Failure to review paralegal’s error costs $1.5 billion

August 5, 2015

document review

Have you ever had that feeling after reviewing a document, such as a stipulation drafted by the opposing party, that you may have missed something important and inadvertently hurt your client’s interests?

No matter how badly such a mistake could harm your own client’s interests, it’s highly unlikely to even remotely approach the level of harm done by an alleged failure to catch an error by large law firm Simpson Thacher & Bartlett, which cost its then-client JP Morgan Chase just short of $1.5 billion.

The story begins in 2006, when a consortium of lenders loaned $1.5 billion to General Motors, with JP Morgan serving as the loan’s administrative agent, and therefore “owed certain duties to the syndicate of lenders with respect to maintaining and monitoring the term loan collateral.”

In 2008, GM was preparing to pay off an unrelated loan in the amount of $300 million, and the company contacted Mayer Brown LLP, its counsel responsible for the loan, to prepare the necessary paperwork for JP Morgan to be repaid and to release the interests the lenders held in General Motors’ property.

A Mayer Brown partner assigned the work to an associate, who, in turn, asked a paralegal to prepare the list of security interests held by GM’s lenders that would need to be terminated.  According to the Second Circuit, the paralegal “was unfamiliar with the transaction or the purpose of the request,” and essentially only knew to “perform a search for UCC-1 financing statements that had been recorded against General Motors in Delaware.”  The search identified three UCC-1s, only two of which related to the $300 million loan.  The third pertained to the $1.5 billion loan.  Unfortunately, neither the paralegal nor the associate realized this, and the third UCC-1 was included in the UCC-3 statement as a security interest identified for termination.

Here’s where the mistake by Simpson Thacher comes in (and that by JP Morgan, for that matter): the UCC-3 statement was sent for review to General Motors, Mayer Brown, JPMorgan, and Simpson Thacher & Bartlett LLP – and no one caught the mistake.

The mistake apparently went unnoticed until GM filed for Chapter Eleven bankruptcy in June of 2009, shortly after which the error was discovered by Morgan Lewis & Bockius LLP, counsel to JP Morgan in the matter, who then, on behalf of JP Morgan, disclosed the error to the unsecured creditors’ committee in the bankruptcy (a committee’s responsibility is to ensure that the maximum dollar amount is paid to unsecured creditors from the bankruptcy estate).  JP Morgan did not inform any of the other lenders in the $1.5 billion loan consortium of the mistake, however.

On June 25, 2009, the bankruptcy court approved repayment of the loan in full – but subject to the creditors’ committee’s right to investigate and challenge the validity of the loan’s security interest.  GM repaid the loan in full with interest in early July of 2009, which JP Morgan then distributed accordingly to each of the loan’s lenders.

The committee naturally challenged the security interest’s validity, which was upheld by the bankruptcy court (specifically holding that the security interest was not terminated by the erroneous UCC-3 statement).  The creditors’ committee appealed, however, and on January 21 of this year, the Second Circuit reversed, finding that the lenders’ security interest was terminated when the erroneous UCC-3 statement was filed in 2008.

According to a pair of lawsuits by the lenders in the loan consortium aimed at JP Morgan and Simpson Thacher, the lenders didn’t have any notice of any of these proceedings, and only became aware of the full extent of the situation when the lenders were sued by the bankruptcy’s avoidance trust (the successor-in-interest to the creditors’ committee) to recover any funds paid out pursuant to the bankruptcy court’s order on June 25, 2009.

Furthermore, the lenders’ lawsuits against JP Morgan and Simpson Thacher allege that JP Morgan apparently went to significant lengths to conceal the error and the consequences arising therefrom in the seeming hope that the situation could resolve itself without the other lenders ever finding out.  Obviously, that didn’t work out, and JP Morgan could now be facing fraudulent concealment liability in addition to the gross negligence of the 2008 error.

There are likely a number of lessons to be learned from this case, but perhaps the one most applicable to attorneys is the reminder that, regardless of to whom your work is delegated, you are the party ultimately responsible for the final product.  As such, never use a rubber stamp when a thorough review is called for.