERMINATION STATEMENT AND RELEASE OF REAL ESTATE MORTGAGE Sometimes things come in bunches. Our prior story reported on a New York decision invalidating a mistaken UCC termination statement on the ground that it was not authorized by the secured lender. Three days later, a Pennsylvania bankruptcy court decision came down that deals with UCC termination statements covering personal property, as well as an unauthorized satisfaction of a real estate mortgage. Like the New York decision, the Pennsylvania court rules in favor of the secured lender, on the ground that the termination statement was not authorized. The Pennsylvania case. In In re Rag East LP, 2013 Bankr. Lexis 796 (Bankr. W.D. Pa. 3/4/13), the debtor was a limited partnership controlled by Erik Sobkiewicz. In the spring of 2011, the debtor obtained a $750,000 loan from Primerock Real Estate Fund LP to finance the acquisition of a building in downtown Philadelphia. The loan was secured by an open-end real estate mortgage and a security agreement covering all of the debtor s personal property; the mortgage was recorded on June 10, and a UCC financing statement was filed. Subsequently, in December 2011, the debtor obtained a construction loan from MileStone Bank in the amount of $350,000; this loan was secured by a mortgage on the real estate and a security agreement; the mortgage was recorded and a financing statement filed in December Neither the debtor nor MileStone contacted Primerock regarding the new financing. After the MileStone mortgage was recorded, a Satisfaction Piece purportedly executed by Primerock was recorded in the county records, ostensibly to release both the prior mortgage and security agreement as part of a refinancing. In fact, the Satisfaction Piece was not authorized by Primerock and was presumably executed by the debtor. The same was true of a termination statement purportedly filed by Primerock in March MileStone had knowledge of the Primerock mortgage when it funded its construction loan, and would not have made the loan without having first priority. MileStone assumed the Satisfaction Piece and UCC termination statement were authorized. Later in March 2012, Zhong Zhuang made a loan to the debtor in the amount of $600,000, and MileStone made another construction loan in the amount of $1.5 million. Both of these new loans were made on the assumption that the Satisfaction Piece and termination statement were effective; neither loan would have been made unless Primerock s first priority with respect to both the real estate and personal property had been eliminated. 4

5 Vol. 29, No. 3, March 2013 Clarks Secured Transactions Monthly Primerock did not discover the unauthorized terminations until after the 2012 MileStone and Zhuang loans were made. When the fraud came to light, the debtor granted a mortgage and security interest to Zhuang, who recorded the mortgage and filed the financing statement. Surveying the wreckage, the court found it readily apparent that Primerock, MileStone and Zhuang were the innocent victims of the forged Satisfaction Piece and unauthorized termination statement. (There was no forgery of the termination statement because Article 9 does not require the secured party to sign the UCC-3.) Prior real estate mortgage remains effective in spite of satisfaction document recording. The Pennsylvania court ruled that the Satisfaction Piece and termination statement were ineffective to give the later secured lenders priority over Primerock. In reaching this result, the court first dealt with the real estate mortgage. Under Pennsylvania law, a recorded Satisfaction Piece serves as evidence that the debtor has fully satisfied the loan and that the mortgagee has released the mortgage lien. However, the Satisfaction Piece is only prima facie evidence, and the mortgagee can rebut the presumption if it can show that it did not authorize the Satisfaction Piece. That burden of proof was easily met in the present case. There was no allegation that Primerock authorized the debtor to record the Satisfaction Piece, or had any prior knowledge that it had been recorded. This wasn t a case of a mistake made by Primerock. The argument the later lenders made was that they prevailed as bona fide mortgagees for value under Pennsylvania case law. The court rejected this argument on the ground that Primerock bore no responsibility for misleading the later lenders. Primerock had not created a secret lien, but had properly recorded its mortgage and took no steps to release it. No facts suggested that it should have questioned the continued validity of its mortgage. Primerock was not fraudulently induced to release its mortgage. Under such circumstances, there were no equities to validate the satisfaction, and the secured lender who recorded its mortgage first must retain top-dog priority. The UCC termination statement was ineffective because it was