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The Dilemma of Transferability of Mortgage Loans

2 April 2015
New York Law Journal

We recently discussed in this column some unique issues that apply to security interests in fixtures—being assets that reside at the intersection between real property and personal property.1 This month we continue that theme by addressing issues related to another class of assets that spans both real and personal property, namely, mortgage notes.

As is well-known, the period from the late 1990s until the economic collapse in 2008 witnessed an unprecedented wave of financing of mortgage loans through the issuance of mortgage-backed securities (MBS).2 At the peak of this cycle, nearly 30 million mortgages were originated in the two-year period of 2005-2006, and over $2 trillion dollars of MBS were issued in 2006 alone.3

MBS transactions typically involve the acquisition of large numbers of mortgage loans by a special purpose entity that finances such acquisition through the issuance of debt or beneficial interests. A fundamental feature of these financings is the packaging and then oftentimes multiple transfers of the related mortgage loans.

Current laws clearly do not contemplate nor are they designed to facilitate mass transfers of mortgage notes and related mortgages. As further discussed below, assigning enforcement and other rights with respect to a mortgage loan can in certain circumstances require possession by the assignee of the related note and recordation of the assignment in the real estate records. From an administrative perspective, transferring one mortgage loan is generally a fairly straightforward process, transferring thousands of mortgage loans is not. The Mortgage Electronic Registration System (MERS), implemented in the mid-1990s to assist in the process: transferring the mortgages, did not address the transfer of the related mortgage notes, nor did courts look kindly on the system when challenged by mortgage foreclosure defense lawyers beginning in 2008.4

The fallout from the ensuing financial crisis and dissatisfaction with the existing system for transferring mortgage loans, has caused industry participants and commentators alike to examine more closely the mechanics of mortgage loan transfers and, in certain instances, suggest alternative structures.5 Today we discuss the issues presented in transferring mortgage loans in the context of current financing structures.


A mortgage loan is composed of a promissory note, evidencing the debt of the mortgagor, as well as the lien instrument securing that note—usually in the form of a mortgage or deed of trust. UCC Articles 3 and 96 govern the transfer, ownership and enforcement of mortgage notes. Mortgage promissory notes can be either negotiable or non-negotiable instruments. However, given the inclination of courts to find such promissory notes negotiable,7 we have confined our discussion on mortgage notes to those subject to Article 3.8

The UCC takes a somewhat bifurcated approach to enforcement and ownership of mortgage notes.9Article 3 governs the enforcement of negotiable instruments. Article 9, on the other hand, applies to ownership of both negotiable and non-negotiable notes, including how ownership may be transferred, the effect of transfer on ownership of the related mortgages and the right of the transferee in certain instances to record its interest in the related mortgage records.10 Ownership and enforcement rights may, but don't always, reside within the same person.11 An obvious example is a mortgage servicer.

Article 3, then, determines who has the right to enforce the obligations of a mortgage note, often called the "person entitled to enforce," or the "PETE." The PETE is a particularly important concept, as the PETE is the person entitled to collect from the maker of the note and payment to the PETE discharges the maker's obligation with respect to that payment. The PETE also possesses the right to enforce the collateral securing that note. The PETE is not necessarily the secured party, nor, as noted above, is it necessarily the owner of the note.12 While the PETE is designed, among other things, to provide certainty to the note payor in regard to its payment obligations, claims of ownership and other rights to the proceeds of that payment are determined by Article 9.13

So what exactly is the issue with the clearly all-important role of the PETE in the context of MBS transactions? The problem is that under Article 3 possession is a critical element in transferring rights of a PETE under a mortgage note. One becomes a PETE through just three means: by being the "holder" of a note, a "nonholder in possession of the [note] who has the rights of a holder," or through a lost note affidavit.14 The first two demand possession; the third requires a certification that possession simply wasn't possible.15

The "holder" of a note is defined in UCC §1-201(b)(21)(A). Under that section, to qualify as a holder, a person must possess the note and the note must be payable either to such person or to bearer. The latter requirement can be satisfied either through the terms of the note itself or through an indorsement.16 In addition, under UCC §3-301(ii), a non-holder of a note (i.e, a person in possession of a note which is payable to someone else) who has the rights of a holder can also be the PETE. A person can acquire the rights of a holder through mechanisms normally associated with assignments of or succession to rights of others, such as contractual agreements or subrogation.17However, a person not in possession of the note can only enforce it if entitled to do so pursuant to UCC §3-309 (a provision that does not exist in the New York UCC), which essentially requires the elements of a lost note affidavit, namely that the note has been destroyed, its whereabouts unknown or it was stolen.18 Such person must also show that loss of possession was not a result of another legal transfer or seizure.19

Compare the above restrictions to the provisions governing transfer of ownership under Article 9 of negotiable and non-negotiable notes. These provisions reflect a much more flexible structure, generally permitting effective transfer of ownership without possession or filing.20 Article 9 by its express scope applies to the sale of promissory notes.21 The three criteria that apply to perfecting security interests in promissory notes as collateral apply as well to outright sales of promissory notes. These requirements are outlined in UCC §9-203(b). First, "value" must be given by the purchaser; the seller must have rights or the power to transfer rights in the notes; and there must either be an "authenticated" "security agreement" describing the collateral or the purchaser must possess the note pursuant to the debtor's security agreement.

