Promissory Notes: Another Path to Perfection
By Steven N. Cohen, Karen B. Gelernt, and Lech Kalembka 

Mr. Cohen and Ms. Gelernt are partners and Mr. Kalembka is an associate in the Banking and Finance practice group of Cadwalader, Wickersham & Taft. They may be reached at  scohen@cwt.com kgelernt@cwt.com and lkalembk@cwt.com respectively.

This article explains how, under revised Article 8 of the Uniform Commercial Code, lenders providing financing to mortgage loan originators and consumer lenders can assure themselves of having a perfected security interest in the underlying mortgage loans or consumer loans in circumstances where, under traditional concepts under Article 9 of the UCC, perfection could be challenged. 

The use of promissory notes as collateral serves a vital function in providing prospective homeowners and other consumers access to capital. For not only do the promissory notes evidence the obligation of homeowners and other consumers to repay their mortgage loans and other consumer loans, the promissory notes can also serve as collateral for the financing that a home mortgage loan originator or non-bank consumer lender typically requires to conduct its business. At the same time, the requirement that the secured lender (and not the mortgage loan originator or consumer lender) have physical possession of a promissory note for the secured lender’s security interest to be perfected can pose practical impediments to the financing of these promissory notes. These problems are further compounded in circumstances where the underlying promissory notes are lost or destroyed.

This article reviews the legal underpinnings for traditional financing of mortgage loan originators and consumer lenders and proposes that, by taking advantage of the provisions of revised Article 8 of the Uniform Commercial Code (the “UCC”), lenders providing financing to mortgage loan originators and consumer lenders can assure themselves of having a perfected security interest in the underlying mortgage loans or consumer loans in circumstances where, under traditional concepts under Article 9 of the UCC, perfection could be challenged. 

Background 

In a “mortgage warehouse” transaction an institutional lender, such as a commercial bank, insurance company, or investment bank (an “Institutional Lender”), will lend to a mortgage bank or other “originator” (the “Originator”), which will in turn use the proceeds of the loan to fund loans by it to individual mortgagors.1 Institutional Lenders also lend to Originators to fund consumer loans outside of the real estate context, thus enhancing consumer access to credit generally. 

In exchange for a loan from the Originator, a promissory note (a “Note”) will be executed by the mortgagor (a “Mortgage Note”) or consumer borrower (a “Consumer Note”) in favor of the Originator, together, in the case of a loan secured by real property, with a mortgage on the real property. To secure its obligation to repay the Institutional Lender, the Originator will grant a security interest in the Note in favor of the Institutional Lender. In the case of a real estate loan, the Institutional Lender may also obtain an assignment of the mortgage, typically in blank, although it normally will not have the assignment recorded in the relevant real property records.2 

An Originator of mortgage loans may use the proceeds derived from the sale of such loans to repay its borrowing from the Institutional Lender. In connection with such a transaction, the Institutional Lender will send the relevant loan files to the prospective investor, together with a “bailee letter” that instructs the investor that such investor is acting as the Institutional Lender’s bailee for purposes of maintaining the perfection of its security interest,3 and that such investor should wire any sales proceeds directly to the Institutional Lender. 

Validity and Perfection of Institutional Lender’s Security Interest 

The UCC provides critical advantages to an Institutional Lender that “perfects” its security interest in the Notes. In particular, a perfected security interest has priority over other creditors of, and transferees from, the Originator,4 including lien creditors and a bankruptcy trustee.5 A security interest is perfected when it has “attached”6 and the mechanical step or steps required to afford public notice of the security interest of the creditor,7 e.g., filing a financing statement 8 or obtaining possession of the collateral,9 have been taken. 

“Attachment,” i.e., validity, of a security interest requires the satisfaction of three conditions. First, the debtors must have “rights”10 in the collateral. Second, the creditor must give “value,”11 which for UCC purposes simply means “any consideration sufficient to support a contract.”12 Finally, unless the collateral is in the possession of the secured party or is “investment property”13 subject to its “control,”14 the parties must have executed a written security agreement. (Of course, even if an exception to the written agreement requirement applies, the prudent practice is to enter into a written security agreement.)

 Perfection By Possession 

In the case of “instruments,”15 such as the Notes, perfection is accomplished by “possession.”16 Moreover, except for temporary perfection in limited circumstances,17 possession is the exclusive means for perfecting a security interest in instruments. Possession is not a mere act, but a course of conduct;18 possession, therefore, must be “unequivocal” and “notorious.”19 The drafters of the UCC believed that a rule requiring possession is consistent with long-established commercial practices, and that permitting filing as an alternative would not advance any significant interest.20 Possession by the secured party, accordingly, is both necessary and sufficient, since the debtor’s lack of possession alerts prospective creditors and purchasers that the asset may be subject to a security interest.21 

That being said, the drafters did not include a definition of “possession,” leaving the matter, for better or worse, to be determined on a case-by-case basis.22 Nevertheless, certain clear principles emerge. First, if an Institutional Lender takes actual physical possession of the Notes, its security interest is perfected.23 

Conversely, the security interest of the Institutional Lender in the Notes will not be perfected if the Originator retains possession. See, e.g., Ingersoll-Rand Financial Corporation v. Nunley, 671 F.2d 842, 844-45 (4th Cir. 1982); Grant Gilmore, Security Interests in Personal Property, § 14.1 (noting the “antagonism to the secret lien” under the common law). Likewise, the Institutional Lender cannot successfully argue that the Originator acted as its agent for purposes of perfection by possession, insofar as Official Comment 2 to Section 9-305 (“Comment 2”), declares that “it is of course clear . . . that the debtor . . . cannot qualify as an agent for the secured party.” 

Practical considerations may necessitate that Consumer Notes be held by the Originator. Where the Loans are subject to frequent modifications, or where the Notes are numerous, possession by a Custodian may be impracticable. 