unauthorized. Turning to the rules governing the efficacy of termination statements, the court came to the same result with respect to the personal property collateral. The termination statement could have no effect because Primerock never authorized the debtor to file it. Therefore, Primerock s first-to-file priority controlled. On this point, the court cited UCC 9-509(d), UCC 9-510(a) and UCC 9-513(d). It noted that there are circumstances when a debtor is authorized to file a termination statement on the secured party s behalf, but this was not one of them. This was not a case where Primerock failed to file a termination statement to which the debtor was entitled, thereby enabling the debtor to take that step on Primerock s behalf. As the financing statement was properly filed in the first place, and the related debt remained unpaid, Primerock was the only one entitled to authorize the filing of a termination statement and did not do so. The Pennsylvania court relied heavily on two cases holding that, under the plain language of Article 9, an unauthorized termination statement is ineffective. AEG Liquidation Trust v. Toobro NY LLC, 932 N.Y.S.2d 759, 2011 WL (N.Y. Sup. Ct. 2011) and In re Negus- Sons, Inc., 460 B.R. 754 (B.A.P. 8th Cir. 2011). The court summed up its ruling this way: The decision in this case was not reached without careful thought, especially with regard to the importance of the recording system and the need for reliance on public records. This court holds those principles in high regard and does not seek to weaken reliance on the public records in any way. However, in light of the forgery and unauthorized termination of Primerock s security interest, this Court agrees that the result under Pennsylvania law is the most equitable. Furthermore, while all three mortgagees are victims of these unauthorized filings, Primerock seems to be the most innocent party under the circumstances. While MileStone loaned funds in 2011, it did so with knowledge of the Primerock Mortgage, as the Satisfaction Piece was not recorded until after the MileStone Mortgage. Some key takeaways. The Pennsylvania case is more straightforward than the New York case discussed in our prior story because it was pretty much stipulated that the Satisfaction Piece and termination statement were not authorized by Primerock. The filing of the termination statement did not involve a mistake, as in the New York case. It is notable that the Pennsylvania court went out of its way to equate the law governing recorded satisfactions of real estate mortgages with the UCC rules governing termination statements. The court assumed that the debtor forged the Satisfaction Piece and filed the termination statement without authority, but it would have been helpful to know if any of the lenders knew or should have known about it. For example, did Primerock know that the debtor was trying to get additional financing, and was any portion of the additional financing used to pay down Primerock? Such facts might have affected the equities of the parties under Pennsylvania decisional law. 5

6 Clarks Secured Transactions Monthly Vol. 29, No. 3, March 2013 The Pennsylvania decision, like the New York decision in our prior story, underscores the need for a secured lender to go beyond the record and to inquire about the authorization for release documents. Presumably all the priority problems in the Pennsylvania case could have been avoided if either of the later lenders had simply called Primerock to confirm the state of affairs on its loan. CORRECTION In the February 2013 issue of this newsletter, we reported on a New Jersey bankruptcy decision holding that a state public utility statute requiring regulatory approval as a condition of granting a security interest in trash trucks and intangible collateral was trumped by the free-assignability rules of UCC and UCC Forman v. Carver Federal Savings Bank, 79 UCC Rep.2d 279, 2012 WL (Bankr. D.N.J. 2012). We criticized the decision on the ground that the Article 9 free-assignability provisions don t apply to tangible collateral such as equipment (the fire trucks). Yet we concluded that the court came to the right result based on a special provision of the New Jersey public utility law that allowed security interests in trash trucks without any regulatory permission. We missed the point that the court was citing UCC and UCC for the proposition that the public utility law could not prohibit the assignment of accounts receivable and general intangibles, not that these provisions applied to the trash trucks. In our story, we did not focus on the intangible collateral covered by the bank s blanket security interest in all the assets of the sanitation company. Although a security interest in that collateral was not protected by the New Jersey public utility law, it was protected by UCC 9-406(f) to the extent it included accounts, and