DRAFTING EFFECTIVE AND ENFORCEABLE PROMISSORY NOTES

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1 DRAFTING EFFECTIVE AND ENFORCEABLE PROMISSORY NOTES First Run Broadcast: January 27, 2012 Live Replay: September 20, :00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) Promissory notes are one of the basic tools of transactional practice. They are used to facilitate a range of business and real estate transactions, including M&A, real estate capital improvements and startup finance. But the continuing credit crunch is putting renewed importance on careful drafting and management of promissory notes. With a growing number challenges to the enforceability of promissory notes, particularly in real estate transactions, drafting effective notes is essential to the successful completion of a business or real estate transaction. This program will cover drafting the essential provisions of promissory notes to ensure enforceability, the application of UCC Article 5/Negotiable Instruments, transferability and creditor pledge issues, recent challenges to the enforceability of notes, and much more. Drafting effective and enforceable promissory notes in business and real estate transactions Essential terms and structure of notes term and demand notes Compliance with UCC Article 5/Negotiable Instruments when drafting promissory notes Transferability of notes and creditors taking pledge in notes Recent developments involving promissory notes and the mortgage crisis Speakers: John Murdock is a partner in the Nashville office of Bradley Arant Boult Cummings, LLP, where his practice includes business acquisitions and dispositions, commercial lending, and commercial law generally. He is a member of the Commercial Financial Services Committee of the ABA Business Law Section and formerly served as chair of its Lender Liability Subcommittee. He is also a Fellow of the American College of Commercial Finance Lawyers. Mr. Murdock received his B.S., magna cum laude, from Vanderbilt University and his J.D. from Vanderbilt University Law School.

2 PROFESSIONAL EDUCATION BROADCAST NETWORK Speaker Contact Information Drafting Effective and Enforceable Promissory Notes John Murdock Bradley Arant Boult Cummings, LLP - Nashville (o) (615) JMurdock@babc.com

3 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information and fax or with credit card info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address Drafting Effective and Enforceable Promissory Notes Teleseminar September 20, :00PM 2:00PM 1.0 GENERAL MCLE CREDIT VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER September 13, 2013 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

4 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: September 20, 2013 Seminar Title: Location: Credits: Drafting Effective and Enforceable Promissory Notes Teleseminar 1.0 General MCLE Credit Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

5 Promissory Notes John E. Murdock III Bradley Arant Boult Cummings LLP Nashville, Tennessee I. Article 3 is not just about checks and bank drafts. Article 3 affects rights and duties in issuing, receiving, selling, buying, pledging, or receiving a pledge of, ordinary promissory notes that qualify as "negotiable instruments." This summary addresses the application of Article 3 to promissory notes issued in commercial transactions. A. The two main consequences of Article 3 relate to the transfer of promissory notes. 1. Mechanics and effect of transfer between transferor and transferee. 2. Effect of transfer as to rights between maker and transferee (through the potential status of the transferee as a holder in due course, or "HDC"). B. Article 3 also controls the interpretation and effect of the promissory note itself as an obligation of the maker, whether or not the note is transferred by the initial holder. II. About Article 3 A. Article 3 was amended broadly in The 1990 version is what is meant by most present references to "Article 3." Citations in this summary are to the 1990 version of Article 3 unless otherwise specified. 1. Changed title from Commercial Paper to Negotiable Instruments to better reflect scope. 2. Made many substantive changes, most of which were more relevant to check collections than to promissory note practice. B. Additional official amendments were issued in The 2002 amendments have been adopted thus far in ten states. These amendments make more check collection changes and make some changes of importance to ordinary promissory notes. A present reference to "Revised Article 3" would usually mean the 2002 version. Many citations to the 1990 version are also accurate citations to the 2002 version. C. Article 3 applies an extensive body of law to define the obligations surrounding the issuance and transfer of negotiable instruments. It does not apply to instruments that are not negotiable instruments. A given promissory note thus either 7/

