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Lenders 360

eSign & Commercial Finance: On the Bank Report Card in 2016

Posted in Good Times for Lenders, Regulatory, Technology Innovation, Technology Notes, Value Alignment (Client Interests)

Last year, a new topic started to appear in commercial mortgage loan documents: provisions covering the use of electronic documents (aka “electronic records” or “eDocs”).  Unfortunately, two provisions examined by me were not completely correct.  (And until recently, I made the same mistakes.)

These provisions, however imperfect, support my bet that starting in 2016, the implementation  and use of electronic documents will be part of every bank examination, will be included in every bank’s “report card,” and will be of growing importance within leading commercial lending platforms.

To sum it up: 2016 (or 2017 at the latest) will be the year of the commercial, electronic loan document.  With electronic commerce cemented into the fabric of our personal lives, eSign and electronic documents will finally arrive in commercial lending.

In order to understand “electronic” provisions and to (almost) accept my bold prediction, we need to grasp –

  • The fundamental business drivers or motivations behind the federal eSign law and state versions of UETA
  • The scope and terms of both laws
  • The limits or boundaries where electronic documents and paper documents are different

(Disclaimer: this is a short summary and NOT a book.  Maybe in the future I’ll jump into related topics of federal preemption, the various differences between UETA and eSign, consumer law issues, MISMO SMART documents, MISMO data standards, notary laws, etc.)

For the visually unimpaired, these pictures sum up both eSign and UETA, and the business drivers that propelled their passage into law:

The Paper World: Content Inside Unwieldy Containers (paper documents)

The Paper World:
Content Inside Unwieldy Containers
(paper documents)

The Electronic World: Same Content Inside a Speedy Container (electronic documents)

The Electronic World:
Same Content Inside a Speedy Container
(electronic documents)

 

 

 

 

 

 

 

The differences between paper documents and electronic documents simply are the wheels on the bag.  The content in the bag generally remains unchanged.  But the bag with wheels moves much, much faster (and with less effort on everyone’s part).

DRIVERS

The drive to ditch paper documents for electronic documents is based upon the benefits of increased efficiency, speed to market, quality control, etc.   (It is a sibling to the technology mantra of “fewer people, doing more work, in less space.”)  In the early 2000s, Ernst & Young studied the operations of ten commercial mortgage lenders.  The survey painted commercial mortgage lenders as information companies, with paper processes and systems screaming for a technology solution.   The report concluded:  “[C]ommercial mortgage lending processes are inefficient . . . . This environment is eroding profitability, which has already been hammered  by competition and volatility in the capital markets.  A renewed focus on technology enabled process improvement will improve a lender’s competitiveness, ease the strain on both the organization and operations, and enhance profitability.”

This drive for efficiency continues today, as seen in a 2012 white paper by the FDIC for community banks, on the topic of “bank efficiency and economics of scale.”

FEDERAL AND STATE LAWS

eSign and UETA are the statutes creating and governing electronic documents.  They  authorize the use of electronic records and signatures in transactions (including commercial real estate transactions) using an “overlay” approach that generally preserves existing legal principals:

  • They do NOT eliminate the need to comply with the underlying substantive laws governing transactions, including state laws governing real estate transactions
  • The laws of each state remain determinative; the state-by-state patchwork approach remains in place.  (Link to prefatory notes in UETA.)   (The Law of Electronic Signatures has a summary of the state-by-state approach taken on the adoption of UETA.)

Deferring to state law, of course, is the same approach taken in the “paper” world. Like “paper” documents, electronic documents and records must comply with the substantive law of each state.

By taking this approach, the impact of electronic documents even extends to an industry that is as old as dirt: the real estate industry. The drafters of UETA could not identify a reason to exclude real estate from UETA. The prefatory notes to UETA (on p.2) state the following:

“. . . real estate transactions were considered potentially troublesome because of the need to file a deed or other instrument for protection against third parties. Since the efficacy of a real estate purchase contract, or even a deed, between the parties is not affected by any sort of filing, the question was raised why these transactions should not be validated by this Act if done via an electronic medium. No sound reason was found. . . . exclusion of all real estate transactions would be particularly unwarranted in the event that a State chose to convert to an electronic recording system, as many have for Article 9 financing statement filings under the Uniform Commercial Code.”

This approach drives the concepts underlying both eSign(Section 7001(a)) and UETA (Section 7):

  • If a law requires a record to be in writing, an electronic record satisfies the law
    • Electronic means “relating to technology having electrical, digital, magnetic, optical, electromagnetic, or similar capabilities
    • Electronic record means “contract or other record created, generated, sent, communicated, received, or stored by electronic means”
    • Record means “information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form”
    • Information means “data, text, images, sounds, codes, computer programs, software, databases, or the like”
    • The record must remain accurate (properly stored) and accessible
  • If a law requires a signature, an electronic signature satisfies that law
    • Electronic signature means “an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted by a person with the intent to sign the record
  • A record or signature may not be denied enforceability solely because it is in electronic form

DIFFERENCES

There are exceptions, however, to this “additive” approach.  For example, some aspects of UCC Article 3 (which governs promissory notes) do not work well when the note is an electronic record.  (For example, lost paper notes.) Consequently,  UETA and eSign each implement a parallel approach for UCC Article 3 notes, using a form of electronic record called a “transferable record.”  This is a unique type of “electronic record,” with unique rules and characteristics (eSign Section. 7021; UETA Section 16).

TWO PROVISIONS

In my next post, we’ll apply use these principals to these two provisions:

Example #1:
Borrower hereby acknowledges the receipt of a copy of the Agreement and all other Loan Documents. Bank may, on behalf of Borrower, create a microfilm or optical disk or other electronic image of the Agreement and any or all of the Loan Documents. Bank may store the electronic image of such Agreement and Loan Documents in its electronic form and then destroy the paper original as part of Bank’s normal business practices, with the electronic image deemed to be an original.

Example #2:
Borrower hereby acknowledges and agrees that Lender may create electronic images and destroy paper originals of any imaged documents received or generated by Lender in connection with the Loan. Any such images maintained by Lender as part of its normal business processes shall be given the same legal effect as the paper original(s) thereof. Borrower hereby agrees that Lender may convert any instrument into a “transferable record” under the Uniform Electronic Transactions Act (California Civil Code Section 1633.1, et seq.) (the “UETA”), and that the image of such instrument in Lender’s possession shall constitute an “authoritative copy” under the UETA.

Of course, the provisions are cryptic in nature.  Unfortunately, there is a major problem in both examples.  It is a problem based upon a misunderstanding of UETA. Until recently, I shared the same misunderstanding (even thought I’ve written and spoken on eSign and UETA, and have been active in MISMO since 2005).  More on all of this to come.