Obstacles to Negotiability of Residential Mortgage Notes, Part III

This is the third installment in Max’s analysis of the issues surrounding negotiability of residential mortgage notes, drawing language and analysis from In re Veal but also addressing issues beyond the context of that case.  This segment discusses Article 9. If you haven’t already, you may want to read Part I, a primer on negotiability and Part II on why residential mortgage notes are not negotiable instruments.


Presuming a real estate secured note is a non-negotiable instrument (which itis) and the originator of a given non-negotiable note opts to sell the same then UCC Article 9 applies (as it applies both to sales of secured instruments and secured transactions). In such a case the note must be assigned by the originator/assignor to the assignee AND the assignee MUST pay good and valuable consideration to the assignor in exchange for the assignment.

Thereafter, any further assignment of the non-negotiable note would require full compliance with Article 9 –that is each subsequent assignee must pay good and valuable consideration to the assignor.

In securitized transactions the Pooling and Servicing Agreements (PSAs) constitute such an Article 9 assignment between the Depositor and Trust/Trustee and it includes conditions in addition to those set forth by Article 9 which would represent a threshold requirement in all cases. For example, since the PSAs require an unbroken chain of indorsements on the note from the Originator to the Custodian for the Trust along with actual delivery of the note for each sale in the chain it follows that the notes cannot be acquired simply by the contract of assignment. The drafters of the PSAs have thus imposed a sort of “hybrid Article 3” rule on how the notes must be transferred and delivered with an “unbroken chain of indorsements from the Originator to all intervening parties with the final indorsement to the Trustee for the named trust.” Such additions to the Law of Assignments provided for by Article 9 are specifically allowed by Section 1-302 of the UCC.

Put simply, there can be no mere HOLDER of a non-negotiable note, one is either a proper assignee or not. The requirement for good and valuable consideration is set forth in UCC Section 9-203:

(a) A security interest attaches to collateral when it becomes enforceable against the debtor with respect to the collateral, unless an agreement expressly postpones the time of attachment.
(b) Except as otherwise provided in subdivisions (c) to (i),inclusive, a security interest is enforceable against the debtor and third parties with respect to the collateral only if each of the following conditions is satisfied:
       (1) Value has been given. 
       (2) The debtor has rights in the collateral or the power totransfer rights in the collateral to a secured party.
       (3) One of the following conditions is met:
              (A) The debtor has authenticated a security agreement that provides a description of the collateral and, if the security interest covers timber to be cut, a description of the land concerned.
             (B) The collateral is not a certificated security and is in the possession of the secured party under Section 9-313 pursuant to the debtor’s security agreement.
             (C) The collateral is a certificated security in registered form and the security certificate has been delivered to the secured party under Section 8301 pursuant to the debtor’s security agreement.
             (D) The collateral is deposit accounts, electronic chattelpaper, investment property, letter-of-credit rights, or electronic documents and the secured party has control under Section 7-106, 9-104, 9-105, 9-106, or 9-107 pursuant to the debtor’s security agreement.

It should also be noted that assignment law means a transfer of ownership that does not occur under Article 3. And, it should likewise be noted that the recent draft report of the Permanent Editorial Board of the Uniform Commercial Code specifically states, “the following discussion analyzes the application of these rules to that determination in the case of mortgage notes that are negotiable instruments. The law other than Article 3, including contract law, governs this determination for non-negotiable mortgage notes. That law is beyond the scope of this Report.”

Section 2.01 of the standard PSA provides that the loan notes and the mortgages must be transferred by both indorsement and bycontracts of assignment for valuable consideration. The standard parties are the Seller, the Sponsor, the Depositor and the Trust. The Seller assigns all rights to the Sponsor and the Sponsor in turn executes a similar sale to the Depositor and the Depositor in turn assigns all rights to the Trustee. The typical language provides that each party transfers “all right, title and interest in and to the mortgages and mortgage notes” to the transferee. However, in addition to the law of assignments, Section 2.01 of the standard PSA incorporates the “hybrid Article 3” otherwise agreed provisions allowed by 1-302 of the UCC by requiring that the “original mortgage notes” must also be transferred and delivered and indorsed by all of these parties—the Seller, the Sponsor and the Depositor. The standard language provides that the “original note should have all intervening indorsements from the Originator to all of the intervening parties showing a complete and unbroken chain of indorsements from the Originator with the final indorsement from the Depositor to the Trustee for the trust.”

The PSA terms trump the normal Article 3 and 9 Rules as an otherwise agreed provision under 1-302 of the UCC and therefore the notes in a securitized trust are transferred by assignment and by negotiation by way of the required indorsements. Section 1-302(a) of the UCC states that “except as otherwise provided in subsection (b) or elsewhere in (the Uniform Commercial Code), the effect of the provisions of (the Uniform Commercial Code) may be varied by agreement.” Sub-Section (b) of Section 1-302 then states that the “obligations of good faith, diligence, reasonableness, and careprescribed (the Uniform Commercial Code) may not be disclaimed by agreement. The parties, by agreement, may determine the standard by which the performance of those obligations is measured if those standards are not manifestly unreasonable. Whenever (the Uniform Commercial Code) requires an action to be taken within a reasonable time, a time that is not manifestly unreasonable may be fixed by the agreement.”

Finally, 1-302(c) provides that “the presence in certain provisions of (the Uniform Commercial Code) of the phrase ‘unless otherwise agreed’ or words of similar import, does not imply that the effect of the other provisions not including such words may not be varied by agreement under this section.” The Comments to 1-302 provide among other things that this Section “addresses the effectiveness of contractual provisions that select an exclusive or a non-exclusive” form of transfers and negotiation of instruments.” Also, these Comments make it clear that the parties by agreement may not make an instrument “negotiable” unless it otherwise complies with Section 3-104 of the UCC. Similarly, the Comments state that the parties by agreement may not avoid the applications of UCC Article 9 to a transaction that falls within its scope (See Comments to 9109). And, the Assignment Rules are set and structured by the PSA and the Collateral Mortgage Loan Sales Agreements as the same relate to the PSA.