Though prevalent, these practices do notmeet the technical requirements o the NewYork Uniorm Commercial Code to make thetranseree o a promissory note its “holder.” Thepotential result: unnecessary and totally avoidablelegal issues i the purchaser or pledgee ever needsto establish it holds the note. For example, in aoreclosure, these imperections might let theborrower deeat a motion or summary judgmentby claiming the plainti doesn’t validly holdthe loan.The problem arises rom a careul reading o thetechnical requirements o the UCC as in eect in New York (New York UCC).
New York is oneo only two states that still use the antiquated1951 version o UCC Article 3.
The ‘No-Space Test’
Under any UCC, i a transeree (whether buyeror secured party) wants to become a “holder”
o a negotiable instrument
—or, better, a “holderin due course”
—the transeror must rst duly“negotiate” the instrument to the new holder. Negotiation o a negotiable
instrument requiresdelivery o the instrument to the holder with anynecessary indorsement.
Being a holder (even “indue course”) o an instrument is not necessarilythe same as owning it, though some courts donot grasp the distinction.
An indorsement on the ront or back o aninstrument will unquestionably meet the testor “negotiation.” A separate piece o paper—today’s industry standard, the “allonge”—raiseslegal issues that impair its eectiveness as a validindorsement.First, ancient principles o commercial law,possibly still good law in New York, prohibit use o any additional piece o paper or an indorsementas long as enough space remains to write theindorsement somewhere on the instrument itsel (the “No-Space Test”).Second, even when the law allows a separateindorsement, the New York UCC literallyrequires an allonge to be “rmly axed” to theinstrument, a requirement that today’s practicegenerally funks.Historically, the law disavored use o an allongeto indorse an instrument. The majority viewunder all o the “law merchant,”
the Uniorm Negotiable Instruments Law (NIL),
and thecommon law applied the No-Space Test.
An overwhelming majority o courts in otherstates that have expressly considered this issuehave repeatedly interpreted the 1951 version o UCC §3-202 to carry orward the No-Space Test.
On the other hand, quite a ew cases have alloweda separate allonge under these circumstances.
Only a ew o these cases expressly consideredwhether a particular instrument still had room oran indorsement.
These cases generally upheld anallonge without discussing the No-Space Test. No New York case expressly decides whetherthe New York UCC includes a No-Space Test.A ew New York cases on allonges,
and a ewrom out o state applying the 1951 UCC, donot consider whether the instrument still hadenough space or an indorsement.The Ocial Text o Revised Article 3 doesnot directly address a No-Space Test. But OcialComment 1 to Revised Section 3-204 says: “Anindorsement on an allonge is valid even thoughthere is sucient space on the instrument oran indorsement.”I New York enacted the Revised UCC, anyconcern about a No-Space Test would diminishto the vanishing point. But New York, alongwith only South Carolina, hasn’t done that.Accordingly, the No-Space Test remains at leasta lingering concern in New York. And i lenderswant to identiy and mitigate every possible legalrisk in their documents—as they do—they shouldassume, conservatively, that New York has a No-Space Test.
I New York law does not have a No-Space Test,or i a particular transaction has satised the test,counsel must then ask two more questions beoreusing an allonge. Must the parties physically attachthe allonge to the instrument being indorsed? I so, what does “physical attachment” require?
New York UCC §3-202(2) states: “Anindorsement must be written by or on behal o the holder and on the instrument or on a paperso irmly aixed thereto as to become a partthereo.” This requirement tightened the NIL’sprevious requirement that the indorsement “bewritten on the instrument itsel or upon a paperattached thereto.”The change was deliberate, apparentlydesigned to assure the indorsement would travelwith the instrument. This, it was thought,would “protect subsequent purchasers rom therisk that the present holder or a previous holderhas negotiated the instrument to someoneoutside the apparent chain o title through aseparate document.”
areboth fnance partners o Latham & Watkins, residentin the New York ofce.
Monday, Noember 27, 2006
TRends In Real esTaTe and TITle InsuRance TRends In Real esTaTe and TITle InsuRance
When do allonges meet the requirements of the New York UCC?
By LAwrence SAfrAn And JoShuA Stein
HENEVER a lender transfersor pledges a loan, counsel willremember from law school thatthe assignor must “indorse”
the promissorynote to the assignee. Traditionally, indorse-ments appeared on the same piece of paperas the note. In today’s practice, though, anindorsement often appears on a separate page,an “allonge,” thrown into a folder with thepromissory note but not physically attachedto it. At best, someone might attach theallonge to the note with a paper clip.