In such circumstances, possession under UCC Sections 9-304 and 9-305, obviously, is impossible.

 Indirect Possession 

In some circumstances, rather than delivering the Notes directly to the Institutional Lender, it may be more convenient and economical to leave the Notes with a custodian that is a corporate affiliate of the Originator (an “Affiliated Custodian”). As a preliminary matter, it is important to recognize that affiliation may exist in circumstances beyond the garden-variety parent-subsidiary and sister-sister relationships; for example, an investment advisor is considered an affiliate under the Investment Company Act of 1940 (the “1940 Act”)24 of the investment company it advises, and could be considered an affiliate for commercial law purposes in connection with its custody of Notes pledged by the investment company as borrower. 

Despite the potential administrative and cost advantages, leaving the Notes with the Originator or an Affiliated Custodian creates risk for the Institutional Lender regarding the perfection of its security interest.

 The outcome for the Institutional Lender in this case will depend on the precise nature of the relationship between the Originator and the Affiliated Custodian and, in some circumstances the relative degrees of control over the Notes or the Affiliated Custodian exercisable by the Originator. See, e.g., The Edibles Corporation v. West Ontario Street Limited Partnership, 653. N.E. 2nd 45, 47 (Ill. App. 1995).

 The lodestar of the analysis is Official Comment 2 which provides that “it is of course clear . . . that [an] agent [of the debtor] cannot qualify as an agent for the secured party.”

 Accordingly, where an Affiliated Custodian is a wholly-owned subsidiary of the Originator, control of the Affiliated Custodian by the Originator (and therefore, control of the Notes by the Originator ) is plainly established, and the security interest will almost certainly be unperfected.

 Official Comment 2, however, leaves many questions unanswered. Most importantly, it does not address the situation in which the Originator is a subsidiary of the Affiliated Custodian or in which the Originator and the Affiliated Custodian are sisters or, considered affiliates under the 1940 Act. In these cases, control is not as readily apparent because a subsidiary, sister or investment company is not generally viewed as being “in control of” (as distinguished from being “under common control with”) its corporate parent or investment advisor.

 Similar to the Comment, the case law fails to articulate clear, easily applied rules regarding the application of Section 9-305 in this context, but proceeds instead on a case-by-case—indeed, sometimes contradictory—path.

 Many cases adopt a conservative approach, stating or implying that any close relationship between the debtor and the custodian precludes perfection through possession by a bailee. A leading example is Heinicke Instruments Co. v. Republic Corp., 543 F.2d 700 (9th Cir.1976), in which the debtor pledged the stock of a company he had formerly served as president to secure a personal loan. At the time the loan was made, certificates for the stock had not been issued.

 After the borrower defaulted, the court held that a garnishee of the certificates had priority over the lender because the lender had not perfected its security interest by possession. In particular, the court found that the close relationship between the issuer of the stock and the borrower precluded the issuer from acting as agent for purposes of perfecting the lender’s security interest.25 According to the court, it was “highly dubious” that the issuer could act as agent for anyone except the person to whom the shares were issued, i.e., the borrower.26

 Moreover, the issuer’s relationship to its former president “was too close . . . to provide any effective notice of its agency status to third parties.”27

 Another important holding was rendered in McDonald v. National Bank (In re Hill), 7 B.R. 433 (Bankr. W.D. Okla. 1980). In Hill, the debtor pledged an interest in his motorboat as security for his promissory note.28 The debtor filed for bankruptcy approximately two months later. During the period between the debtor’s execution of the note and his bankruptcy filing, the debtor stored the boat at the residence of his father (who co-made the note).

 Although the facts are somewhat murky, the bank apparently contended that it possessed the boat within the meaning of Section 9-305. The debtor did not have physical possession of the boat, and the bank believed that the debtor’s father was its de facto agent. The court rejected these contentions and found that the bank’s security interest was not perfected by possession. “Mere possession by the debtor or a person closely associated with him cannot perfect the secured party’s interest.”29 In addition, the court noted that “[t]he debtor could have removed the boat at any time had he so wished. This was not the required unequivocal, absolute and notorious notice to others.”30

 Similarly, in Rhode Island Hospital Trust National Bank v. Monack (In re Lee), 28 B.R. 319 (Bankr. D.R.I. 1983), the court found that the secured party had not perfected its interest in a boat by possession where the collateral was held by a relative of the debtor. The boat in question was sold to the debtor by the seller, which retained a security interest in the boat.  The boat was in possession of the cousin of debtor’s wife, an arrangement approved by the seller. The court concluded that “storing the boat on the property of a relative of the debtor does not constitute ‘taking possession of the collateral’ by an alleged secured party, within the meaning of UCC 9-305.”31 It reasoned that the seller had failed to demonstrate that the cousin of the debtor’s wife was not controlled by the debtor or that the placing the boat on her property adequately informed potential lenders of the possible existence of a security interest.32

 Other courts have adopted a more liberal stance. For example, in Levey v. Burke, Wilson & McIlvaine (In re Bragiel), 151 B.R. 186 (Bankr. N.D. Ill. 1993), the debtor, a partner in a law firm, granted a security interest in his shares of stock in the law firm to his bank lender. The firm held the shares under a triparty agreement that expressly acknowledged the pledge to the bank.33

 Relying on the absence of any indication that the debtor controlled, or even appeared to control, the firm, the court concluded that the law firm was the creditor’s bailee and that the possession by the firm of the shares was adequate to place third parties on notice that debtor’s control of shares was not unfettered. The court stated that the existence of obligations to the debtor does not necessarily disqualify a party from having the status of a bailee under Section 9-305. 34

 In a holding seemingly at odds with Official Comment 2, the court in Clancy v. Kane (In re Bruce Farley Corp.) held that the possession of two promissory notes by the debtor’s wholly-owned subsidiary, putatively acting as agent for the creditors, perfected the creditors’ security interest in the collateral. 26 B.R. 164 (S.D. Cal. 1981). The debtors, BFC, pledged the notes to the creditors, the Clancys, to secure payment of two loans made by the Clancys to the BFC. The notes initially were held directly by the Clancys and later were transferred to Seacoast Escrow Corporation, a wholly-owned subsidiary of BFC (“Seacoast”) in order to initiate collection actions. The trustee in bankruptcy claimed that the Clancys lost their perfected security interest when they transferred the notes to Seacoast because Seacoast could not act as agent for the Clancys under Section 9-305. 35

 Rejecting the contentions of the trustee, the court held that Seacoast was clearly acting as the creditors’ agent when it took possession of the collateral, and, accordingly, the Farleys continued to have a perfected security interest in the Notes.