6 invokes Article 3 because it is negotiable, or Article 3 is irrelevant to it because the note is not negotiable. These differences are the main subject of this summary. III. Basic concepts of Article 3 A. A promissory note is only a negotiable instrument if it meets specific requirements as to what it says. Section B. A negotiable instrument may be transferred by delivery alone or by negotiation. Sections 3-201, Delivery alone conveys whatever rights the transferor had in the note and gives rise to implied warranties of transfer (title, authority, no unauthorized alterations, no defenses to payment, no knowledge of bankruptcy of maker). Sections 3-203(a), Negotiation is delivery plus any necessary indorsement, creating a "holder" (one in possession of an instrument that runs to him or her). Sections 3-201, a. Negotiation conveys the rights of the transferor and often adds an indorser with statutory recourse obligations making the indorser liable for the credit of the maker. Sections 3-204, b. If the holder qualifies, the holder may also be a holder in due course ("HDC") and have greater rights to collect from the maker than the transferor had. Sections 3-302, For this reason, a maker would always prefer that a promissory note is not negotiable, and a payee or subsequent owner would always prefer that a promissory note is negotiable. IV. Practice Issues - Terms and Conditions of Issuance A. The statute of limitations applicable to a promissory note may vary based upon whether or not it is a negotiable instrument. Article 3 contains its own statute of limitations. Section For a note payable at a definite time, an action must be commenced within six years after the due dates stated in the note, unless the maturity is accelerated. In that case, it must be commenced within six years after the accelerated due date. Section 3-118(a). For a demand note, an action must be commenced within six years after the demand, but if no demand is made, an action is barred if no payments of interest or principal are made for ten years. Section 3-118(b). B. The obligations of multiple makers who sign a negotiable promissory note are joint and several unless the note requires otherwise. Section C. A co-maker has a statutory surety status as an "accommodation party" to the extent the co-maker signs a negotiable promissory note but did not receive the proceeds of the note. The terms and conditions of this status as provided by Article 3 7/

7 may not be the same as common law requirements applicable to other obligations of suretyship. Sections 3-419, D. Negotiable promissory notes are subject to procedural requirements in their enforcement that do not apply to non-negotiable notes, such as the obligation to physically present the instrument and demand payment or to give indorsers notice of the dishonor by the maker (such as by obtaining a "protest," a formal certification of dishonor required mostly in international transactions). Sections 3-501, 3-502, 3-503, Many of these requirements are customarily waived in the "boilerplate" of promissory notes. V. Practice Issues - Transfer by Negotiation A. An "allonge" is a writing separate from a negotiable instrument on which an indorsement is provided incidental to the transfer of the instrument. Section 3-204(a). Allonges are commonly used as matters of convenience for temporary transfers (such as the pledge of a promissory note to a lender) and for outright purchases. Some technical requirements still exist regarding transfer of promissory notes using an indorsement provided by an allonge. For example, to be an effective indorsement, an allonge must be "affixed" to the instrument. The precise degree of affixation that suffices is not clear and this can be a trap for the unwary. 1. Example: Southwestern Resolution Corp. v. Watson, 964 S.W.2d 262, 33 UCC Rep. Serv. 2d 1144 (Tex. 1997). An allonge was stapled and taped to a note. There was evidence that the allonge had been removed five or six times for photocopying and re-attached each time. The court held that the indorsements on the allonge were valid. The court said that stapling is the modern method of "affixing" one paper to another and that the 1990 revision s deletion of the former requirement that an allonge be "so firmly affixed to the instrument as to become a part thereof" removed any doubt whether stapling was sufficient. 2. Example: Estrada v. River Oaks Bank & Trust Co., 550 S.W.2d 719, 22 UCC Rep. Serv. 719 (Tex. Civ. App. 1977, n.r.e.). Estrada executed four notes to Lewis. Lewis pledged the notes to the bank. He did not indorse them, but executed a single collateral assignment of the four notes. The bank stapled the assignment to the notes. The court held that even if the assignment qualified as an allonge (which it probably didn t under pre-revision Article 3), a single signature was not sufficient to indorse four notes. The court noted that "indorsement by allonge has never been considered as prudent or desirable as an indorsement on the instrument itself." 550 S.W.2d at 728. In reversing a summary judgment for the bank, the court noted that as a transferee of the notes, the bank can still recover against Lewis. The lack of a proper negotiation only precludes it from being an HDC. B. Additional explanatory words added to indorsements generally do not impair their effect. For example, some borrowers who pledge promissory notes wish to include the words "for collateral security only" or similar phrases. The expanded language of the indorsement does not impair the ability of the pledgee lender or any 7/

