Obstacles to Negotiability of Residential Mortgage Notes, Part I

In the series that begins below, Max analyzes the issues surrounding negotiability of residential mortgage notes, drawing some laguage and analysis from the In re Veal ruling, but also addressing the issues more comprehensively and from a broader perspective.  This first segment discusses negotiability generally; subsequent segments will address why residential mortgage notes aren’t negotiable interests and Article 9.


Article 3 of the Uniform Commercial Code carries forward and codifies venerable commercial law rules developed over several centuries during which negotiable instruments played a much different role in commerce than they do today. As stated by Grant Gilmore, Article 3 is not unlike a “museum of antiquities — a treasure house crammed full of ancient artifacts whose use and function have long since been forgotten.” Grant Gilmore, Formalism and the Law of Negotiable Instruments, 13 Creighton L. Rev. 441, 461 (1979). His following quotation is apt and often‐repeated:< “codification . . . preserve[d] the past like a fly in amber.”

In addition, Article 3 does not purport to govern completely the manner in which those ownership interests are transferred. For the rules governing those types of property rights, Article 9 provides the substantive law. UCC § 9‐109(a)(3) (Article 9 “applies to . . . a sale of . . . promissory notes”). Article 9 includes rules, for example, governing the effect of the transfer of a note on any security given for that note such as a mortgage or a deed of trust. As a consequence, Article 9 must be consulted to answer many questions as to who owns or has other property interest in a promissory note. From this it follows that the determination of who holds these property interests will satisfy the inquiry as to who is a real party with the right to enforce the note in any action involving that promissory note.

Unlike Article 3, Article 9 is a relatively recent innovation which attempts, among other things, to regularize nonpossessory financing. It was last completely revised in 1999, although there are currently amendments to that version being offered for adoption by the states.

UCC § 9‐109(a)(3) states that Article 9 applies to any sale of a “promissory note,” which is defined in § 9‐102(a)(65) as “an instrument that evidences a promise to pay a monetary obligation, [or] does not evidence an order to pay . . . .” In turn, an “instrument” under Article 9 is defined as “a negotiable instrument or any other writing that evidences a right to the payment of a monetary obligation, is not itself a security agreement or lease, and is of a type that in ordinary course of business is transferred by delivery with any necessary indorsement or assignment.” UCC § 9‐102(a)(47). See UCC § 9‐203(g) (“The attachment of a security interest in a right to payment or performance secured by a security interest or other lien on personal or real property is also attachment of a security interest in the security interest, mortgage, or other lien.”).

With very few exceptions, the same rules that apply to transactions in which a payment right serves as collateral for an obligation also< apply to transactions in which a payment right is sold outright. See UCC § 9‐203. Rather than contain two parallel sets of rules – one for transactions in which payment rights are collateral and the other for sales of payment rights –Article 9 uses nomenclature conventions to apply one set of rules to both types of transactions. This is accomplished primarily by defining the term “security interest, found in UCC § 1‐201(b)(35), to include not only an interest in property that secures an obligation, but also the right of a purchaser of a payment right such as a promissory note. UCC § 1‐201(b)(35) (The term “security interest” also “includes any interest of a consignor and a buyer of accounts, chattel paper, a payment intangible, or a promissory note in a transaction that is subject to Article 9.”). That is, it transfers a note in a manner not contemplated by Article 3. Article 9 explicitly incorporates definitions found in Article 1. UCC § 9‐102(c).

Even if the note is not a “negotiable instrument,” and thus Article 3 would not directly apply, it may “be appropriate, consistent with the principles stated in § 1‐102(2) [now § 1‐103], for a court to apply one or more provisions of Article 3 to the writing by analogy, taking into account the expectations of the parties and the differences between the writing and an instrument governed by Article 3.” Comment 2 to UCC § 3‐104. See also Fred H. Miller & Alvin C. Harrell, The Law of Modern Payment Systems § 1.03[1][b] (2003).

Continue to Part II