 Conspicuously absent is any effort by the court to reconcile its holding with Official Comment 2. In fact, the court seemed motivated more by considerations of equity than by doctrine. Thus, the court referred to the Clancys’ complete unawareness of the subsidiary relationship of the creditor to Seacoast. In light of the circumstances, “to allow the action taken by the creditor intended to satisfy the debt [i.e., surrendering the notes to Seacoast for purposes of collection] be the action that renders the interest unperfected would be inequitable.”36 The court held, therefore, that “whether the interest remained perfected, the trustee in bankruptcy was estopped from contesting the continuing validity of the perfected security interest.”37

 The cases, therefore, do not offer clear guidance as to what types of affiliation between debtor and custodian preclude perfection under Section 9-305. Nevertheless, certain factors have been emphasized by the courts. Specifically, the existence and extent of control maintained over the collateral by the debtor may drive a court’s determination. This is the issue to which the discussion now turns.

 Control was central to the court’s determination in Clarkson Co. Ltd. v. Shaheen, 533 F. Supp. 905 (S.D.N.Y. 1982). In Shaheen, the principal (Shaheen) of several corporations he controlled pledged his stock in such corporations as collateral for his guarantee of debts owed by such corporations to another corporation (MacMillan) controlled by Shaheen.38 The relevant stock certificates were held by an attorney appointed as escrowee.39

 In a subsequent dispute between a judgment creditor and MacMillan, the latter claimed a perfected security interest in the shares prior to the judgment lien. The fulcrum of the court’s analysis is the familiar concept that perfection requires “actual and exclusive possession” by the secured party, which in turn has two components. First, that the “pledgor surrender his dominion over the property, and . . . [second, that] any semblance of ostensible ownership by the

pledgor be negated”.40 In this case, because the pledgor controlled not only the actions and assets of the entities whose shares he pledged, but also those of MacMillan, the court concluded that the secured party lacked the required level of possession.41 In fact, Shaheen was able “to use the assets of MacMillan and all the related companies as he chose at any time regardless of pledges, escrows, public stockholders, or fellow directors.”42 At bottom, “MacMillan’s possession was, in fact, Shaheen’s possession.”43 The pledge was thus a sham and the security interest unperfected.

 The holding in Merrill Lynch, Pierce, Fenner & Smith v. Van Kylen (In re R. Van Kylen), 98 B.R. 455 (Bankr. W.D. Wis. 1989) also provides instruction regarding those powers, which if retained by the debtor, will likely preclude possessory perfection of the security interest. In Van Kylen, the debtor had pledged his interest in a cash management account (“CMA”) maintained with his broker to Citizens State Bank. The governing agreement enabled the debtor to control investments in the CMA and direct the broker to deposit the funds therein into a checking account, thereby allowing the debtor direct access to funds in the CMA at any time.

 The court held that because the debtor’s rights with respect to the CMA were “general intangibles”,44 the bank’s failure to file a financing statement was fatal to its claim of a perfected security interest.45 Further, even assuming arguendo that the assets held in the CMA were instruments, the bank’s assertion of perfection through constructive possession would fail. Specifically, because the debtor was not deprived of control over the CMA, the bank could not have perfected its security interest by possession. “Any control exercisable by the debtor over the putative agent for the secured party defeats the secured party’s claims to possession. . . . 46 In sum, “[t]he degree of control the [debtor] possessed over both the collateral and the putative agent render[ed] the possession of the collateral by [the broker] inadequate to impart notice to third parties . . .”.47

 Another leading case examining the issue of debtor control of collateral (although not instruments) is Hassett v. Blue Cross and Blue Shield (In re O.P.M. Leasing Services, Inc.), 46 B.R. 661 (Bankr. S.D.N.Y. 1985). In O.P.M., the debtor’s predecessor (the principals of which were also principals of the debtor) deposited $100,000 with their attorneys as security for a contingent obligation. The obligation and security was later assigned to the debtor, which maintained the money with the same attorneys (which were also the successor debtor’s attorneys).48 Under the terms of the escrow arrangement the debtor was to receive any interest on the funds prior to the release of the collateral to the secured party.49 The contingent event occurred and the escrowed funds were released to the secured party shortly before the debtor filed for bankruptcy.50

 The bankruptcy trustee argued that the secured party’s security interest in the escrowed funds was not perfected by possession because the secured party could only take the funds if the contingency (the debtor’s failure to pay certain amounts) occurred. The court instead focused on the debtor’s lack of control of the disposition of the collateral. Finding that the funds were not within the control of the debtor since the debtor retained only a contingent right to the funds,51 the court held that the secured party maintained possession of the collateral.

 Out of the mist of Section 9-305 and cases thereunder, some signposts can be detected to guide the Institutional Lender if the Notes are held by an Affiliated Custodian that is not presumptively controlled by the Originator. In particular, the likelihood that an Institutional Lender’s security interest will be deemed to be perfected will increase to the extent that (i) Originator controls neither the activities of the Affiliated Custodian nor or the disposition of the Notes, (ii) the name of the Affiliated Custodian is readily distinguishable from that of the Originator and (iii) the Affiliated Custodian takes measures, such as segregating the Notes from other proprietary and custodial assets, designed to provide notice of the existence of the security interest.52

 Nevertheless, given the proclivity of judges (especially in insolvency proceedings) to set aside security interests when afforded the opportunity, it is prudent to assume for planning purposes that a court could avoid a security interest when Notes are held by an Affiliated Custodian, irrespective of the nature of the affiliation.