it was protected by UCC 9-408(c) to the extent it included general intangibles, such as sanitation collection routes. For intangible collateral, the UCC provisions did indeed trump the public utility law restrictions. For tangible collateral, such as the trash trucks, the public utility law expressly allowed the attachment of security interests without regulatory approval. In short, the court got it right in ruling for the secured creditor on all points. We apologize for the error, and we thank our subscriber, Frank Peretore, for setting us straight. Mr. Peretore is a member of the Peretore & Peretore P.C. law firm in Sparta, New Jersey. The firm represented the secured creditor in the New Jersey case and briefed the summary judgment motion that carried the day. AUCTION SALES OF REPOSSESSED CARS WERE PRIVATE SALES BECAUSE ALL ATTENDEES HAD TO PAY A $1,000 REFUNDABLE FEE Foreclosure sales under Article 9 can be either public sales or private sales. The difference is important because (1) the pre-disposition disclosures differ and (2) the secured party can t bid at a private sale. The case law generally holds that a public sale is a sale open to the general public (i.e., not just to car dealers) and handled by way of auction. In response to a certified question from the Fourth Circuit, the highest court in Maryland has recently ruled that auctions which charge a refundable $1,000 attendance fee were private sales even though they were publicly advertised and open to the general public for competitive bidding. The Maryland case involved a special piece of consumer credit legislation that required more detailed post-disposition disclosures to the debtor for private sales than for public sales. On the assumption that the auction it used to foreclose on two cars was a public sale, the secured lender gave the wrong notice and thus violated the special Maryland statute. The Maryland case. In Gardner v. Ally Finance, Inc., 2013 WL (Md. 3/1/13), Ally (formerly known as GMAC) entered into two secured transactions under retail installment sales contracts governed by the Maryland Creditor Grantor Closed End Credit Act (CLEC). Upon the consumers default, both cars were repossessed. GMAC then sent a notice to the debtors indicating that its cars would be sold at a public sale conducted by Manheim of Baltimore-Washington on a specific date. The predisposition notices did not mention that members of the public needed to provide a refundable $1,000 cash deposit in order to attend the auction, though the debtors were told that they could attend the auction and bring interested bidders if they wanted to. The auction sales were advertised every Sunday in the Baltimore Sun s classified auction section. The ads mentioned the $1,000 refundable fee. One of the plaintiff consumers tried to attend the auction but was rebuffed because she couldn t pay the deposit. Following the two auction sales, GMAC sent postdisposition notices to the debtors indicating the amount of its deficiency claim, which complied with the CLEC requirements for public sales but did not comply with the more detailed disclosures for private sales. Md. Com Laws (j)(2). The plaintiffs sued GMAC in Maryland federal district court on the theory that GMAC violated the CLEC because the sales of its cars were in reality private sales that required more detailed post-disposition disclosures. GMAC filed a motion for summary judgment on the ground that the sales were public auctions because they were both widely 6

7 Vol. 29, No. 3, March 2013 Clarks Secured Transactions Monthly advertised and open to the public for competitive bidding. The trial court granted the motion, the consumers appealed to the Fourth Circuit, and the appellate court certified the issue to the Maryland court of appeals. Maryland high court finds that auctions were private sales. The court pointed out that neither the CLEC nor the UCC defines the terms public auction or private sale. The court then turned to the legislative history of the CLEC. When the statute was enacted in the early 1980s, it enabled a secured creditor to sell repossessed goods only by public auction. A 1987 amendment added private sales as an alternative to public auctions. The court noted that the 1987 amendments were intended to balance giving the creditor the benefit of the freedom to seek the best resale price on the repossessed goods, with protecting the debtor against collusive and detrimental favored buyer private sales that are not commercially reasonable. The court then looked to Article 9 of the UCC for guidance. In particular, it noted that UCC measures commercial reasonableness not in terms of the proceeds fetched at foreclosure but by the procedures surrounding the sale. The court then reasoned the postsale disclosures in the CLEC were intended to address the potential for collusion to the detriment of the buyer during a private sale