What about the mortgage? Here we come upon a well-known phrase: "The mortgage follows the note." Whether that principle holds true or not, however, has become a subject of some controversy.22

UCC §§9-203(g) and 9-308(e) provide that attachment and perfection of a security interest in a right to payment automatically attaches and perfects a security interest in a mortgage on real property securing that right. According to the related commentary, these provisions codify the common law rule that transfer of an obligation secured by real property also transfers the actual lien and help prevent separation of the mortgage from the note.23 The commentary goes on to state that Article 3, at least in regard to negotiable instruments, continues to dictate to whom the maker must pay in order to discharge the related obligation.

Here, however, is where personal property and real property law may collide. Not all courts or jurisdictions have agreed with the concepts behind §§9-203 and 9-308. One notable example is the 2011 decision of the Supreme Judicial Court of Massachusetts, being the highest state court in Massachusetts, in U.S. Bank Nat. Ass'n v. Ibanez.24

In Ibanez, the court held that non-judicial foreclosures of the defendants' homes by trustees of securitization trusts were void because the trusts were not actual "assignees of the mortgages at the time of notice of sale and subsequent foreclosure."25 According to the court, the foreclosing entity must establish adequate proof through a complete chain of assignments linking it to the record holder in order to foreclose (allowing that the assignments need not even be recorded at the time of notice of sale). It held further that an assignment of land in blank does not give legal title to the bearer.

More importantly for this discussion is the statement by the court that the mortgage does not, as a matter of Massachusetts law, automatically follow the note. The plaintiffs contended that since they held the mortgage note, they had a sufficient financial interest in the mortgage to foreclose. Brushing that argument aside, the court stated simply that "where a note has been assigned but there is no written assignment of the mortgage underlying the note, the assignment of the note does not carry with it the assignment of the mortgage."26 The court, in deferring to real property law over personal property law, echoed many of the issues previously discussed in this column in regard to fixtures, namely that when real property and personal property intersect, the result is not always predictable given the variability in local real property statutes and common law.27

To summarize, then, if it is PETE status that controls the right to enforce the mortgage, PETE status generally requires physical possession of the mortgage note, but possession of the note doesn't necessarily entitle the holder to enforce the mortgage. Clearly, these concepts present significant hurdles to MBS securitization structures in their current form.

What about MERS? MERS, as its name denotes, is an electronic system for recording mortgages. According to its website,28 MERS acts as mortgagee in the county land records for the lender and servicer and, accordingly, future assignments of any loan where MERS is the mortgagee are not necessary because MERS remains the mortgagee no matter how many times servicing (i.e., PETE status) is transferred. MERS would act on behalf of and on the instructions of the holder of the mortgage note.

MERS also offers what it refers to as the MERS eRegistry, being a system of record that is intended to track and identify electronic promissory notes for electronic mortgage loans, and is intended to identify the current holder and custodian of an authoritative copy of an eNote. According to the MERS website, the concept of a national eNote registry evolved from the need to track and identify electronic promissory notes (or eNotes) for electronic mortgage loans.

MERS, however, is dealing with a number of challenges. Previously, MERS held mortgages but not notes, and so the note registry at MERS is a relatively recent development. In addition, electronic promissory notes and electronic mortgages are still in their infancy and not widely accepted. Moreover, MERS does not bear the imprimatur of statutory sanction, and may still suffer from negative association in the public mind with a legacy of litigation by various claimants seeking redress from the housing market meltdown.

Alternative Structures

Variations in state real property laws, and the complex interplay between real and personal property laws pose a dilemma for those seeking reassurance that mass transfers of mortgage loans can withstand scrutiny.The issue has been recognized by commentators and many have begun exploring potential solutions.29

One effort, being spearheaded by the General Counsel's office of the Federal Reserve Bank of New York, involves the drafting of a federal statute that would provide the legal foundation for a national mortgage note registry. Among the goals of the statute is to support the dematerialization of both negotiable and non-negotiable mortgage notes such that once deposited into the registry, the records of the registry establish PETE status (similar to what has been done with respect to uncertificated securities and the records of the issuer's registrant). In addition, the holder of the mortgage note, as shown on the registry, would have the power available to noteholders and mortgage assignees under state law to foreclose the associated mortgage (assuming the mortgage note is enforceable).