8 subsequent person to become a holder or enforce the instrument. See Section 3-206(b), (d),(e). C. It must always be remembered that transfer warranties arise by statute if a negotiable promissory note is transferred and that indorser liability arises upon an indorsement. Sections 3-203(a), 3-416, 3-204, It is equally important to remember that these same undertakings may not be implied by common law if a nonnegotiable promissory note is transferred, so they should be provided or disclaimed by contract to reflect clearly the intention of the parties. VI. Rights of a Holder in Due Course A. Effect 1. A holder in due course takes a negotiable promissory note free of most claims to the instrument and free of most defenses otherwise available to the maker. a. Fraud. With limited exception, a person obligated on a negotiable instrument cannot assert against an HDC fraud that occurred in the underlying transaction. Section 3-305(b). The only fraud that can be asserted is "fraud that induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its character or its essential terms." Section 3-305(a)(iii). This is sometimes referred to as "real fraud," to distinguish it from "personal fraud," which is the ordinary type of fraud and cannot be asserted against an HDC. "Real" fraud may be found only when the maker has signed a document without a reasonable opportunity to understand its meaning, such as when a signature page is switched from another document to a negotiable instrument. Mere ignorance or lack of diligence in signing is not "real" fraud. For example, in New Bedford Institution for Savings v. Gildroy, 634 N.E.2d 920, 25 UCC Rep. Serv. 2d 450 (Mass. App. Ct. 1994), an investor with an MBA from Harvard signed a promissory note without reading it when a business associate told him he was signing a loan application for another deal. Because he had an opportunity to read the note, he could not assert the fraud against a thrift with the rights of an HDC. b. Payment not known to the holder. The basic principle of negotiable instruments is that an HDC is entitled to rely on the instrument and is not bound by anything extrinsic to it. If the maker or another person obligated on the instrument makes a payment, he needs to have the payment noted on the instrument so that anyone who later takes the note is aware of the payment. With respect to payments made to a person who has already transferred the note to a new holder, the rule has always been (and still is in most jurisdictions) that the payment does not discharge the debt. For protection, the maker has to require the person being paid to produce the note (and to record the payment on the note if the note is not finally paid and will be returned to the holder). This rule is changed by the 2002 amendments to Article 3 (adopted in only a few jurisdictions). New Section 3-602(b) provides that a payment to a person formerly entitled to enforce the note is effective against a later transferee unless the maker has received notice of the transfer and an address at which payments are to be made. The Official Comment notes that this change makes the rule consistent with UCC 7/

9 Section 9-406(a), Restatement of Mortgages Section 5.5 and Restatement of Contracts Section 338(1). For example, in Bank of Miami v. Florida City Express, Inc., 367 So.2d 683, 25 UCC Rep. Serv (Fla. Dist. Ct. App. 1979), Florida City Express executed two promissory notes in favor of a supplier. The supplier discounted the notes to the bank, but Florida City Express paid the supplier the full amount owed, some of the payments being made before the transfer to the bank and some after. The bank did not give to Florida City Express that the bank had acquired the notes until it attempted to make collection. The court held that because the bank was an HDC, it was entitled to recover the full amount of the notes from Florida City Express. Under the 2002 amendments, the liability of Florida City Express would be reduced by the amount of any payments made after the bank came into possession of the notes. c. Security interests and ownership claims. If a party wishes to have an indefeasible claim to a negotiable promissory note, whether as a lien security interest or as an owner, it should take possession of the original instrument in order to make it impossible for another HDC to exist. Thus, for example, while Revised Article 9 allows for the perfection of security interests in "instruments" (which for the purpose of Revised Article 9 include, but are not limited to, negotiable promissory notes) by filing a financing statement, a holder in due course of the instrument will still have priority. Sections 9-312(a), 9-330(d), 9-331(a). d. A holder in due course does not take free of a limited number of defenses: infancy, duress, lack of capacity, illegality that nullifies the obligation, "real" fraud (where maker lacked intent to sign an instrument), discharge by insolvency proceeding, and the statute of limitations. B. How HDC status is obtained. 1. Becoming HDC in one's own right (i.e., other than by "shelter"). a. The HDC must be a "holder" (defined above). b. The holder must give "value." Note that the definition of "value" in Article 3 (Section 3-303) is different from the Article 1 definition of value (Section 1-204, which applies in most other articles. Under the Article 1 definition, a binding promise (including a binding commitment to extend credit) constitutes "value," but under the Article 3 definition, value is not given until the promise is actually performed and then only to the extent that it has been performed. (i) Hypothetical: Borrower pledges a note to Bank as security for a line of credit. Bank has given "value" under Article 1, so its security interest can attach. Bank does not give "value" under Article 3 until Borrower draws on the line of credit. If, before Borrower draws on the line of credit, Bank learns that the maker alleges that the note was issued to Borrower in payment for defective goods, Bank cannot be a holder in due course of the note. 7/