and requires [that] greater qualitative and quantitative information be disclosed to the debtor. Based on this legislative history and Maryland case law, the court concluded that openness and transparency are the hallmarks of commercial reasonableness as applied to competitive bidding. The court explained: The public auction concept, as well as CLEC s language, purpose, and design, thus, define the answer to the Certified Question. A public auction requires transparency in the process for its own integrity. The post-sale disclosure requirements for a private sale are implicated when openness and transparency are not present, to enable a debtor to challenge the procedures used to sell a vehicle that affect the amount of the deficiency judgment assessed against the debtor. In the present case, the admission fee obscured transparency because bidders and interested parties would have had to accumulate and part with money, at least temporarily, in order to merely observe the auction. The admission fee shielded the process used to sell Ms. Gardner s and Mr. Scott s cars from observation and, thus, could not constitute a public auction under CLEC. Rather, the sales were, in actuality, private sales subject to the postsale disclosure requirements of Section (j)(2). Some final observations. We think the Maryland Court of Appeals got it wrong. The admission fee was a logical requirement to limit the attendees to serious bidders. The debtor who showed up in this case and did not have the money to pay the admission fee obviously was in no position to make a bid. Requiring auctions to allow non-serious bidders to show up and gawk or potentially disrupt the auctions serves no legitimate purpose. Ironically, this decision may cause lenders to do more private sales, with the admission fee and the post-sale disclosure requirements, instead of trying to conduct public sales with unqualified gawkers. What about a bidder s fee instead of an admission fee? The opinion states that the admission fee in issue must be differentiated from other financial mechanisms employed by auctioneers that are not addressed herein, such as a bidder s fee, which is a deposit charged to an auction attendee who intends to bid and is later refunded to an unsuccessful bidder. An admission fee limits who can attend an auction, but a bidder s fee limits who can bid. How are the statute s purposes advanced by prohibiting admission fees, but potentially allowing bidder s fees? What about other auction requirements? Can the auctioneer require the bidder to produce a credit card to show an ability to pay in advance, even if no provisional charge is made to the card? How about a driver s license to prove who they are (in case the auction is considered a private sale and the secured party must disclose information about the purchaser)? What about Internet auctions? Are they open to the public if (a) limited to registered users, (b) they require advance submission of a credit card, and (c) not every person (particularly the debtor in the particular transactions) has a computer? The case law indicates that Internet auctions are public sales that are considered commercially reasonable. See, e.g., Moore v. Wells Fargo Construction, 903 NE2d 525, 678 UCC Rep.2d 436 (Ind. Ct. App. 2009). The 2010 amendments to Article 9 add language to Comment 2, UCC making it clear that Article 9 permits public and private dispositions conducted over the Internet. TENTH CIRCUIT VALIDATES SECURITY INTERESTS IN THE SALE PROCEEDS OF FCC BROADCAST LICENSES recent decision of the Tenth Circuit validates a A prebankruptcy security interest in the proceeds of a postbankruptcy sale of a broadcast license so long as the sale is approved by the FCC. The court held that the FCC statute prohibiting the assignment of a broadcast license does not 7

8 Clarks Secured Transactions Monthly Vol. 29, No. 3, March 2013 extend to the economic value of the license in the form of sale proceeds. In so ruling, the Tenth Circuit deferred to a 1994 decision by the FCC drawing a distinction between public and private property rights in broadcast licenses. The court applied Section 552 of the Bankruptcy Code, which prohibits postpetition security interests but makes an exception for postpetition proceeds of prepetition security interests. Not surprisingly, the new decision is a godsend to the telecom industry and its secured lenders. The Tenth Circuit case. In In re Tracy Broadcasting Corp., 696 F3d 1051, 78 UCC Rep.2d 987 (10th Cir. 2012), the debtor was a Nebraska communications company whose most valuable asset was an FCC broadcast license. Valley Bank perfected a security interest in all the debtor s general intangibles and proceeds. The debtor made no attempt to sell the license to a third party prior to filing its Chapter 11 bankruptcy petition in An unsecured creditor brought an adversary proceeding to determine the