Filing a UCC-3 Termination Statement – There is No Room for Error

The Delaware Supreme Court ruled last fall that a UCC termination statement inadvertently releasing collateral on a $1.5 billion term loan was valid. The creditor could not later claim it did not intend to include the collateral in its release of other collateral with regard to a different credit facility.   Official Committee of Unsecured Creditors v. JPMorgan Chase Bank, NA (Del. 2014).

The termination statement clearly stated that the security interest on the assets of General Motors held by JPMorgan, among other lenders, was released. But neither the creditors nor General Motors “subjectively intended” to terminate the security interest. The UCC-3 termination statement was intended to apply only to the assets securing another credit facility, not an unrelated term loan. When JPMorgan discovered the mistake it informed the unsecured creditors committee in the General Motors Chapter 11 bankruptcy that the termination statement was filed inadvertently and did not terminate the term loan security interest. The unsecured creditors cried foul and went to court.

JPMorgan claimed that while it authorized the filing (as well as read and approved it) the authorization did not make the filing effective with respect to errors it might contain. The unsecured creditors committee took the position that a termination statement authorized by the secured creditor is effective upon filing regardless of errors.

The applicable provisions of the Delaware UCC (identical language appears in the Iowa UCC) say that the filing of a termination statement by an authorized person has the effect of terminating the financing statement to which it relates. A terminated financing statement ceases to be effective upon this filing. The effectiveness is not subject to the accuracy of the statement.

It makes sense to place the burden of the accuracy of a termination statement on the creditor. To do otherwise would mean that subsequent creditors could not rely on a filed termination statement when making its credit decisions.

The takeaway from this case is obvious. Make sure your termination statements are accurate. And this rule extends to reliance on previously filed financing statements. Make sure there have not been any intervening events that might make the financing statement ineffective. In other words, it’s the little things that will get you down.

-Marc Ward

Fredrikson & Byron, P.A.



Avoiding Bank Liability when a Commercial Customer is Defrauded/UCC Article 4A

As a follow up to our recent cyber-security seminar, you should know about a decision of the Eighth Circuit Court of Appeals regarding whether a bank or a commercial customer bears the risk for a cyber-theft from a client’s account. Choice Escrow v. BancorpSouth, 754 F. 3d 611 (8th Cir., June 11, 2014).

In this case thieves accessed the online bank account of Choice Escrow and Land Title and directed BancorpSouth to wire hundreds of thousands of dollars to a bank account in Cypress. The net loss was $440,000.00. Choice attempted to place responsibility for this loss on the bank. But because the bank followed the procedures of Article 4A of the Uniform Commercial Code (Article 12 of the Iowa UCC) the loss fell on Choice and not the bank.

Iowa UCC Article 12, just like 4A, allows a bank to shift the risk of loss to the commercial customer if the bank and the commercial customer agree to a security procedure designed to protect against fraud if (1) the procedure is a commercially reasonable method, (2) the bank accepted the payment order in good faith, and (3) the bank followed the written instructions of the customer.

Only those security procedures agreed to by the commercial customer count under Article 12 unless the bank offers a commercially reasonable procedure to the customer and the customer declines to use that procedure in favor of another procedure.

The court relied heavily on FFIEC guidance published in 2005 entitled “Authentication in an Internet Banking Environment.” The Guidance noted that most security systems include one or more of the following (1) something the user knows (like a PIN); (2) something the user has (like an ATM card) and (3) something the user is (a person or a fingerprint, for example).

BancorpSouth went further than the Guidance required and provided Choice with four security measures (1) a unique user id and password (2) device authentication software to identify the computer being used (3) dollar limits on daily wire activity and (4) dual control, two persons would have to independently approve the transaction. The court concluded that these four security measures met the requirements of the Guidance and were otherwise commercially reasonable. Choice declined daily dollar limits and dual control.

But technical compliance with the procedures is not enough to get a bank off the hook. A bank must also follow those procedures in good faith by reflecting the customer’s reasonable expectations and its instructions. Choice asserted that these expectations were not met because the bank should have checked the payment orders for irregularities. The court disagreed. Choice knew that bank employees did not see the orders until after the security procedures were complete, and it would be unreasonable to expect the employees to know Choice’s business (it has over 400,000 other customers) and how much would be typically wired (there had been legitimate wires in the past larger than the fraudulent ones). The court thus concluded that the bank met the customer’s reasonable expectations and followed the instructions of the customer with respect to wiring funds. As a result, the bank avoided liability for the fraudulent wire transfers.

