Washington State: Promissory

Notes Secured by Real Estate

Governed by the UCC
Submitted by MichaelFierro on April 7, 2014 - 8:07pm
Under Washington state law, a promissory note secured by a real
estate mortgage is governed by the Washington UCC as a security
interest in personal property, not by the recording statute as an
interest in real property. In In re HW Partners, LLC, No. 11-03366-
JAR11, 2013 WL 4874172 (Bankr. E.D. Wash. 2013), the Bankruptcy
Court for the Eastern District of Washington held that the attachment
of a security interest in a right to payment also created an attachment
of a security interest in the underlying real property collateral securing
that right to payment. The security interest in the right to payment
then governs the law under which attachment and perfection are to
be judged. This proposition holds even when the underlying collateral
does not fall within the scope of the law governing the security
interest, such as real property collateral.

The court applied the Uniform Commercial Code (UCC) of

Washington State to a security interest in promissory notes, despite
those promissory notes being secured by real estate mortgages.
While Article 9 of the UCC governs security interests in personal
property, Article 9 does not extend to interests or liens on real
property. However, the court held that the mortgage follows the note.
Even though the promissory notes were secured by real estate
mortgages, they remained personal property and the mortgages were
immaterial to this determination. Thus, the promissory notes, along
with the mortgages, fell under Article 9 of the state UCC, rather than
the states real estate recording statute. The first party to perfect its
security interest in the promissory notes, regardless of the security
interest in the mortgages, had priority.

Additionally, the court held that there was no bifurcation of perfection

between the promissory notes and the real estate mortgages. The
court found that this approach, though adopted in a previous case by
the Sixth Circuit Court of Appeals (In re Maryville Savings & Loan
Corporation, 743 F.2d 413 (6th Cir. 1984)), had since been criticized
by subsequent decisions and finally overruled by amendments to the
Washington UCC, as evidenced in the Official Comments to Article 9
of the Washington UCC.

The two competing creditors in the instant case contested whose

security interests in the debtors property were perfected first, thereby
giving that creditor priority in the proceeds of the collateral. Both
creditors had security interests in promissory notes secured by
mortgages on the debtors property. The security interests in the
promissory notes were separately granted to the two creditors by the
financier of a development project who had obtained the notes,
secured by mortgages, from two developers. The developers
defaulted on their obligations and the two competing creditors moved
to collect against the collateral.

Both creditors successfully acquired security interests in the

promissory notes and mortgages. One of the creditors, MKA,
recorded its security interest in the mortgages on April 18, 2008 and
June 5, 2008. But MKA did not perfect its security interest in the
promissory notes until it filed a UCC financing statement on June 2,
2009. The second creditor, the Hendricksons, recorded their security
interest in the mortgages after MKA on October 23, 2008. However,
the Hendricksons filed a UCC financing statement on October 23,
2008, took possession of the promissory notes through an escrow
agent on November 6, 2008, and took physical possession of the
promissory notes on January 5, 2009 after the debtors default. Each
of these actions by the Hendricksons was sufficient to perfect their
security interest in the promissory notes, each of which occurred prior
to MKA filing its financing statement on June 2, 2009.

The bankruptcy court held that the security interests in the promissory
notes fell under the purview of Article 9 because promissory notes
are personal property. Because the mortgages followed the
promissory notes under Washington state law, the security interests in
the mortgages were perfected when, and only when, the security
interests in the promissory notes were perfected.

Though MKA recorded its security interest in the mortgages earlier

than the Hendricksons, it perfected its security interest in the
promissory notes after the Hendricksons had perfected their security
interest in the notes. MKA would have been successful under the
state recording statute, but it did not have priority under Article 9 of
the UCC. Thus, the court rejected MKAs claim and granted
summary judgment to the Hendricksons because they were the first
to perfect a security interest in the promissory notes.
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