 In light of the uncertainty, in circumstances in which it is expedient to leave the Notes with the Originator or an Affiliated Custodian, parties such as the Institutional Lender may wish to avail themselves of the 1994 revisions to Article 8 of the UCC, discussed below.

 Lost Notes

 An Institutional Lender also confronts difficult perfection issues where the Notes have been lost or destroyed (“Lost Notes”). A particularly vexatious problem may arise if a Note, believed to be lost, is subsequently located at a time when the Originator is in financial distress the Institutional Lender seeking to exercise post-default remedies.53

 Research has disclosed only limited precedent relevant to the proper classification under Article 9 of the UCC of an asset such as a Lost Note or what rights, if any, a secured party or other transferee, such as an Institutional Lender acquires by an assignment of a Lost Note.

 There are good arguments that a Lost Note should be either an “instrument” or a “general intangible”54 under the UCC, a security interest in which, therefore, may be perfected thereunder.

Nevertheless, because there is no precedent directly on point, the matter is uncertain.

Under the definition of instrument described in Section 9-105(1)(i) of the UCC,55 a Lost Note will be an “instrument” if it (i) is a “writing”, (ii) evidences a right to the payment of money, and (iii) is transferred in the ordinary course of business by delivery.

 The second requirement for a Lost Note to be an instrument, i.e., that a Lost Note involves the right to the payment of money, is plainly satisfied. It is less certain, however, whether the other components of the definition are satisfied.

 Unless a copy or other reproduction of a Lost Note exists, the writing requirement of the definition is obviously failed. Not infrequently, however, reproductions of the Lost Notes in, e.g., microfiche form, will exist.

 There is some support for the proposition that a reproduction of an originally executed promissory note is a writing, thereby satisfying the first requirement. Under Section 1-201(46) of the UCC, “writing” is defined to include “any intentional reduction to tangible form.” Although the definition is not elucidated in the relevant Official Uniform Comment, and research has found no case on point, the “reduction” of a Lost Note to “tangible form” through the medium of microfilm may cause such a Lost Note to satisfy the definition of “writing.” As discussed below, there is some case law that supports the proposition that a copy of an otherwise unavailable original satisfies the requirement that a instrument be reduced to writing.

 The third requirement, that an instrument be of a type which is in ordinary course of business transferred by delivery with any necessary endorsement or assignment, is most problematic. It does not appear that even a microfilmed copy of a promissory note can be fairly said to be so transferred. Nonetheless, the limited available case law does not rule out the characterization of a Lost Note as an instrument.

 A somewhat helpful holding regarding the characterization of an asset such as a Lost Note as an instrument is Bray v. Cadle Company, 880 S.W.2d 813 (Ct. App. Tex. 1994). In Bray, the borrower executed a promissory note in favor of the lender, which note was secured by another note that had previously been made in favor of the borrower (the “Collateral Note”). Both notes were later assigned by the lender to the appellee. Because the Collateral Note had been lost, the appellee only received a copy.56

 After the borrower defaulted on its note and the lender sued for a deficiency judgment, the borrower contended that because the original Collateral Note had been lost, the lender, and therefore the appellee, lacked an interest in the Collateral Note.57 The court, however, apparently treated the photographic copy of the Collateral Note as the functional legal equivalent of the original.58 In particular, the court believed that since the original was lost, the lender’s possession of the copy satisfied the “notice” function of a possessory pledge.59 See also General Elec. Co., Inc. v. Tracey Service Co., 729 F.2d 1446 (3d Cir. 1984) (Table) (even though the stock certificate had been lost, corporate stock was an “instrument”).60

 Nevertheless, the Bray court’s reasoning is not clear; it did not, for example, examine the transferability characteristics incorporated in or even mention, the definition of “instrument” in UCC Section 9-105(1)(i).

 In addition to the problem of characterization, it is not clear that the transfer of microfilmed copies of the Lost Notes would perform the essential function served by the possessory pledge of providing notice to third parties that, because a creditor or its agent has physical possession of property and the debtor therefore ostensibly has surrendered possession, such property is subject to a security interest. See, e.g., First Sav. Bank of Virginia v. Barclays Bank, S.A., 618 A.2d 134 (D.C. App. 1992); In re Raiton, 139 B.R. 931 (Bankr. 9th Cir. 1992).61

 Therefore, while it is possible, it does not seem likely that a Lost Note, even if represented by a reproduction, is an instrument.

 If a court were to find that a Lost Note is not an instrument, it could find that it is a “general intangible.”62 This result is intuitively appealing. First, rights to payment under various types of agreements, including swap receivables, servicing rights and, indeed, uncertificated loan participations, are understood to be general intangibles.

 Although not directly on point, Section 3-804 of the UCC is relevant to the analysis insofar as it provides that the obligee of a Lost Note retains a property right enforceable against its obligor. Under Section 3-804 of the UCC:

 “The owner of an instrument which is lost, whether by destruction, theft or otherwise, may maintain an action in his own name and recover from any party liable thereon upon due proof of his ownership, the facts which prevent his production of the instrument and its terms.”