The key takeaways from this case are (a) don’t just follow the FFIEC Guidance but go a step further to take into account changes since 2005 (b) it’s difficult to have too many security procedures (c) document the offering of security procedures to customers and whether or not they are accepted (d) provide your customers with a copy of the procedures you will follow with respect to wire and other transfers so they understand what to expect and finally (e) make sure your employees follow those procedures every time.

– Marc Ward


Have No Fear: Non-binding Letters of Intent are Indeed Non-binding Letters of Intent

When it comes to letters of intent, non-binding means non-binding. This principle was affirmed recently by the Delaware Supreme Court, en Banc.

Appriva Medical, Inc. was acquired by ev3, Inc. through a merger of the two companies. The letter of intent contained provisions that neither party disputed were non-binding at the time the LOI was signed with respect to the financial terms of the acquisition. As is typical of letters of intent the letter also contained binding provisions with respect to confidentiality and transferability and a no-shop clause. One of the non-binding financial terms related to earn out payments based on the performance of a particular Appriva product. It stated that “ev3 will commit to funding based on the projections prepared by its management to ensure that there is sufficient capital to achieve the performance milestones detailed above.”

The corollary provision (Section 9.6) that was ultimately agreed to in the merger agreement stated “notwithstanding any other provision in the Agreement to the contrary, from and after the closing [ev3’s] obligation to provide funding [for the product] shall be at [ev3’s] sole discretion, to be exercised in good faith.”

As you can readily see, the parties went from a commitment to provide enough capital to ensure success of the product in the LOI to one based on the acquiror’s sole discretion in the merger agreement.

Appriva argued at the trial that the non-binding provision in the LOI was binding on ev3 despite Section 9.6. It based this claim on the integration clause in the merger agreement that read “This Agreement contains the entire understanding among the parties…and supersede and replace all prior and contemporaneous agreements, understandings, oral or written, with regard to such transactions, other than the Letter of Intent, dated March 15, 2002, as amended.”

The Delaware Supreme Court in ev3, Inc. v. Lesh, (No. 515, 2013; Sept. 30, 2014) concluded that the trial court erred in allowing Appriva to make this argument. A non-binding provision in a letter of intent does not becoming binding merely by referencing it in the acquisition agreement. The reference simply incorporated the binding provisions of the letter of intent into the merger agreement. This is particularly the case when the non-binding provision conflicts with the binding provision on the same subject especially when it begins “notwithstanding any other provision in the Agreement to the contrary.”

Although there is a better way to bring the binding provisions of an LOI into a binding agreement than a blanket reference to the letter, this decision makes sense because (1) the parties were clear what was binding and what was not in the LOI, (2) the negotiations clearly evolved from a commitment to fund product development to a discretionary commitment to be decided by ev3 alone, and (3) Section 9.6 by its terms overrode any other contrary provision.

-Marc Ward

Baur is Back!

When the Iowa Supreme Court released its opinion last summer in Baur v. Baur Farms, Inc., the decision raised concerns over the impact it would have on buy-sell agreements in closely-held corporations. The concerns were generated as much by what the Court did not say as for what it did say. After stating the general principle to be followed in determining whether the actions of majority shareholders were oppressive to the minority, the Supreme Court sent the case back to the trial court to gather more information and decide if the majority shareholder had acted oppressively when it failed to honor the minority shareholder’s demand that his shares be purchased for more than the price stated in the bylaw provision establishing a right of first refusal. The trial court recently issued its opinion on the matter and, finding no evidence of oppression, dismissed the case.

To briefly recap Baur Farms, Inc. was organized in 1966 by two brothers, Merritt and Edward. Their sons, Jack, Dennis and Bob, received their shares in the corporation from their fathers as gifts and inheritance when they passed away.

Jack was not part of the farm operation. Until recently Bob had run the farm before turning day-to-day operations over to a nephew, a son of Dennis who died a few years ago. The original corporate bylaws contained a stock redemption feature at $100 per share. This provision was amended in 1984 to include a buyout provision at either a mutually agreed price or “book value per share of the shareholders’ equity interest in the corporation as determined by the Board of Directors, for internal use only, as of the close of the most recent fiscal year.”

After years of on again, off again negotiations, Jack, the minority shareholder, sued his brother Bob and their family farm corporation alleging oppression on the part of Bob for not purchasing Jack’s shares at the price he demanded.

