11.30.2022 | Articles

Why Do We Care About eNotes?

By Richard E. Gentilli, Brian F. Plunkett

We are often asked by lenders whether they should accept either so-called “eNotes” or paper promissory notes that are electronically signed or signed via PDF scan of a signature (i.e., not so-called “wet ink” originals). The quick answer is “not yet.”

This is because there are practical reasons why lenders should think twice before deciding to accept eNotes or electronically signed paper notes in their everyday loan practice.  In this article we briefly analyze the law concerning the enforceability of eNotes in Massachusetts and discuss the pitfalls that lenders should watch out for if they choose to accept them or choose to not require wet ink original notes.

A. What is an eNote?

In a nutshell, an eNote is a promissory note put into an electronic record format with certain safeguards for the control and transferability of the note. This is different than just signing a paper note either by means of an electronic signature or via a PDF or scanned signature. An eNote is digitally created, signed, transferred and managed and is not just a scanned version of a paper note. There are two statutes that govern the enforceability of eNotes in Massachusetts: The “Uniform Electronic Transactions Act” (UETA) which is a state-adopted statute and the “Electronic Signatures in Global and National Commerce Act” (E-SIGN), which operates at the federal level. These two statutes refer to “transferrable records” as a legal term for eNotes. Under both the UETA and E-SIGN, an electronic record or signature must be equally valid and enforceable as a record or signature put into a wet-ink, or paper format. The UETA does not govern the “traditional” hard paper promissory notes and other negotiable instruments that fall under rules set forth in the Uniform Commercial Code (the “UCC”) but instead provides a UCC-like framework for the enforceability of eNotes.  It does this by transplanting some of the same concepts, rights and defenses applicable to paper notes under the UCC to what is called “transferrable records” under the UETA. An electronic record is considered a transferrable record under the UETA if: (1) it would have been considered a note under the UCC had it been put in hard paper or “in writing”, and (2) the issuer of the electronic record expressly agrees that it is a record that is transferrable.  The concept of negotiability of notes under the UCC (i.e., the ability to transfer or sell a promissory note to another party) is thus replaced by the concept of transferability of the electronically transferrable record under the UETA. The individual who “controls” the electronic record is considered the holder of the eNote and has similar enforcement rights to those of an individual who “possesses” a traditional, hard paper note under the UCC.

The UETA lays out the requirements to be met for establishing who controls an electronic record.  The gist of it is that the system employed for the issuance or transfer of the electronic record has to (i) show which electronic document is the unaltered authoritative copy of the eNote (the “original”), (ii) indicate to whom the original was issued or transferred, (iii) have safeguards for the custody and integrity of the record by whomever is asserting control, (iv) require such person’s consent for any alterations to the original version, and (v) make it clear whether the record in question is the original or a copy. With that mandatory framework in mind, the issue with a lender accepting eNotes becomes whether, as a practical matter, a lender can satisfy the criteria for the enforceability of eNotes or if a lender should instead proceed by way of the more cautious route of accepting only wet ink, paper notes and avoid eNotes altogether.

Because eNotes are typically generated and transferred through what is known as the “MERS eRegistry,” which is an established online registry that tracks and records the control and transfer of eNotes and eMortgages, this system can create an electronic trail of “evidence” which a lender using such platform can retrieve and attempt to introduce in court (if necessary) to establish themselves as the rightful holder of an eNote. There is no requirement in the UETA or E-SIGN to use the MERS eRegistry, but their tracking system currently appears to be dominant in the US market for eNotes and eMortgages.  The danger in relying upon eNotes, however, is that for a lender to successfully prove that they have the right or “standing” to sue to enforce an eNote, the lender must be able to convince a judge that the electronic system employed for the issuance or transfer of their interests in the eNote, either as the original holder or as a transferee, conclusively establishes them as such.  Because the MERS eRegistry does not actually store the eNote for lenders but merely tracks transfers, a lender will have to prove that the electronic system used by the lender to store the eNote properly preserved the original version of the eNote in its intact form.  This is not yet a well-established process under Massachusetts law.

It appears that there are no appellate state court rulings in Massachusetts that provide guidance on the types of evidence that a court might find sufficient for lenders to establish themselves as having control of an eNote. To date, there have been only three appellate decisions (in Florida, Indiana, and New York) that address the above-mentioned hurdles, but these decisions are not binding on Massachusetts courts and are not as detailed or clear as one might wish in analyzing the legal issues.