 If, as Section 3-804 makes plain, the obligee under a Lost Note has rights thereunder enforceable against the obligor, it would seem unreasonable to hold that such rights cannot be effectively assigned. To hold otherwise would appear, among other things, to contravene the UCC’s animating purpose of “permit[ting] the continued expansion of commercial practices through custom, usage and agreement of the parties.”63

 There is one holding that, although somewhat ambiguous, appears to support the characterization of a Lost Note as a general intangible. In re Southern, 32 B.R. 761 (Bankr. D. Kan. 1983). In Southern, the debtors made a borrowing secured by a promissory note and deed of trust arising from the sale of land to a third party.64 After bankruptcy proceedings were initiated in respect of the debtors, the lender was unable to find the collateral note.65 The court indicated that, despite the lack of a possessory pledge, the lender’s security interest would have been properly perfected if it had filed a financing statement.66 Although it appears that the court therefore considered the lost promissory note to constitute a general intangible, the court’s failure to differentiate in this regard between the contract for deed and the note leaves the matter somewhat doubtful.67

 Finally, although not concerned with lost notes, the court’s holding in In re Cambridge Biotech Corp., 25 UCC Rep. Serv. 2d 1076 (Bankr. D. Mass. 1995), is consistent with the conclusion that assets such as the Lost Notes remain personal property. In Cambridge, the issue before the court was whether non-negotiable, non-transferable certificates of deposit were instruments. In holding that they were instead general intangibles, the court noted, significantly for purposes of the characterization of a Lost Note as a general intangible, that because they were “personal property . . . not excluded from the scope of Article 9 . . . [they] must fall into the ‘catch-all’ category of ‘general intangibles’.”68

 Perfection Under Revised Article 8

In 1994, the American Law Institute and the National Conference of Commissioners on Uniform State Laws approved a substantially revised version of Article 8 of the UCC (“Revised Article 8”),69 which, as of December 1, 2000, had been enacted in the District of Columbia and every State except South Carolina. Most importantly for purposes of this article, Revised Article 8 expanded the scope of its predecessor to include not only traditional investment securities but the broader concept of “investment property.”70 It is the elasticity of this concept that enables parties such as an Institutional Lender in many circumstances to perfect a security interest in Notes held by the Originator or an Affiliated Custodian, Consumer Notes held by the Originator, and in Lost Notes (or the functional equivalent of a security interest therein).

 The analysis proceeds as follows. A security interest in “investment property”71 may be perfected automatically,72 by “control”73 or, in most cases, by filing a UCC financing statement.74 Perfection under Revised Article 8 is feasible because the statute governs a broad range of investment property and other “financial assets,”75 such as the Notes.

 “Investment property” includes a “security entitlement,”76 which arises when a “securities intermediary” (i.e., a bank or broker that in the ordinary course of business maintains securities accounts for others and is acting in that capacity) credits a financial asset to a “securities account.”77

 In addition to a security, a “financial asset” includes any interest in property that “is, or is of a type, dealt in or traded on financial markets or which is . . . a medium for investment”78 and any property held by a securities intermediary in a securities account if the securities intermediary has expressly agreed to treat the property as a financial asset.79 “Financial asset” also includes a “negotiable instrument”.80

 As noted above, a security interest in a security entitlement can be perfected automatically,81 by “control”82 or by filing a financing statement.83

 “Control” of a security entitlement is achieved in one of two ways. First, a secured party has control if it becomes the entitlement holder 84 (i.e., has the relevant financial assets credited to a securities account exclusively in its name).85 Alternatively, a secured party has control over financial assets that remain credited to the securities account of the debtor (or an account whose name identifies both the ownership interest of the debtor and the security interest of the secured party) if the secured party obtains the agreement of the relevant securities intermediary, with the consent of the debtor, to comply with “entitlement orders”86 (i.e., directions) issued by the secured party without further consent of the debtor. In a critical difference from the bailee-with-notice context, ability of the debtor to withdraw or substitute collateral does not impair the secured party’s “control” under Revised Article 8.

 It appears that Notes, whether Lost Notes, Mortgage Notes physically held by an Affiliated Custodian or Consumer Notes held by the Originator, should satisfy the “functional” text paraphrased above and thus qualify as financial assets. Even if they did not, however, the parties may “opt into” Revised Article 8 by obtaining the agreement of the relevant Custodian that qualifies as a securities intermediary to treat the Notes as a “financial asset.”87 A security entitlement to such a Note will exist when the Custodian credits it to a securities account.88

Thus, as long as a Custodian qualifies as a securities intermediary, an Institutional Lender should be able to obtain a perfected security interest in Notes held by an Affiliated Custodian or in Lost Notes if such Notes are designated financial assets under Revised Article 8 and the Institutional Lender obtains control. Similarly, if the Originator is holding Mortgage Notes or Consumer Notes and qualifies as a securities intermediary, perfection by control should be available.89

 In addition, if the Originator is not a broker or securities intermediary, the Institutional Lender can perfect by filing an effective UCC-1 financing statement with respect to the Notes.

 In the case of Mortgage Notes held by an Affiliated Custodian, concluding that the Lender is perfected may, at first blush, seem contrary not only to Sections 9-304 and 9-305 of the UCC, but to the ancient common law principles in which they are rooted. Nevertheless, nothing in Revised Article 8 precludes an institution that is a securities intermediary from acting as such with respect to financial assets owned by its affiliates.

 A critical difference between attempting to perfect in a Note or other instrument held by a custodian affiliated with the debtor under Section 9-305 and under Revised Article 8 is the difference between the Article 9 concept of bailee and Revised Article 8 concept of securities intermediary. The former is essentially relational; as discussed above, it focuses on the relationship between the debtor and the person or entity in possession of the collateral. The concept of securities intermediary, in contrast, is functional; it is principally concerned with the activities performed by such an entity in the financial markets.

