Revised UCC Article 9: Impact on “Wet
Funding” Mortgage Loan Transactions
Stuart Goldstein and Lech Kalembka
Revised Article 9 of the Uniform Commercial Code applies to security interests in
mortgage notes and includes provisions that significantly affect the perfection of
security interests in wet funding transactions.
A s most readers are probably
aware, the Uniform Com-
mercial Code (“UCC”) is a com-
prehensive body of state commer-
cial law, Article 9 of which governs
the creation, perfection and en-
forcement of security interests in
most forms of personal property. A
substantially revised version of Ar-
ticle 9 of the UCC (the “Revised
UCC”)1 has been adopted in all 50
states and, as of October 2001, is in
effect in 47 states2 and the District
of Columbia.
Wet Funding UCC Issues
Although Article 9 does not apply
Mr. Goldstein is a partner resident in the Char-
lotte office of Cadwalader, Wickersham & Taft.
Mr. Kalembka is special counsel resident in the
firm’s New York office. The authors gratefully
acknowledge the contributions of Charlie Bryan
and Joshua Yablonski to the preparation of this
article.
52 THE REAL ESTATE FINANCE JOURNAL/Winter 2002
to the creation or transfer of inter-
ests in real estate,3 Article 9 is not
rendered inapplicable to a security
interest in a secured obligation
merely because such obligation is
itself secured by property excluded
from Article 9.4 Accordingly, Ar-
ticle 9 applies to security interests
in mortgage notes (“Mortgage
Notes”), even though it excludes
the creation and transfer of inter-
ests in mortgages.5
In a typical “wet funding”
transaction, the lender (the
“Lender”) either:
(1)lends money to an originator
or purchaser of mortgage
loans (either is referred to as
an “Originator”) in return for
a pledge of a portfolio of resi-
dential mortgage loans, or
(2)enters into a “reverse repur-
chase” transaction (a “Repo”) un-
der which the Lender “purchases”
mortgage loans (including the re-
lated Mortgage Notes) from an
Originator with a concomitant
obligation to “sell” such assets to
the Originator in the future.
The Revised UCC includes provi-
sions which significantly affect
the perfection of security interests
in wet funding transactions. Be-
fore discussing the new rules, this
article briefly outlines the previ-
ously applicable provisions.
Prior UCC
Under the prior version of the
UCC (the “Prior UCC”), a securi-
ty interest in Mortgage Notes and
other “instruments”6 was perfect-
ed either:
 1. through direct possession by the Lender,7 or
2. through possession by a “bailee” with notifica-
tion of the security interest of the Lender.8
In the case of Mortgage Notes held by a bailee, per-
fection would, however, be jeopardized if the bailee
was controlled by, or even closely affiliated with, the
Originator.9
Wet funding practices and servicing needs may
make strict compliance with these rules impossible,
however. Accordingly, the Prior UCC included
rules that accommodate the practical impossibility
of the Lender’s obtaining immediate possession of
the Mortgage Notes at closing and the necessity for
the Lender or its bailee to relinquish possession at
times to the Originator to permit servicing and en-
forcement. In particular, under the Prior UCC, a se-
curity interest in Mortgage Notes was automatically
perfected for 21 days from the time it attached with-
out possession by the Lender or a bailee if the securi-
ty interest was given for “new value” under a written
security agreement.10 In addition, a perfected secu-
rity interest remained perfected for 21 days if the
Lender transferred possession to the Originator “for
the purpose of ultimate sale or exchange or [for] pre-
sentation, collection … [or] renewal ….”11
Revised UCC
The Revised UCC similarly provides for perfection
of a security interest in Mortgage Notes and other in-
struments through actual and constructive posses-
sion. The rules regarding perfection through posses-
sion by a bailee have changed significantly, however.
Specifically, where the Mortgage Notes are held by a
third person, that person must “authenticate a
record”12 in which it “acknowledg[es] that it holds
possession of the collateral for the secured party’s
benefit.”13 In contrast to the Prior UCC, simple no-
tification to a bailee in possession, with the excep-
tion discussed below, will be inadequate to perfect
the security interest of the Lender in Mortgage
Notes.
Fortunately, the drafters of the Revised UCC re-
alized that this rule would, if applied indiscriminate-
ly, disrupt “take-out” practices in the secondary
market. Therefore, a secured party in possession of
Mortgage Notes that wishes to transfer possession to
a prospective purchaser need only instruct the pur-
chaser “to hold possession of the collateral for the
secured party’s benefit” to maintain perfection and,
therefore, need not obtain any acknowledgement
from it.14
The Revised UCC also provides for temporary
perfection to accommodate wet funding and servic-
ing necessities, but shortens the period during which
the security interest remains automatically perfected
from 21 days to 20 days.15
Perfection by Filing
In an important development, the Revised UCC
permits the perfection of security interests in Mort-
gage Notes and other instruments by filing a UCC
Financing Statement.16 This should facilitate the
servicing of Mortgage Notes by permitting the Orig-
inator or servicer to retain possession for more than
20 days,17 and will also afford protection in the event
that the Mortgage Notes are lost.