10 (ii) Hypothetical: Developer gives Builder a note in the principal amount of $100,000 in payment for a job. Builder sells the note to Investor to raise ready cash. Because Developer s credit is shaky, Investor pays only $80,000 for the note. Investor can be an HDC of the note and can enforce it as an HDC for the full $100,000 plus any applicable interest. (iii) Hypothetical: Same facts as the preceding hypothetical except Investor does not pay Builder the full $80,000, he pays $40,000 and promises to pay the remaining $40,000 at a later date. Because Investor has paid only half of the amount he promised, he is entitled to HDC status only to the extent of half the amount owing on the instrument ($50,000). Investor may be able to collect the full $100,000 from Developer, but the second $50,000 is subject to any claims or defenses that Developer may have arising out of the same transaction as the note. See Section 3-302(d). (iv) Hypothetical: Instead of selling the note, Builder borrows $70,000 from Bank and pledges the note as collateral. Bank is an HDC only to the extent of the amount owing on the secured debt (2)(ii). c. The holder must take the instrument in good faith. Section d. The holder must take the instrument without notice that: (i) It is overdue or has been dishonored. Unless the maturity of the note has been accelerated, a default in the payment of interest alone does not make the note overdue. If any part of the principal is in default, however, the note is overdue until the default is cured. Section 3-302(a)(2)(ii); see Section Section 3-302(a)(2)(iv). Section 3-302(2)(a)(v,vi). (ii) (iii) There is any unauthorized signature or alteration. There are any claims or defenses to the instrument. 2. Acquiring HDC status through the "shelter" principle. a. Section 3-203(b) provides that a transfer of the instrument, whether or not the transfer is a negotiation, gives the transferee all of the rights of the transferor to enforce the instrument, including rights of a holder in due course. (i) Hypothetical: Borrower, who is an HDC of a note, pledges the note to Bank as security for a loan. Bank fails to obtain Borrower s indorsement on the note and so cannot be an HDC in its own right. It still acquires Borrower s right to enforce the note as an HDC. (ii) Hypothetical: Debtor grants Finance Company a security interest in a portfolio of notes of which Debtor is an HDC. Finance Company 7/

11 perfects its security interest by filing and does not take possession of the notes. Finance Company does not succeed to Debtor s position as an HDC because it is not a "transferee" under Section 3-203(a). If Finance Company later (perhaps through a workout agreement) takes possession of the notes, it then succeeds to Debtor s status as an HDC. b. Example: New Bedford Institution for Savings v. Gildroy, 634 N.E.2d 920, 25 UCC Rep. Serv. 2d 450 (Mass. App. Ct. 1994). Welch and Gildroy were co-owners of a hotel. In order to get financing for the completion of another hotel, in which Gildroy was not a co-owner, Welch approached Taunton State Bank ("TSB") and falsely told them Gildroy was a co-owner. TSB approved the loan and allowed Welch to procure Gildroy s signatures on the loan documents. Gildroy, apparently thinking he was signing documentation for a loan application for the hotel in which had an interest, signed the note without reading it. (The opinion is not clear as to exactly what he thought he was signing.) TSB was acquired by New Bedford Institution for Savings ("New Bedford"). The note was never indorsed to New Bedford. Therefore, New Bedford could not be a holder in due course in its own right. Under the shelter principle, however, New Bedford did succeed to TSB s rights as a holder in due course. The court noted that, contrary to the common misunderstanding, a payee of a note can be a holder in due course. (Comment 2 to Section confirms this.) Gildroy asserted further that TSB was not a holder in due course because it had not taken the note in good faith as required by the predecessor of Section 3-302(a)(2). The court indicated that TSB s failure to follow good banking practices by accepting without question a note not signed in the presence of a bank officer complied with the then-existing definition of "good faith," which required only "honesty in fact." The court implicitly acknowledged that the result might have been different under the 1990 revisions which added a requirement of "the observance of reasonable commercial standards of fair dealing." See Section 3-302(b)(1) or, in jurisdictions that have adopted Revised Article 1, Section 1-201(19). VII. When is a promissory note a negotiable instrument? It must be a specific promise to pay and little else (i.e., a "traveler without baggage"). A. The instrument must be a signed writing. There is no equivalent of electronic chattel paper or electronic letters of credit. See Sections 3-103(a)(6), 3-103(a)(9). B. The instrument must contain an unconditional promise or order to pay money. Section 3-104(a). A note is unconditional unless (i) it states an express condition to payment, (ii) it states that it is subject to or governed by another writing, or (iii) it states that the rights or obligations with respect to the note are stated in another writing. A mere reference to another document, however, does not make the note conditional. Section Example: A note states: "This note is executed in connection with that certain Credit and Security Agreement dated March 15, 2006 by and between Enron Corporation and Continental Illinois National Bank." The note may be negotiable. 7/

