ESIGN and Transferable Records
With the need for social distancing during the current COVID-19 pandemic, you have probably heard a lot about eClosings and eMortgages. As explained in frequently asked questions (FAQs) prepared by Fannie Mae, “[a]n eClosing is the act of closing a mortgage loan electronically.” The Fannie Mae FAQs describe the term eMortgage to generally refer to an eClosing process that involves the note and mortgage being executed through the use of electronic signatures. The eClosing process could ultimately result in a note and mortgage signed electronically –an eMortgage—or the note and mortgage might require wet-ink signatures while disclosures are provided electronically to the applicant and signed electronically by the applicant. The Fannie Mae FAQs note that this latter process ending with electronic disclosures and a physical note and mortgage is often referred to as a hybrid closing.
Your credit union might already be using a hybrid closing process and might be interested in moving toward an eMortgage process involving an electronically signed note and mortgage. Today’s blog will solely focus on the statutory requirements that must be satisfied to have an enforceable electronically signed note. A later blog will address requirements that affect whether an electronically signed mortgage is permissible under state law.
Wait, ESIGN Permits Electronic Signatures on a Promissory Note Governed by Article 3 of the Uniform Commercial Code?
A promissory note executed by a borrower evidences the borrower’s written promise to repay a loan received from a credit union. A promissory note, in general, is governed by Article 3 of the Uniform Commercial Code (UCC). The scoping provisions of the Electronic Signatures in Global and National Commerce (ESIGN) Act, suggest that the general rule of validity related to electronic records and electronic signatures does “not apply to a contract or other record to the extent it is governed by . . . the Uniform Commercial Code, as in effect in any State, other than sections 1–107 and 1–206 and Articles 2 and 2A.” See, 15 USC § 7003(a)(3). But a different section of the act, section 7021 of title 15 of the United States Code, provides the framework for using an electronic record like a promissory note governed by Article 3 of the UCC. That section explains that the key concept in facilitating an electronically signed note is the transferable record.
A transferable record is an electronic record:
- That would be a note under Article 3 of the UCC if it was not an electronic record;
- Which the credit union making the loan intends to treat as a transferable record; and
- That documents a loan secured by real property.
See, 15 USC § 7021(a)(1). Under ESIGN, an electronic record is “a contract or other record created, generated, sent, communicated, received, or stored by electronic means.” The act defines an electronic signature as “an electronic sound, symbol, or process, attached to or logically associated with a contract or other record and executed or adopted by a person with the intent to sign the record.” Read together, the ESIGN Act seems to permit an electronically signed note in connection with a mortgage loan secured by real property.
Having a transferable record, by itself, is not enough. Another key concept is that of control of the transferable record. Control of a transferable record confers the same status as a holder of a note under Article 3 of the UCC. See, 15 USC § 7021(d). A party may become the holder of a note through the process of negotiation—indorsement of the note and transfer of possession. Holder status provides the ability to enforce the terms of the physical note. The ESIGN Act, among other things, provides a credit union in control of a transferable record with the ability to enforce the terms of the transferable record, just like a holder of a note has the ability to enforce the terms of a physical note under Article 3 of the UCC.
The act has specific requirements related to control of a transferable record. Under the act, a credit union would be deemed to have “control of a transferable record if a system employed for evidencing the transfer of interests in the transferable record reliably establishes that person as the person to which the transferable record was issued or transferred.” See, 15 USC § 7021(b). Moreover, there are other conditions that must be satisfied to demonstrate control of a transferable record:
“A system satisfies subsection (b), and a person is deemed to have control of a transferable record, if the transferable record is created, stored, and assigned in such a manner that-
(1) a single authoritative copy of the transferable record exists which is unique, identifiable, and, except as otherwise provided in paragraphs (4), (5), and (6), unalterable;
(2) the authoritative copy identifies the person asserting control as-
(A) the person to which the transferable record was issued; or
(B) if the authoritative copy indicates that the transferable record has been transferred, the person to which the transferable record was most recently transferred;
(3) the authoritative copy is communicated to and maintained by the person asserting control or its designated custodian;
(4) copies or revisions that add or change an identified assignee of the authoritative copy can be made only with the consent of the person asserting control;
(5) each copy of the authoritative copy and any copy of a copy is readily identifiable as a copy that is not the authoritative copy; and
(6) any revision of the authoritative copy is readily identifiable as authorized or unauthorized.” See, 15 USC § 7021(c).
This concept of control requires a system of record that evidences who has control of a transferable record. It also requires being able to show that at any single point in time there is one person who has the authoritative copy of the transferable record—a copy that is essentially tamper-proof. This demonstrates the important role that the system of record for generating and transferring transferable records plays here. Without the system of record adequately tracking transfers of interest in the transferable record, it would be difficult to identity which person has control of a transferable record and can enforce it.
These requirements related to transferable records and control illustrate that integrating the use of electronic signatures and electronic records in a credit union’s mortgage notes involves more than just obtaining the consent of borrowers to use electronic signatures. A credit union may need to consider its readiness or the readiness of its vendors in order to meet some of these statutory requirements. For example, does a credit union or its vendors have the capability to generate a transferable record and satisfy the conditions for control in section 7021? The answer to these questions may help credit unions determine where they are located on the readiness spectrum when it comes to originating electronically signed mortgage notes. Credit unions can also look to industry participants for more information about these issues. Both Fannie Mae and Freddie Mac have several resources that can help credit unions evaluate whether they are ready to originate mortgage loans evidenced by transferable records.