B. What an eNote is not.

As mentioned above, a scanned signature transposed on a (hard) paper note, or on a PDF copy of a note is not an “eNote”. Neither is a note signed through DocuSign or the scanned image of a paper note. When dealing with paper notes, while a scanned or digital signature may suffice (provided it is clear a borrower intended to be bound by the documents so signed) for a lender to pursue a borrower for the monies owed as a contractual liability, such a document is not a promissory note or an instrument that is protected under the UCC and it does not entail the rights, defenses, and other protections afforded by that statute. Similarly, because scanned or PDF copies of a note are not transferrable records, the protections afforded to eNotes under the UETA do not apply. In either case, enforcement issues arise with respect to pursuing collateral ostensibly securing such scanned or electronically signed documents. For example, in order to foreclose on a real estate mortgage in Massachusetts, the lender must execute an affidavit that the foreclosing lender is the holder of the original signed paper note. If the lender is only in possession of a scanned signature on a paper note, what is the original?  How can the lender be deemed to be holding the original where any number of duplicates could be printed seemingly identical to the original? Similarly, it is not clear under the UCC how one would establish oneself as a holder of a note so signed or how a subsequent transferee would enforce a note supported only by a scanned signature. Section 3-309 of the UCC provides that:

(a) A person not in possession of an instrument is entitled to enforce the instrument if (i) the person was in possession of the instrument and entitled to enforce it when loss of possession occurred, (ii) the loss of possession was not the result of a transfer by the person or a lawful seizure, and (iii) the person cannot reasonably obtain possession of the instrument because the instrument was destroyed, its whereabouts cannot be determined, or it is in the wrongful possession of an unknown person or a person that cannot be found or is not amenable to service of process.

(b) . . . The court may not enter judgment in favor of the person seeking enforcement unless it finds that the person required to pay the instrument is adequately protected against loss that might occur by reason of a claim by another person to enforce the instrument. Adequate protection may be provided by any reasonable means.

Note that possession of an instrument under the UCC is required for a down-stream transferee to pursue remedies (or its loss must occur while held by the person seeking to enforce it). In the absence of an original wet signature on a note, evidentiary problems would seem to become almost insurmountable.

C. Reasons to proceed with caution when departing from traditional wet signature notes.

There are many valid reasons for a lender to proceed with caution when deciding whether to accept eNotes. Caution is warranted because there are potential hurdles, including evidentiary ones, to being able to prove in court (i) who controls the eNote, (ii) whether an eNote was properly transferred or assigned (if applicable), (iii) whether in case of a mortgage foreclosure the lender had physical possession of the original note at the time of the foreclosure, and (iv) if the electronic signature on the eNote conclusively originated from the borrower. These issues become especially pertinent when lenders wish to sell or transfer the eNote and can be tricky to deal with due to the relatively novel nature of eNotes, the unfamiliarity of judges with how they work and the lack of legal rulings to date on these matters.

There are also hearsay and best evidence rule issues that should be considered where novel technology issues are involved. Although we are not suggesting that these issues can never be properly navigated in court, there are multiple issues that must be addressed when attempting to enforce an eNote, all without authoritative judicial precedent outlining how to proceed.  Because of the lack of existing case law as to the enforcement of eNotes and the consequent lack of familiarity with eNotes by most judges, litigating such issues for the first time is likely to be expensive and is almost guaranteed to result in an appeal by one side or the other.

Because of the strict requirements governing real estate foreclosures, pursuant to which the lender is required to “hold” or “possess” the original note and the uncertainty of whether having control of an eNote under the UETA would count as holding the note under the Massachusetts foreclosure laws, a lender wishing to foreclose on a Mortgage securing an eNote would have to, at a minimum, sue for a declaratory judgment that he or she actually “possesses” or holds the note within the meaning of the foreclosure law before initiating the foreclosure process. As a result and until such time as the Massachusetts courts have provided greater guidance on this topic, it would be prudent for lenders to require that loans secured by real estate should be evidenced by a wet ink signed, paper note.

Similarly, if the note is secured by a security interest in personal property of a borrower, use of an eNote is also not recommended as the issue of subsequent enforcement under UCC §3-309 remains an open question. The lack of a wet ink signed paper note also will complicate and create issues with the potential to sell or transfer the note to a subsequent holder during the existence of the loan.

As stated above, lenders should never accept an e-signature or a scanned signature on an ordinary paper note unless the borrower follows up immediately by providing the wet ink original as part of the closing. Issues as to what constitutes an original under the circumstances are significant and may make enforcement and/or negotiation of such a note very difficult.

Finally, because Massachusetts court judges are unfamiliar with eNotes, any litigation involving such notes could take months or years to resolve and is likely to be costly in legal fees. Discretion may suggest that lenders wait for others to first trailblaze the path, reveal the pitfalls and litigate the myriad issues involving eNotes before adopting this new technology.

This communication is for informational purposes only and should not be construed as legal advice on any specific facts or circumstances.

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