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 state’s 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 debtor’s 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 debtor’s 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 debtor’s 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 MKA’s claim and granted summary judgment to the Hendricksons because they were the first to perfect a security interest in the promissory notes.