Lenders must be aware, though, that exclusive re-
liance upon filing will entail risks. In particular, the
security interest of a secured party that perfects sole-
ly by filing will be subordinate to the security inter-
est of a third party that gives value and takes posses-
sion “in good faith and without knowledge that the
purchase18 violates the rights of the secured par-
ty.”19 This priority rule subjects the Lender to the
risk that, through fraud or negligence, an Originator
or servicer in possession of Mortgage Notes will
transfer possession to a third party that meets the
quoted criteria.20 As a result, a Lender relying solely
on filing should consider taking steps to notify pro-
spective lenders that acquiring a security interest in
the Mortgage Notes would violate the Lender’s
rights. Such steps would include incorporating lan-
guage in an attachment to the Financing Statement
and, if possible, on the Mortgage Notes themselves
to the effect that any acquisition by a third party of
a security interest in the Mortgage Notes “violates
the rights” of the Lender.
Miscellaneous Changes
Several additional changes deserve mention. First,
the Revised UCC provides that the sale of a “prom-
issory note”21 is automatically perfected,22 without
the need for filing or possession. Literally, this rule
provides the Lender with automatic perfection in
Mortgage Notes in, for instance, a Repo transaction.
Given the uncertain characterization of a Repo as a
“true sale” or disguised financing,23 however, Lend-
ers should continue taking the steps necessary to per-
fect their security interests to mitigate the conse-
quences of a judicial recharacterization.
Second, the Revised UCC codifies the “mort-
gage-follows-the-note” doctrine24 under which the
perfection of a security interest in a Mortgage Note
THE REAL ESTATE FINANCE JOURNAL/Winter 2002 53
Revised UCC Article 9: Impact on “Wet Funding” Mortgage Loan Transactions
automatically perfects a security interest in the re-
lated mortgage.
Conclusion
The Revised UCC permits greater flexibility in the
wet funding market, in particular by providing for
perfection of security interests in Mortgage Notes
through UCC filings. Although this innovation car-
ries with it some risk for Lenders, it will surely in-
crease efficiency, and therefore reduce transaction
costs, in this important market. ■
Notes
1. Revised Article 9. Secured Transactions (With Conform-
ing Amendments to Articles 1, 2, 2A, 4, 5, 6, 7, and 8).
2. The version of the Revised UCC enacted in Alabama,
Florida and Mississippi has an effective date of January 1,
2002.
3. Prior UCC § 9-104(j); see also Revised UCC § 9-
109(d)(11).
4. Prior UCC § 9-102(3); see also Revised UCC § 9-109(b).
5. Id.
6. “Instrument” was defined in prior UCC § 9-105(1)(i) as “a
negotiable instrument … or any other writing which evidenc-
es a right to the payment of money … and is of a type which
is in ordinary course of business transferred by delivery with
any necessary endorsement or assignment.” A substantially
identical definition is included in Revised UCC § 9-
102(a)(47). In most cases, Mortgage Notes will be “instru-
ments.”
7. Prior UCC §§ 9-304, 9-305.
8. Prior UCC § 9-305.
9. Prior UCC Off. Cmt. 2, § 9-305. Although the topic is be-
yond the scope of this article, we note that perfection may be
achieved under Article 8 of the UCC in certain cases even
where the bailee is affiliated with the Originator.
10. Prior UCC § 9-304(4).
11. Prior UCC § 9-305(5)(b).
12. Authentication of a record includes manually executing a
traditional paper record and, with respect to information
54 THE REAL ESTATE FINANCE JOURNAL/Winter 2002
which is “stored in an electronic medium,” adopting a symbol
or using an encryption process with the “present intent … to
… adopt or accept a record.” Revised UCC § 9-102(a)(7),
(69).
13. Revised UCC § 9-313(c)(1). According to the Official
Comment to this provision, such an acknowledgement is un-
necessary if the third party in possession is an “agent” of the
secured party, which is not also an agent of the debtor. Re-
vised UCC Off. Cmt. 3, § 9-313. Nevertheless, given the pos-
sible difficulty of determining agency status, and the poten-
tially disastrous consequences of an erroneous determination,
a prudent Lender will obtain an acknowledgement along the
lines of the quoted text whenever it does not itself hold the
Mortgage Notes.
14. Revised UCC § 9-313(h); see also Revised UCC Off. Cmt.
9, § 9-313.
15. Revised UCC § 9-312(e), (g). Such a filing must be made
in the jurisdiction in which the debtor is “located.” Revised
UCC §§ 9-301(1), 9-501(a)(2). A debtors location, in turn,
is determined pursuant to the rules specified in Revised UCC
§ 9-307.
16. Revised UCC § 9-312(a).
17. Revised UCC Off. Cmt. 2, § 9-312.
18. We note that “purchase” includes acquiring an interest in
property through a pledge or lien. UCC § 1-201(32).
19. Revised UCC § 9-330(d).
20. It is important to note that the Revised UCC does not im-
pose any obligation upon prospective lenders to inspect the
UCC records. Moreover, mere notice that the Lender has a
security interest in the Mortgage Notes is insufficient to dis-
qualify the prospective lender from taking advantage of the
priority rule described in the text. Nonetheless, if such a lend-
er did inspect the UCC records, then language indicating that
any security interest in the Mortgage Notes it obtains “vio-
lates the rights” of the Lender would be sufficient to preserve
the priority of the security interest of the Lender. See Off.
Cmt. 7, § 9-330.
21. Revised UCC § 9-102(a)(65).
22. Revised UCC § 9-309(4).
23. See Revised UCC Off. Cmt. 4, § 9-109.
24. Revised UCC § 9-308(e). The secured party will not,
however, become the mortgagee of record under this provi-
sion. Instead, its rights regarding the mortgage will be senior
to a subsequent lien creditor of the mortgagee, including a
bankruptcy trustee. Revised UCC Off. Cmt. 6, § 9-308.