validity of the bank s security interest in the license, in light of the federal statute (47 USC 310(d)) prohibiting assignments of broadcast licenses. The bankruptcy court and the federal district court ruled in favor of the unsecured creditor based on the plain language of the federal statute prohibiting any assignment. On appeal, the Tenth Circuit reversed, holding that federal law permits an FCC licensee to grant a security interest in the economic value of its license, i.e., the proceeds of sale to a third party. The Tenth Circuit also concluded that the Nebraska UCC recognizes that a security interest in the proceeds of a license sale attaches when the licensee enters the security agreement prepetition, regardless of whether a sale is contemplated at that time. Even though the secured lender can t take a security interest in the license itself, its right to future proceeds is a UCC general intangible that attaches prepetition and thus is protected from attack under Section 552 when the proceeds are generated by a postpetition sale of the license to an FCC-approved party. The Tenth Circuit decision held that the federal statute does not forbid security interests that attach to the proceeds of sale, so long as they don t cover the license itself. The decision is notable for the deference it gives to the economic interest/ public interest distinction drawn by the FCC itself in In re Cheskey, 9 FCC 986 (1994). Under the FCC s own analysis, license holders have no property rights in the actual broadcast frequencies themselves as against the federal government, but they do have a property right in the proceeds from a sale of the license, whether it be prebankruptcy or postbankruptcy so long as that sale is approved by the FCC, and they may grant a security interest in that property right. In the Cheskey case, the FCC reversed its prior position. Impact of UCC The Tenth Circuit decision also contains a valuable discussion of how UCC supports free-assignability of sales proceeds for an FCC license as a general intangible. That provision, added in 2001, recognizes and enforces such security interests with respect to regulated property. The Tenth Circuit explained: [Section 9-408] does not by its terms specifically address licenses issued by the federal government. But it overrides state licensing laws that would bar the creation, attachment, and perfection of security interest in state-issued licenses that are essentially identical to the security interest claimed by Valley Bank; and by doing so, it implicitly recognizes the propriety of creation, attachment, and perfection of such security interests in federal licenses when, as here, no federal law is thereby violated. Evaluation of the decision. The Tenth Circuit s approach seems correct. It does not conflict with the federal statute. It gives deference to the position of the FCC itself, as found in the Cheskey decision. It bifurcates the property interest into a private economic benefit piece and a public regulatory piece, which is consistent with the freeassignability principle imbedded in state law in the form of UCC It is consistent with the broad reach of the general intangibles category of collateral under Article 9, which clearly encompasses regulatory property such as licenses. And, as a policy matter, it encourages the flow of secured lending to broadcast licensees without interfering with the regulatory interests of the FCC as licensor. For two other thoughtful decisions in the same vein, see MLQ Investors, L.P. v. Pacific Quadracasting, Inc., 146 F3d 746, 36 UCC Rep.2d 199 (9th Cir. 1998), cert. denied, 525 U.S (1999) and In re TerreStar Networks, Inc., 457 BR 254, 2011 WL (Bankr. SDNY 2011). CLARKS SECURED TRANSACTIONS MONTHLY (ISSN ) is published monthly by A.S. Pratt & Sons, th St. NW, Third Floor, Washington, DC Copyright 2013 THOMPSON MEDIA GROUP LLC. All rights reserved. No part of this newsletter may be reproduced in any form, by microfilm, xerography, or otherwise, or incorporated into any information retrieval system, without the written permission of the copyright owner. For permission to photocopy or use material electronically from Clarks Secured Transactions Monthly (ISSN ) please access www. copyright.com or contact the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, CCC is a not-for-profit organization that provides licenses and registration for a variety of users. For customer service information, call EDITORIAL INQUIRIES: Direct to Catherine Dillon, Managing Editor, A.S. Pratt & Sons. POSTMASTER: Send address changes to CLARKS SECURED TRANSACTIONS MONTHLY, A.S. Pratt & Sons, th St. NW, Third Floor, Washington, DC To order this newsletter, go to or call toll-free This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal or accounting advice or other expert assistance is required, the services of a competent professional should be sought. 885