There is a growing trend in the world of finance whereby the loan documents and signatures for the loan documents are all electronic. That is to say, there was never an actual physical document and thus no “signature” in the classic sense of the word.  The statutes are in place to deal with that trend, but a lack of case law makes disputes among Banks assigning these notes an open question.  Its always good to be at the front of a good trend, but the opposite is also true.

Credit: Warner Brothers

As you probably are aware, nationally electronic signatures for promissory notes are governed by the Electronic Signatures in Global and National Commerce Act (the “eSign Act”).  15 U.S. 96 §§7001 et seq.  Among other things, the eSign act mandates that electronic signatures on real estate finance documents, including promissory notes, cannot be denied validity, effect or enforcement because they are electronic.  Here in Texas, the Texas Uniform Electronic Transactions Act (“TUETA”) adds another layer to the statutory scheme. TEX. BUS. & COM. CODE § 322.001.

There are requirements to fall under the TUETA and eSign statutory framework. In Texas, once the preliminary requirements for TUETA are met, then if note can properly be considered a “transferable record” which permits the electronic note to be enforced under article 3 of the UCC.

The question then becomes: how can the electronic promissory note with the electronic signature be assigned to a new party in a way to ensure that the new party becomes the holder in due course?

Consider for a moment a physical negotiable instrument. In the olden days (ie, currently for most banks) the instrument would be a physical piece of paper and the actual holder (eg, in his hand) of the document was the prima facie Holder in Due Course of the instrument.

Article 3 assumes that the person without possession might be determined as the Holder in Due Course of an instrument in that article 3 places the burden on proving Holder status on the person asserting that status. This comes up, among other areas, when a Bank is handling a large volume of notes that are often assigned (eg, mortgage warehousing).  To accommodate the practical challenge of moving the physical notes, a bailee will be used to essentially hold in the name of Bank 1, such that transferring a note to Bank 2 is a book entry.

The question is whether an electronic instrument can be “held” and if so, how can an assignee of the electronic note prove it is the Holder when there is nothing to hold. The current practice is to utilize eVaulting, which provides something like a MERs system but for electronic notes.  These notes are incorporated with a secure token, which functions like password protection, such that only a party with the key (something similar to an extremely long and complex password) can utilize the document.

In this sense, both the signature and the note itself are identified by their secure token and the sole ability of the purported holder to be able to access the document. Its neat technology, which is akin to the block chain, which is the underlying tech for things like bitcoin.  However, it’s tough to explain and thus, tough to prove up to a judge.

Curious about how courts have handled this, I did a nationwide Westlaw search for “eVaulting” without any date parameters. A total of 20 cases were returned in the results.  None of the cases returned had anything to do with this topic in any substantive way.  For my Texas folks, there are zero returns for “transferable record”.

I have no doubt that lenders across the county have been able to assert their electronic notes against borrowers successfully and in ways which did not result in opinions on the topic (published or otherwise). However, the purpose in searching eVaulting was to see if any of the Bank’s had asserted claims against other Banks for failure to deliver holder in due course rights or other deficiencies in the electronic notes as a result of the assignments.

The point is, I am not arguing that the current paradigm isn’t right or proper, it’s just that there is a lot of money and notes moving around without a lot of case law to back up the reasons for the way things work.