12 2. Example: A note states: "This note is executed in connection with and is governed by that certain Credit and Security Agreement dated March 15, 2006 by and between Enron Corporation and Continental Illinois National Bank." The note is not negotiable. 3. The instrument cannot contain any other undertakings or instructions by the maker beyond the obligation to pay money, except for a few customary ancillary promises permitted by Section 3-104(a)(3) ((i) an undertaking or power to give, maintain or protect collateral, (ii) an authorization to confess judgment or to realize on or dispose of collateral, and (iii) a waiver of any of the obligor s legal rights). For this reason, the typical lease or installment sale contract cannot be a negotiable instrument (although a separate note given in connection with such a transaction may be negotiable). a. Example: Ford v. Darwin, 767 S.W.2d U.C.C. Rep. Serv. 2d 426 (Tex. Ct. App. 1989). A "Promissory Note Agreement" that contained an undertaking to sell stock was not a negotiable instrument. b. Example: Walter Implement, Inc. v. Focht, 709 P.2d 1215, 42 UCC Rep. Serv. 356 (Wash. Ct. App. 1985). An equipment lease did not contain the "order" or "bearer" language and contained additional promises and undertakings, so it could not be a negotiable instrument. It could be assigned but could not be negotiated. c. Undertakings by a person other than the maker do not defeat negotiability. In Spidell v. Jenkins, 727 P.2d 1285, 3 UCC Rep. Serv. 2d 161 (Idaho Ct. App. 1986) an attorney and his client executed a document titled "Promissory Note" in which the attorney promised to perform legal services and the client promised to pay the attorney $8,500. The court held that the promises by the attorney did not make the note non-negotiable. (It was, however, held to be non-negotiable because it was payable to the attorney rather than to his order.) C. The promise must be to pay a "fixed" amount of money. Section 3-104(a). 1. Interest may be variable and may be based upon references to extrinsic sources (such as a bank's index rate). This was a change made by the 1990 amendments. The traditional rule was that the amount of interest must be calculable from the information on the note itself. Section Principal must be fixed, however. For example, in RTC v. Oaks Apartments Joint Venture, 966 F.2d 995, 18 UCC Rep. Serv. 2d 492 (5 th Cir. 1992), a partnership and five partners signed a promissory note promising to pay "the sum of TWO MILLION AND NO/100 DOLLARS ($2,000,000) or so much thereof as may be advanced in accordance with the terms of a certain Loan Agreement executed on even date herewith, with interest thereon at the rate provided below." The partners claimed that a separate agreement limited each partner s individual liability to 20% of the outstanding debt. The RTC argued that it was a holder in due course of the note and that D Oench, Duhme (under which the RTC may have rights similar to those of a holder in 7/

