By Paul Hodnefield, Esq.
It is not unusual for a secured party to discover that a third party has “terminated” its financing statement without permission. What remedies does UCC Article 9 provide a secured party against the unauthorized filer? Perhaps none, at least that was the outcome of a recent case, Fjellin v. Penning, 2014 U.S. Dist. LEXIS 121763 (D. Nebr. Sept. 2, 2014).
Four M Corporation (“Four M”) operated three Dairy Queen stores in Nebraska. Between 2009 and 2011, Four M borrowed money on three occasions from one of its stockholders, the Van Liew Living Trust (collectively with its trustees, the “Trust”). To secure the repayment obligations, Four M granted the Trust a security interest in certain property, including the Dairy Queen stores. The Trust perfected its security interest by filing a UCC financing statement with the Nebraska Secretary of State.
In early 2012, Four M entered into an agreement to sell the assets of its Dairy Queen stores to a third party. Four M’s outside legal counsel, Kaplan and his law firm (collectively, “Kaplan”), represented the company in the transaction. Kaplan prepared all the relevant agreements and other sales documentation. Kaplan did not represent the Trust for this transaction, only Four M.
The sale closed on April 11, 2012, for the purchase price of $1,035,000. However, the Trust never consented to the sale, as was required by the security agreements executed by Four M. A few days later, Kaplan filed a UCC3 amendment to terminate the Trust’s financing statement. The Trust did not authorize Kaplan to file the termination statement.
Another stockholder, Penning, allegedly misappropriated the proceeds of the sale. Instead of paying the entire amount due on secured obligation to the Trust from the sale proceeds, Penning sent only a partial payment. After that payment, the Trust was still owed $129,550.
The Trust filed suit against both Penning and Kaplan. With respect to Kaplan, the Trust brought two claims. The first claim asserted that Kaplan was liable for damages under UCC § 9-625 for filing a termination statement without the Trust’s authorization. The second claim alleged that Kaplan was negligent for failing to ensure that the secured debt owed to the Trust was paid in full before terminating the financing statement.
Kaplan brought a motion to dismiss both of the Trust’s claims. In support of the motions, Kaplan argued that § 9-625 only applied to actions by the secured party, not counsel for the debtor. With respect to the negligence claim, Kaplan asserted there was no causal relationship between the termination statement filing and the Trust’s damages. The court agreed with Kaplan on both counts.
After reviewing the official comments to § 9-625 and secondary sources, the court concluded that the section applied only to secured parties that violate Article 9. Because Kaplan was not a secured party, the court concluded that § 9-625 did not provide a remedy for the alleged violation of Article 9. The court, therefore, granted Kaplan’s motion to dismiss this claim.
With respect to the negligence claim, the court found no causation between Kaplan’s acts and the Trust’s alleged damages. Even if the termination statement rendered the security interest unperfected, it did not make the security interest invalid. The Trust’s security interest remained valid even after sale of the collateral. The Trust could have exercised its rights against the proceeds of the collateral pursuant to the security agreement.
The court found that the Trust failed to plead a causal connection between the termination and damages cause by Penning’s failure to pay the secured obligation out of the sale proceeds. Therefore, the court dismissed the negligence count against Kaplan.
The court did overlook some issues that might have made a difference in this case and this may not be the final decision. The court granted the Trust leave to amend its complaint to assert other claims against Kaplan. It is quite possible that this is not the last we’ll hear of this case.
There is one important point to take away from this case. A secured party should not rely on § 9-625 to provide a remedy for damages or equitable relief after a third party files an unauthorized amendment. However, that does not mean a secured party has no remedy.
Arguably, the secured party does not have to take any action if it did not authorize the filing of a termination statement. An unauthorized termination statement is not effective. The secured party remains perfected despite the filing of an unauthorized termination statement by another party.
Nevertheless, there are measures a secured party can take if it discovers an unauthorized termination statement. The 2010 Amendments to Article 9 amended § 9-518 to expressly allow the secured party to file an information statement if it believes an amendment was filed without its authorization. Moreover, the law of the state where the UCC record was filed may provide remedies under law other than Article 9, such as a properly pleaded common law negligence claim.
Paul Hodnefield is Associate General Counsel for CSC and a frequent speaker/writer on UCC due diligence issues. Please feel free to contact him with questions or comments at phodnefi@cscinfo.com or 800-927-9801, ext. 62375.