The Iowa Supreme Court declared in its 2013 Baur decision that majority shareholders act oppressively against minority shareholders when the reasonable expectations of the minority shareholders are frustrated. Those expectations were described as an expectation to share proportionately in a corporation’s profits and net worth. In the key sentence the Court said “majority shareholders act oppressively when, having the corporate financial resources to do so, they fail to satisfy the reasonable expectations of a minority shareholder by paying no return on shareholder equity while declining the minority shareholder’s repeated offers to sell shares for fair value.” The Court also noted that unreasonable transfer restrictions like buy-sell agreements could be unenforceable.

After taking further evidence in the case, the district court considered whether Jack Baur’s reasonable expectations were denied him because (a) the corporation never paid a dividend and (b) the corporation/majority shareholder would not pay him the amount he demanded for his 26% interest in the corporation. The amount Jack asked for far exceeded traditional notions of book value and took only limited account of the tax effect on the corporation.

The non-payment of dividends was handled easily since Jack did not claim that the failure to pay dividends was oppressive conduct and even conceded that farm corporations like Baur Farms should not pay dividends.

The district court also concluded that the price Jack demanded for his shares of stock was not reasonably related to their fair value. The district court had no trouble declaring that it was unreasonable for Jack to expect more than book value as defined in the bylaws. This was especially true in this case because it was Jack who originally suggested the revised bylaw provision in 1984. But then the court added ambiguity to its decision by declaring that fair value means liquidation value.

In coming to this conclusion the district court observed that (1) receiving shares by gift or inheritance will impact the reasonableness of a shareholders expectations; (2) the determination of fair value has to be fair to all shareholders; (3) it is unreasonable to expect a corporation to sell assets or liquidate in order to meet a minority shareholder’s demand for payment; (4) bylaw restrictions, and by extension buy-sell restrictions, matter (5) the reasonableness of a minority shareholder’s expectations must be viewed in light of the burden that those expectations have on the corporation and the remaining shareholders (in this case the tax impact of the transaction and the burden of borrowing money to pay for the shares); and (6) Jack’s expectations can’t be different than Bob’s since they received the shares in the same manner, gift and inheritance, and Jack knew that his father and uncle wanted the business to continue so long as a family member wanted to farm it (that is, liquidating the corporation to satisfy his wish was not reasonable).

The one troubling aspect of the district court’s opinion is the meaning of “fair value.” The district court concluded that it means “the market value of [the corporation’s] assets, discounted to their liquidation value.” I think this means market value net of any tax effects. Does this mean that a buy-sell price restriction at book value or less is unreasonable? Earlier in the opinion the district court said that Jack could not reasonably expect a price other than book value because of the existence of the bylaw provision. So which is it?

The district court’s decision has been appealed to the Supreme Court so the last word has not been spoken. I hope the Court will address the book value versus liquidation value ambiguity, as well as what liquidation value means and whether it is the same as fair value? I don’t think the Court will address whether a buy-sell agreement that provides for payment of less than fair market value net of tax is enforceable or how far the majority needs to go to satisfy the demands of the minority for the fair value of their shares (selling assets, borrowing money, liquidating the company).

For now there is no reason to believe a buy-sell provision that is agreed to by the shareholders and contains a clear and unambiguous calculation of the price to be paid under certain circumstances will not be upheld by the courts, but there is reason to read for the next Baur court opinion very carefully.

-Marc Ward

Series LLC – A Reason to Form an LLC in Iowa, Not Delaware

Forming business entities in Delaware instead of other states is often seen as the more sophisticated approach. And there are often compelling reasons to do so, better developed case law, greater familiarity among corporate practitioners, and a more responsive (some might say captive) legislature reacts quickly to legal developments. But there are virtues to the LLC statutes in other states. Alphonse v. Arch Bay Holdings, LLC (5th Cir. 12/11/3, unpublished) illustrates one good reason to choose a state other than Delaware if a Series LLC is contemplated.

Alphonse’s home was foreclosed on in Louisiana by Arch Bay Holdings, LLC-Series 2010B. After the property was seized and sold at auction, Alphonse brought an action against Arch Bay Holdings, LLC in federal district court under various state and federal statutes for essentially foreclosing on his house through fraudulent means. Note that the action was brought against the Series LLC, not the Series (the circuit court unfortunately described the Series LLC as the “parent company” of the Series).

The circuit court considered res judicata, the internal affairs doctrine, and the Full Faith and Credit Clause on appeal. While the court’s dicta on the internal affairs doctrine and the Full Faith and Credit Clause is troubling (the court overlooked Louisiana’s LLC act provision that declares the laws under which a foreign LLC is organized will govern the liability of its members) the matter of res judicata points out a clear difference between Series LLCs formed in Delaware versus Iowa.