The financial crisis exposed significant weaknesses and therefore uncertainty in regard to current structures for financing large groups of mortgage loans. That uncertainty continues unresolved. Clearly, improvements to financing structures designed to facilitate mortgage transfers will become more critical as the economy and, in particular, the residential real estate market, continues to recover.

It is difficult to see how these issues may be effectively addressed short of federal intervention. In fact, industry participants have begun discussions over such possible solutions as a national mortgage note registry implemented through federal legislation.30 Proponents of such a system clearly have a laudable goal in mind. Whether they or others will have success convincing Congress of the need for such system, and what that system, if ultimately approved, will look like, remains to be seen.

Reprinted with permission from the April 1, 2015 edition of New York Law Journal © 2015 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited.


1. See Barbara Goodstein, "Figuring Out Fixtures," 252 N.Y.L.J. No. 26 (Aug. 7, 2014).

2. Mortgage-backed securities are composed of pools of either individual residential or commercial mortgages, RMBS and CMBS respectively. Since RMBS and CMBS are created through somewhat different mechanisms and have somewhat different issues, the scope of this article is limited to RMBS.

3. See James Harvey, "Trends in Residential Mortgage Loan Originations and their Impact on Community Banks," Financial Industry Perspectives (December 2009), available at and "Freddie Mac Update" available at

4. See U.S. Bank Nat. Ass'n v. Ibanez, 458 Mass. 637, 941 N.E.2d 40 (2011).

5. See John Patrick Hunt, "Should the Mortgage Follow the Note?" 75 Ohio St. L. J. 155 (2014); and Dale A. Whitman, "A National Mortgage Registry: Why We Need It, And How To Do It," 45 UCC L. J. 1 (April 2013).

6. Note that, as discussed in previous columns, every jurisdiction other than New York has adopted the 1990 Official Text of Article 3 and, as of the date of submission of this article for publication, 11 states have adopted the 2002 Official Text of Article 3. References in this article to sections of UCC Article 3 are to the 2002 Official Text of Article 3 and not to the New York version of that Article. Citations to Article 9, on the other hand, are to the New York version of that article.

7. See Dale A. Whitman, "How Negotiability Has Fouled Up The Secondary Mortgage Market, And What To Do about It," 36 Pepp. L. Rev. 737 (2010).

8. Clearly, not all mortgage notes are negotiable instruments. However, the distinction between negotiable and non-negotiable instruments is a complex subject and beyond the scope of this article.

9. See Report of the Permanent Editorial Board for the Uniform Commercial Code, Application of the Uniform Commercial Code to Selected Issues Relating to Mortgage Notes (Nov. 14, 2011) (PEB Report) at 8-11.

10. See U.C.C. §§9-109(a) (3); see also PEB Report, supra note 9, at 8-11.

11. See PEB Report, supra note 9, at 8.

12. U.C.C. §3-203 cmt. 1; see also U.C.C. §3-301, which states as follows: "A person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument."

13. See PEB Report, supra note 9, at 8.

14. See U.C.C. §3-301.

15. Note that, under U.C.C. §3-420 cmt. 1, delivery to an agent is delivery to the payee.

16. See U.C.C. §3-204(a).

17. See the PEB Report at 5.

18. U.C.C. §3-309(a)(iii) (in the 1990 text) and 3-309(a)(3) (in the 2002 text).

19. See the PEB Report, supra note 10, at 6.

20. U.C.C. §9-309(4).

21. U.C.C. §9-109(a)(3).

22. See Hunt, supra at note 5; U.S. Bank Nat. Ass'n v. Ibanez, 458 Mass. 637, 941 N.E.2d 40 (2011).

23. See U.C.C. §9-203 cmt. 9 and U.C.C. §9-308 cmt. 6.

24. See Ibanez, 458 Mass. 637, 941 N.E.2d 40.

25. Id. at 648.

26. Id. at 652. The court went on to state that "the holder of the mortgage holds the mortgage in trust for the purchaser of the note, who has an equitable right to obtain an assignment of the mortgage." Id. at 652.

27. Whitman notes in his article that courts in some states have gone so far as to hold that having the mortgage note is itself irrelevant to the right to foreclose. See Whitman, supra note 5, at 10.


29. See, e.g., Whitman, supra note 5.

30. The author of this column is a member of a working group related to this effort.

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