United States: Note Sale Expansion: Its Source And Implications (Part Two Of Three-Part Series)

Part II

As discussed in Part I of this series, note sales have significantly expanded in recent years.  Part I explained the reasons behind this expansion, including the surplus of non-performing notes, lenders' preference for note transfers over foreclosures, and the federal government's shift in focus from foreclosures to note sales. Here, Part II discusses the basics of note sales focusing on the transfer of promissory notes and management responsibilities.

I. Introduction

Through note sales, lenders seek to disconnect from the borrower and essentially act as if the loan never existed.1 Consequently, the seller's goal in a note sale is to fashion the transaction in a manner which ensures that it will no longer be affected by the borrower's performance. Lenders often sell notes "as-is," which makes purchasers vulnerable to various risks.2 Conversely, the buyer hopes to enter into an agreement that ensures a valuable interest in property, rather than a serious risk or liability. Thus, buyers must conduct diligent research on two separate levels: the loan document and the borrower's ability to perform under it, and the value of the property securing the note. If the purchaser fails to adequately examine either of these facets, hidden defects could arise, such as inadequacies in the loan document or additional liens against the secured property. To be a worthwhile transaction for the buyer, the value of the collateral should exceed amounts paid for the note and expected incidental costs.3 When entering into a note transaction, both parties must be aware of the others' goals and proceed accordingly.

The actual note transfer process entails the purchaser entering into a note purchase agreement with the lender. This agreement somewhat resembles those used in traditional sales, but typically contains less assurances. The purchase agreement should warrant the lender's ability to sell the note and transfer all rights under it and related documents. It should specifically identify the interests assigned to the purchaser and should ideally allow an inspection period during which the buyer may perform due diligence on the property.

Although the note sale process appears relatively simple at first glance, the buyer and seller should consider potential issues with note sales that are not readily apparent: (1) judicial foreclosures are not affected by mortgage assignments;  and (2) the law governing transfer of notes varies depending on whether the transferred note is negotiable.

II. Recording Mortgage Assignments

After closing the note sale, the buyer takes possession of the original note. In the case of mortgage notes, the assignment should be recorded in the county in which the property is located, but assignment of the mortgage is not necessary to transfer the right to judicially foreclose.4 Consequently, a purchaser who wishes to judicially foreclose need not prove the existence of a chain of mortgage assignments. Although assignments are not essential to judicial foreclosures, they serve valuable purposes, nonetheless. First, recording assignments ensures that notice of suits affecting the property or mortgage reach the proper party. A mortgage assignee has an interest in learning of proceedings related to the secured property, and a lack of recorded assignment often extinguishes an assignee's defense opportunities. Second, recording assignments eliminates risks associated with dishonesty or fraud by the mortgagor. In these disputes, courts prefer a bona fide purchaser who has relied on the absence of recorded mortgage assignments over the note purchaser who failed to record. Thus, recording the mortgage assignment protects secondary market purchasers from potentially detrimental proceedings.

III. Transfer of Rights

Which law applies to a transfer depends on whether the underlying note is negotiable.

U.C.C. Article 9 applies to the transfer of ownership of all mortgage notes. Under U.C.C. 9-203(b), either delivery of the note pursuant to a written agreement or execution of a document assigning the note may transfer ownership. Section 9-203(g) states that whoever receives the economic benefits of the note receives the economic benefits from the mortgage.

U.C.C. Article 3 governs the transfer of entitlement to enforce notes, but only those notes that are negotiable. Conversely, conditional notes are covered by the common law of contracts. Thus, in order to determine whether Article 3 applies to the transfer of entitlement rights, one must ascertain whether the note is negotiable. U.C.C. Article 3 establishes the following definition of a negotiable note:

  • An unconditional promise to pay a fixed amount of money, with or without interest or other charges . . . , if it: (1) is payable to bearer or to order . . . ; (2) is payable on demand or at a definite time; and (3) does not state any other undertaking or instruction . . . to do any act in addition to the payment of money.

If a note is negotiable, the strict transfer standards of Article 3 apply: (1) physical delivery of the note to the person enforcing it with appropriate endorsement, making that individual a "holder"; (2) physical delivery of the note to the person enforcing it without an endorsement, making that individual a "non-holder who has the rights of a holder"; or (3) provision of a "lost note affidavit," available under specifically delineated circumstances.

As stated by Dale Whitman in his article on this topic, "[F]iguring out whether a given note is negotiable can be hard, while determining whether a given negotiable note was properly transferred is relatively easy."5

IV. Conclusion

This Part of our series has outlined two aspects of note sales. First, judicial foreclosures do not require record of mortgage assignments, but to receive important notices of suits, in particular the real estate recordation, may be preferred. And second, whether the strict standards of the U.C.C. or the lenient guidelines of the common law apply to the transfer of enforcement rights hinges on the note's characterization as negotiable or non-negotiable.

This article is intended as a general overview and readers should consult legal counsel with specific questions regarding the transfer of notes. As previously stressed in Part I, both interested buyers and sellers should seek legal assistance prior to entering into a loan purchase agreement.

Next week, the third and final part of this series will evaluate a recently issued OCC bulletin that addresses the transfer of notes and mortgage loans.


1. The Buying and Selling of Distressed Notes, Bryan Cave LLP (Aug. 5, 2009), http://www.bryancave.com.

2.  Mark S. Biskamp, Real Estate Note Sales, Rebusiness Online (Feb. 22, 2011), http://www.rebusinessonline.com/main.cfm?id=17069.

3.  Jeffrey J. Porter & Jeff Mosteller, Real Estate Note Purchases, SettlePou Blog (Mar. 7, 2012), http://blog.settlepou.com/real-estate-note-purchases/.

4.  Dale A. Whitman, What We Have Learned From the Mortgage Crisis About Transferring Mortgage Loans, 49 Real Prop. Tr. & Est. L.J. 2, 44–45 (2014).

5.  Id. at 34.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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