 Moreover, since possession by a nonaffiliated bailee has always been available to perfect in an instrument, expanding the coverage of the assets eligible for perfection through actions taken by a securities intermediary under Revised Article 8 to include such financial assets as promissory notes would be virtually pointless if the bailee principle of nonaffiliation were transplanted to the definition of securities intermediary. Such a result would, in practice, not only conflict with the plain language of the Revised Article 8, but would violate its abiding purpose of modernizing the rules governing custody of financial assets and providing more flexible means for perfecting security interests therein.90

 The official commentary to Revised Article 8 makes a decisive preemptive strike against any arguments that the use of securities intermediaries should be shackled by common law bailee precepts. In particular, such commentary emphasizes that the “concept [of control] is not to be interpreted by reference to similar concepts in other bodies of law.”91 Moreover, “the requirements for ‘possession’ derived from the common law of pledge are not to be used as a basis for interpretation.”92 Accordingly, and crucially for purposes of the analysis, the control provisions “are designed to supplant the concepts of ‘constructive possession’ and the like.”93 Indeed, a “principal purpose” of including the control provisions in Revised Article 8 was “to eliminate the uncertainty and confusion”94 that the common law rules engender.

 An interest in a Lost Note likewise should be subject to perfection as a Revised Article 8 financial asset. The payment obligation represented thereby would appear to satisfy the functional prong of the definition of financial asset.95 Obtaining the agreement of the relevant Custodian under UCC Section 8-102(a)(9)(iii) to treat a Lost Note as a financial asset will eliminate any doubt concerning its status in this regard.96 Perfection can thus be achieved by implementing either of the control mechanisms described above.97

 Accordingly, under Revised Article 8 the Institutional Lender will have a perfected security interest in a security entitlement to Mortgage Notes or Lost Notes if a Custodian that is a securities intermediary agrees to treat such Notes as financial assets and either credits them to a securities account exclusively in the name of the Institutional Lender or enters into a “control agreement” with the Borrower and the Institutional Lender respecting such Notes.

 In the case of a Consumer Note or a Mortgage Note held by the Originator that qualifies as a securities intermediary, the same procedures can be implemented.

 The agreements of the Custodian or the Originator, as the case may be, in this regard need not be made in a separate agreement, but may instead be incorporated in the custodial or other agreement governing the relationship among the parties.

 In addition, because a security interest in investment property can also be perfected by filing a financing statement,98 such a filing is a useful precautionary measure.99 Such a filing should provide the Institutional Lender with another basis for a first-priority security interest in a security entitlement to the Notes. In the case of Mortgage Notes, such a filing will also perfect a security interest in a Lost Note to the extent it constitutes a general intangible.100

 Finally, because a court could conclude that a security interest in Mortgage Notes can in fact be perfected by giving notice to an Affiliated Custodian under Article 9 of the UCC, it is prudent formally to designate the Affiliated Custodian as a bailee with notice of the Institutional Lender’s security interest.

 Conclusion

 Serious doubt concerning the perfection of the Institutional Lender’s security interest in the Notes may arise where the Notes must be held by an Affiliated Custodian or where they have been, or are believed to have been, lost. The Institutional Lender may, therefore, find that its collateral is effectively worthless precisely when the collateral is most needed–when the Originator is insolvent or otherwise unable to perform its obligations.

 The financial asset and related control provisions of Revised Article 8 allow Institutional Lenders greatly to mitigate this risk, and do so in a manner that is relatively easy to understand and document. As a result, these provisions not only enhance the position of Institutional Lenders, but should also increase the access of Originators to credit.

 Endnotes

1 In some cases, the insurance company or investment bank may instead purchase the related mortgage loans outright. In either case, bonds may subsequently be issued which are backed by the future proceeds of the mortgages in a “securitization” transaction.

2 As a practical matter, the Institutional Lender will likely conclude that under the “mortgage-follows-the-note doctrine” the perfection of its security interest in the Notes will perfect a security interest in the underlying mortgage.

 We note that this doctrine is codified in Sections 9-203(g) and 9-308(e) of the revised version of Article 9 of the UCC that is scheduled to become effective on July 1, 2001. Revised Article 9. Secured Transactions (With Conforming Amendments to Articles 1, 2, 2a, 4, 5, 6, 7, and 8) (the “Revised UCC”).

 3 See infra, “Perfection By Possession,” and accompanying text.

4 Priorities between competing creditors are determined under UCC § 9-312. In general, a perfected security interest has priority over an unperfected security interest (UCC § 9-301(1)(a)). See note 5, infra, and accompanying text.

5 UCC § 9-301(1)(b), 11 U.S.C. § 544.

6 UCC § 9-203.

7 UCC § 9-303.

8 UCC § 9-302(1).

9 UCC §§ 9-304, 9-305.

10 UCC § 9-203(1)(c).

11 UCC § 9-203(1)(b).

12 UCC § 1–201(44).

13 Defined in UCC § 9-115(1)(f).

14 UCC §§ 9-203(1)(a), 8–106, 9-115(1)(e). The concepts of “investment property” and “control” are discussed in detail, infra.

15 Defined in UCC § 9-105(1)(i) as “a writing which evidences an obligation to pay money and is of a type which is in ordinary course of business transferred by delivery with any necessary endorsement.”

16 UCC §§ 9-304, 9-305.

Possession is the exclusive means of perfecting a security interest in the proceeds of a letter of credit and money, and an alternative to filing in the case of goods, documents, chattel paper and certificated securities. See UCC §§ 5-116(a), 8-106(a), 8-301(a), 9-115(4)(a), 9-305.

 Note that the Revised UCC provides that “control” is the exclusive means of protecting a security interest in a “letter-of-credit right.” Revised UCC §§ 9-102(a)(51), 9-107, 9-314(a).

 17 Specifically, a security interest in an instrument is automatically perfected for 21 days when granted in exchange for new value, and remains perfected for 21 days after possession is surrendered for purposes of ultimate sale or collection. UCC § 9-304(4), (5).

