Mortgage Notes--Must You Have Possession to Be Secured?
A group of investors loaned money to a mortgage company for certain individual properties. Each investor was given an assignment of mortgage which identified the property covered and the investor. However, none of the investors actually possessed an assignment of mortgage. The mortgage company held onto the papers for the investors. Three years later, the mortgage company filed for bankruptcy. The trustee claimed that the investors failed to properly secure their interests because they did not possess the assignments of mortgages. He said that the assignments were instruments and noted that the only way to properly perfect a security interest in an instrument was to take possession of the instrument. Therefore, he argued, the mortgages belonged to the bankruptcy estate.
The investors disagreed. First, they claimed that the assignment of mortgages were non-negotiable notes, and therefore did not fall under the UCC definition of instruments. This being the case, they argued, they did not have to possess the papers in order to have a security interest in them. The court disagreed. UCC § 9-105 (i) defines an instrument as "a negotiable instrument...or a certified security deposit...or any other writing which evidences a right to the payment of money and is not itself a security agreement or lease and is of a type which is in ordinary course of business transferred by delivery with any necessary indorsement or assignment" [emphasis added]. The court ruled that non-negotiable promissory notes fell under the area "any other writing." Therefore, the court ruled, the only way to perfect a security interest in these papers would have been to possess the papers. Next, the investors claimed that possession was not the only way to perfect a security interest in a note. They argued that the notes clearly mentioned that there were mortgages and gave potential purchasers sufficient warning that there were security interests in the notes. Again, the court disagreed. UCC clearly states that a party must take possession of an instrument for perfection. In some instances, a party is given 21 days in which to take possession, but after that time, the party must have the instrument in his or her possession. Finally, two of the investors asserted that they allowed the mortgage company to hold the notes "in a fiduciary capacity for their benefit." The court rejected this argument as well, stating it is a "well-settled principle that a debtor or those under his control cannot act as the possessory agent for the secured party for purposes of perfection." The court ruled that all of the security interests were unperfected and that the entire amount claimed by the investors could be returned to the bankruptcy estate. In re Investors & Lenders, Ltd., 165 B.R. 389 (D. N.J. 1994) Comment: When taking a security interest in instruments, you must take possession of those instruments. However, UCC law does allow a 21-day period for certain instances--when an instrument is first acquired (you have 21 days from the time you give value until the time you take possession of the instrument) and when an instrument is released (you have 21 days in which the debtor can sell, exchange, present, collect, renew, or transfer the instrument). Except for these two time periods, you must have possession of the instrument if you wish to claim a secured interest. Here, the lenders went three years without taking possession, and so they were unable to satisfy their claims against the defunct mortgage company. Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006. This article originally appeared prior to 2000.
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