Under Delaware law there are several reasons to conclude that a Series is not a separate legal entity from the Series LLC. If this ambiguity did not exist the circuit court might have come to a different conclusion on the issue of res judicata. In Iowa, if certain conditions are met each Series is a separate legal entity. See for example Iowa Code Section 489.1201(3). For lawyers crafting LLC agreements certainty can be a blessed thing.

-Marc Ward

Nomura v. Cadwalader and Legal Opinion Due Diligence

The question in Nomura Asset Capital Corporation v. Cadwalader, Wickersham & Taft, LLP, 980 NYS 2d 95 (N.Y. App. Div., February 13, 2014) was whether a “red flag” in the due diligence documents was enough to require the law firm rendering a legal opinion in a commercial loan securitization to investigate further notwithstanding a certificate from the client that a loan was an eligible loan under the terms of the financing.

The court affirmed, as modified, the trial court’s dismissal of Cadwalader’s motion for summary judgment on Nomura’s claim of malpractice. The claim was in connection with Cadwalader’s representation of Nomura in a 1997 structuring and issuance of interests in a REMIC trust.   Loans in a REMIC trust must be principally secured by real property.  “Principally secured” means the fair market value of the real property is at least 80% of the loan.  Whether the underlying property meets this test is usually determined by an appraisal of the property.

In this case, the security for one of the loans may not have met the 80% test.  It was not disputed that Cadwalader did not review the appraisals.  The court also concluded that the firm had no duty to do so because it was not standard practice in the industry to do so and the client specifically told them not to as well.

This did not end the inquiry however because of the existence of a “Deal Highlights” document that was faxed to Cadwalader from Nomura several weeks before the issuance of the legal opinion.  In this 39-page document that sounds like a promotional piece, although the court never says, there is a statement that the loan is “secured by the land, building, and operations” of a hospital.  The collateral is also identified as “the land, building and property management (operations)” of the hospital.  Later in the Deal Highlights an alternative appraisal of $40,600,000 excluding operations is revealed.  This was very close to the minimum $40,000,000 necessary to support the $50,000,000 loan.

Based on the two references to operations and the alternative appraisal, the court concluded that a jury could find that the law firm could not reasonably rely on the certificate of the client that all of the loans were REMIC-qualified, and further inquiry was warranted.

While the significance of the “Deal Highlights” might be questioned (neither party submitted it as part of their original exhibits, it only came to light after the trial court asked for a copy when it was referred to during oral arguments).  And the alternative appraisal that was so close to the $40,000,000 floor was just that, an alternative not relied on by Nomura, this case is a reminder that a client’s certificate does not protect a law firm if circumstances make the reliance unwarranted.

-Marc Ward


Iowa Legislature Provides Some Relief from Corporate Financial Disclosure Requirements

Last week Senate File 2200 was signed by the Governor.  This bill amends Iowa Code Section 490.1620 providing some relief from the current law that requires corporations to deliver financial statements to its shareholders.  The revisions exempt corporations with fewer than 100 shareholders from delivering certain financial statements to its shareholders.  A corporation must still deliver the financial statements to a shareholder who requests them.  This should relieve most closely held corporations from the burden of preparing financial statements within a certain period of time, but it is still good practice to keep shareholders informed of the financial condition of the company.

-Marc Ward

Annual Financial Statements Must Now be Delivered to Shareholders

One of the changes to the Iowa Business Corporation Act that went into effect this year is a new requirement that corporations deliver financial statements to their shareholders. These financial statements must include a balance sheet, an income statement and a statement of changes in shareholders' equity.  The financial statements must be sent within 120 days of the end of the fiscal year.  If a corporation has a December 31 fiscal year end, which would be typical, this deadline is April 30. See Iowa Code Section 490.1620.

This change was part of the Business Law Section's overhaul of the IBCA last year, but now we see it as overly burdensome on closely-held corporations and are working on a fix.  In the meantime, you should alert your corporate clients of this new requirement.

-Marc Ward

CLE on 2013 Amendments to the IBCA and the Baur Farms Decision

Drake Law School is sponsoring a Continuing Legal Education program on Friday afternoon, September 20th , from 1:00 to 5:00,

for 3 ½ hours of CLE Credit at the Neal and Bea Smith Law
Center (Legal Clinic), 2400 University Avenue, Des Moines, IA 50311. 

Here is a link to the agenda,
; and  

here is a link to register

I'll be on a panel discussing the recent Baur v. Baur Farms, Inc. decision by the Iowa Supreme Court.

- Marc Ward