18 United States v. Jones, 533 F.2d 1387, 1391 (6th Cir. 1976).

19 Transport Equipment Co. v. County State Bank, 518 F.2d 377, 381 (10th Cir. 1975).

20 See Official Uniform Comment 1 to Section 9-304. See also First Sav. Bank of Virginia v.

Barclays Bank, S.A., 19 UCC Rep. Serv. 2d 1167, 618 A.2d 134 (D.C. App. 1992); In re Raiton, 17 UCC

Rep. Serv. 2d 962, 139 B.R. 931 (Bankr. 9th Cir. 1992).

 Note, however, that the Revised UCC will permit perfection of a security interest in an instrument by filing (Revised UCC § 9-312(a)), although such a security interest generally will be subordinate to a competing security interest therein that is perfected by possession (Revised UCC § 9-330(d)).

 21 See Transport Equipment, supra, note 19 (presence of agent of secured party on debtor’s premises insufficient to give notice).

 According to two leading commentators, the principle of notice has: “shaped the law of security interests in personal property for four hundred years: A party who wishes to acquire or retain a[n] . . . interest in property that is effective against others must, as a general matter, make it possible for others to discover that interest.”

 Douglas G. Baird and Thomas H. Jackson, Possession and Ownership: An Examination of the Scope of

Article 9, 35 Stan. L. Rev. 175, 178 (1983).

 22 David A. Ebroon, Possession by Possession In Article 9: Challenging the Arcane but Honored

Rule, 69 Ind. L.J. 1193 (1994) citing In re Automated Bookbinding Services Inc., 471 F.2d 546, 551-552

(4th Cir. 1972).

23 Id.

24 15 U.S.C. § 80a-1 et seq.

25 543 F.2d at 706.

26 Id.

27 Id. at 706-07.

28 Although this case and Rhode Island Hospital, note 31, infra, involved (coincidentally) boats, and therefore are not entirely on point, they are relevant insofar as they deal with perfection issues arising when possessory collateral is placed with a person or entity having a pre-existing relationship with the debtor.

29 Id. at 436.

30 Id. (citing Transport Equipment, note 19, supra).

31 Id. at 320.

32 Id.; see also Gibson v. Resolution Trust Corp., 51 F.3d 1016 (11th Cir. 1995) (possession of collateral by law firm acting as agent for bank did not amount to constructive possession by officers and directors); Merchants Nat. Bank of Cedar Rapids, Iowa v. Halberstadt, 425 N.W. 2d 429 (Iowa App.

1988) (agreement appointed auctioneer agent of debtor, not secured party).

33 151 B.R. at 187.

34 151 B.R. at 189.

 See also In re Allen, 134 B.R. 373 (Bankr. 9th Cir. 1991) (bailee need not be under secured party’s exclusive control so long as it is not under the debtor’s exclusive control); Norwest Bank v. Berquist (In re Rolain), 823 F.2d 198 (8th Cir. 1997) (creditor had a “perfected security interest in notes held by debtor’s attorney because debtor lacked unfettered use of notes).

 According to a treatise:

 “The bailee-with-notice technique . . . contemplates the collateral being held or controlled by someone aligned (at least initially) with the debtor. The bailee presumably already has some pre-existing relationship with the debtor, and his receiving notification of the secured party’s interest merely operates to transfer possession – albeit constructively – to the secured party.”

 J. Worley, Possessory Security Interests § 14.04[2][a][ii] at 14-48 (1976).

 35 Id.

36 Id. at 166.

Although not entirely clear, it appears that Seacoast held the notes beyond the twenty-one-day

period provided by UCC § 9-304(5).

37 Id.

38 Apparently, this transaction was effected to forestall enforcement action by the Securities and

Exchange Commission with respect to the creditor corporation. 533 F. Supp. at 911.

39 Id. at 908.

40 Id. at 917 (quoting 4B Collier, Bankruptcy, ¶ 70.86 at 982 (14th ed. 1978)).

41 Id. at 917-18.

42 Id. at 913.

43 Id. at 917.

44 98 B.R. at 464; see also UCC § 9-106.

45 Id. at 464; see also UCC § 9-302(1).

46 Id. at 466.

47 Id. at 467.

48 46 B.R. at 664.

49 The court noted, however, that accrued interest was not, in fact paid to the debtor and was instead transferred to the secured party, together with the principal. Id.

50 Id. at 665.

51 Id. at 668.

52 We note that certain courts prior to the enactment of the UCC held that a secured creditor had a perfected security interest in property stored at the premises of the debtor under “field warehouse” arrangements. See generally Union Trust Co. v. Wilson, 198 U.S. 530 (1905); Bostian v. Park National Bank, 226 F.2d 753 (8th Cir. 1955).

 Although the procedures necessary to establish the transfer of possession from the debtor to the custodian in such an instance are “not measured by any fixed set of rules,” McCaffey Canning Co. v. Bank of America, 109 Cal. App. 415, 435 (Cal. Dist. Ct. App. 1930), “[i]t is the duty of the pledgee to make such segregation and marks as will indicate his possession to business men [sic] of ordinary prudence . . .”. Western National Bank v. Chapman (In re Spanish-American Cork Products Co.), 2 F.2d 203, 204 (4th Cir. 1924).

 Procedures cited by courts that found a valid possessory pledge include (i) locking the collateral in an area in which the debtor was denied access, (ii) identifying the warehouse premises as subject to the interest of the creditor, and (iii) tagging the collateral to furnish notice of the pledge. Union Trust Co., 198 U.S. at 537; Manufacturers & Traders’ Bank v. Gilman, 7 F.2d 94 (1st Cir. 1925). 53 For example, the security interest of the Institutional Lender would likely be subject to the “strong arm” avoidance power of the bankruptcy trustee. 11 U.S.C. § 544(a).

 54 UCC § 9-106.

55 See note 15, supra.

56 880 S.W.2d at 815, 817.

57 Id. at 817.

58 Id.

59 Id. at 816-17; see also UCC §§ 9-304, 9-305.

60 The court in In re Investors & Lenders, Ltd., 156 B.R. 145 (Bankr. D.N.J. 1993), held that because the debtor maintained possession of the original promissory notes, possession by the creditor of copies was insufficient to perfect its security interest. The holding in Investors is distinguishable from the facts assumed with respect to the Lost Notes, however.

61 At the same time, the absence of originals of the Mortgage Notes eliminates a critical risk otherwise addressed by the possessory pledge, namely that the debtor will negotiate the paper to a third party in violation of the rights of a creditor.

62 It is likely that a Lost Note constitutes a “payment intangible”, and thus a “general intangible,” under the Revised UCC, i.e., “a general intangible under which the account debtor’s principal obligation is a monetary obligation.” Revised UCC § 9-102(a)(61), (42). A security interest therein will be perfected by filing and a sale thereof will be automatically perfected under the Revised UCC. Revised UCC §§ 9-310(a), 9-309(3).

It would not seem that a Lost Note would fall into the other major category of intangible payment rights under the UCC, i.e., “accounts,” since a Lost Note does not constitute a “right to payment for goods sold or leased or for services rendered.” UCC § 9-106.

 A subsequently enacted statute can be relevant to the interpretation of prior law. See, e.g., red Lion Broadcasting Co. v. Federal Communications Commission, 395 U.S. 367 (1969). Also, the text of an approved, but not yet enacted, statute is relevant to the interpretation of present law. See Carlson v. Giacchetti, 21 UCC Rep. Serv. 2d 872 (Mass. App. 1993).

63 UCC § 1-102(2)(c).

64 32 B.R. at 763.

65 Id. at 764.

It is not clear whether, as in Bray, a copy of the note existed and, if so, whether it was in the lender’s possession.

66 Id. at 765.

67 To the extent the Southern court found that the lost notes were general intangibles, its holding is inconsistent with the holding in Bray – underscoring the uncertainty in this area.

68 25 UCC Rep. Serv. 2d at 1086.

69 Revised Article 8. Investment Securities (With Conforming and Miscellaneous Amendments to Articles 1, 4, 5, 9, and 10).

70 Defined in UCC § 9-115(1)(e).

71 UCC § 9-115(1)(f).

72 A security interest in investment property granted by a “broker” (as defined in UCC § 8-102(a)(3)) or a “securities intermediary” (as defined in UCC § 8-102(a)(14)) is automatically perfected when it attaches UCC § 9-115(4)(c).

73 UCC §§ 9-115(1)(e), 9-115(4)(a), 8-106.

74 UCC § 9-115(4)(b). Note that filing is not an effective means of perfecting a security interest in investment property where the debtor is a broker or securities intermediary. UCC § 9-115(4)(c). As noted above, a security interest in investment property granted by such an entity is automatically perfected without further action. See note 70, supra.

75 UCC § 8-102(a)(9).

76 UCC § 8-102(a)(17).

77 UCC § 8-501(a). A “securities account” essentially is an account to which a financial asset is credited by a securities intermediary for the owner or pledgee.

78 UCC § 8-102(a)(9)(ii) (emphasis added).

79 UCC § 8-102(a)(9)(iii).

80 UCC § 8-103(d).

 An instrument is negotiable if, among other things, it contains a promise to pay a “sum certain” and is payable on demand or at a definite time. UCC § 3-104.

 81 See notes 72 and 74, supra.

82 See note 73, supra, and accompanying text.

83 See note 74, supra, and accompanying text.

84 UCC § 8-106(d)(1).

85 UCC § 8-501(a).

86 UCC § 8-102(a)(8).

87 UCC § 8-102(a)(9)(iii).

88 A security entitlement under the Revised UCC is not a specific property right in a particular item. UCC § 8-503(b). Rather, it is a bundle of contractual, statutory and property rights, the most important of which involves the obligation imposed on a securities intermediary to maintain sufficient interests in financial assets to satisfy the claims of its entitlement holders. UCC § 8-504(a).

89 Although the security interest will be automatically perfected in this case, taking the steps necessary to obtain control is advisable. For example, a secured party with control in most instances takes free of any “adverse claim” (as defined in UCC § 8°-102(a)(1)) to the relevant investment property. UCC § 8-510.

90 See Uniform Commercial Code - Investment Securities, Prefatory Note, 1.

 Also, we note that participants in the repurchase agreement (“repo”) market have for some time been comfortable that an effective delivery can occur with respect to, and a security interest perfected in, securities subject to so-called “hold-in-custody” repos, i.e., repos in which the “seller”/borrower of funds does not deliver the securities to the “buyer”/lender of funds.

 This structure appears to highlight the accommodation of traditional bailee principles to commercial reality.

 91 Official Uniform Comment 5 to Section 8-106.

92 Id.

93 Id.

94 Id.

95 See note 78, and accompanying text; see also UCC § 8-102(a)(9)(ii).

96 See note 79, and accompanying text.

97 See notes 73, 81, 83 and 84, and accompanying text; see also UCC § 8-106(d)(1), (2).

98 But see note 74, infra. As described in the text, in the case of an Originator that is a securities intermediary, a filing will not be effective. Instead, automatic perfection will apply. UCC § 9-115(4)(c).

99 Such a financing statement should be filed in the jurisdiction in which the Borrower maintains its chief executive office. UCC §§ 9-103(6)(d), 9-401.

 We note that under Revised Article 9, the proper jurisdiction to file a financing statement with respect to a debtor that is a “registered organization” (i.e., a corporation, limited partnership or limited liability company) will change from the jurisdiction in which the debtor’s place of business or chief executive office is located to the jurisdiction under whose laws it is organized. Revised UCC §§ 9-102(a)(70), 9-301, 9-307, 9-501(a).

 100 Filing is an alternative method of perfecting a security interest in an instrument under the Revised UCC. See note 20, supra.