13 due course) precluded the use of the side agreement. The court held that the uncertainty with respect to the principal amount of the note precluded the note from being a negotiable instrument. It remanded the case for determination whether D Oench, Duhme applied. D. The promise must be payable on demand or at a definite time. Sections 3-104(a)(2), A note that does not state a time for payment is payable on demand. Section 3-108(a). 2. A note is payable at a definite time even though it provides for prepayment, acceleration, extension at the option of the holder, or extension to a further definite time at the option of the maker or upon a specified event. Section 3-108(c). For example, in DH Cattle Holdings Co. v. Smith, 607 N.Y.S.2d 227, 22 UCC Rep. Serv. 2d 799 (App. Div. 1994), after a college football player was drafted in the first round, his business advisors got him into a number of tax shelters. He executed a note in the amount of $490,500 payable to a cattle breeding partnership. The note stated certain dates on which payments of principal and interest were payable. It further provided "subsequent payments of principal and interest shall be made as animals or semen are sold but in no event later than December 31, 1989." The player stopped making payments when he suspected the deal was fraudulent. Later, the note was pledged to Rabobank in connection with a loan to an affiliate of the partnership. The court held that the fact there was a final date by which all of the principal and interest had to be paid made the note payable at a definite time. Thus, Rabobank could be an HDC. E. The promise must be payable to order to bearer. Sections 3-104(a)(1), These are "magic words" under Article 3. If the note is not payable to order or to bearer, it is not a negotiable instrument. It can say "pay to the order of First National Bank," or it can say "pay to First National Bank or order," but if it just says "pay to First National Bank," it is not negotiable. Section 3-104(c) makes an exception for checks, but there is no comparable exception for notes. 1. The original text of Article 3 contained a provision that a writing otherwise qualifying as a negotiable instrument but missing the magic words "order" or "bearer" would be governed by Article 3, except that there could be no holder in due course of such an instrument. The 1990 and 2002 versions contain no comparable provision. See Official Comment 2 to Section In Spidell v. Jenkins, 727 P.2d 1285, 3 UCC Rep. Serv. 2d 161 (Idaho Ct. App. 1986), a note reading in part: "I... promise to pay to Norman E. Spidell or Lennette M. Spidel of Route 5, Box 5324, Nampa, Idaho 83651, the sum of EIGHT THOUSAND FIVE HUNDRED DOLLARS ($8,500)...." was held to be nonnegotiable because it did not contain the word "order." VIII. Other characterization issues. 7/

14 A. Even if a promissory note meets the requirements to be a negotiable instrument under Article 3, if it also meets the definition of a "security" under Article 8, Article 8 preempts Article 3 entirely. Section 3-102(a). B. Characterization under Article definitions: "Instrument" means a negotiable instrument or any other writing that evidences a right to the payment of a monetary obligation, is not itself a security agreement or lease, and is of a type that in ordinary course of business is transferred by delivery with any necessary indorsement or assignment. The term does not include (i) investment property, (ii) letters of credit, or (iii) writings that evidence a right to payment arising out of the use of a credit or charge card or information contained on or for use with the card. "Investment property" means a security, whether certificated or uncertificated, security entitlement, securities account, commodity contract, or commodity account. "Chattel paper" means a record or records that evidence both a monetary obligation and a security interest in specific goods, a security interest in specific goods and software used in the goods, or a lease of specific goods. The term does not include charters or other contracts involving the use or hire of a vessel. If a transaction is evidenced both by a security agreement or lease and by an instrument or series of instruments, the group of records taken together constitutes chattel paper. C. Section allows an obligor under a non-negotiable promissory note to waive defenses against assignees in the same manner that the obligor would be bound if the instrument were negotiable and in the hands of a holder in due course. 7/

15 Promissory Notes John E. Murdock III Bradley Arant Boult Cummings LLP Nashville, Tennessee Issue Article 3 Instrument Article 8 Security Common Law Obligation Form Strict rules of negotiability: (i) written promise to pay, (ii) a fixed amount of money, (iii) to order or bearer, (iv) on demand or at a definite time, (v) and (almost) no other promise, and (vi) which is not an Article 8 security (a) (i) an obligation, (ii) evidenced by a certificate in bearer or registered form or uncertificated and transferable on official records, (iii) one of a class or series or divisible into a class or series, and (iv) of a type traded on a securities exchange or expressly opted in (15). Anything that is not an Article 3 negotiable instrument or an Article 8 security Article 3 may be applied by analogy. See comment to Obligation Statute of limitations 6 years / 10 years Varies (not addressed) Varies Statute of frauds Varies (not addressed); likely applies Does not apply Varies; likely applies Obligation of Joint and several Varies (not addressed) Varies 7/

16 multiple makers Obligation of comakers acting as sureties Accommodation party with statutory suretyship provisions , Varies (not addressed) Varies Procedure for payment Required procedures (presentment 3-501, notice of dishonor 3-503, protest 3-505) Anticipates presentment 8-207, no details, no concepts of dishonor Varies Credit for payments Only if made to actual holder under 1990 version; if made to last known holder under 2002 amendments Transfer Only if made to registered owner or bearer Likely last known owner of the obligation Method By delivery (plus indorsement) , 203 By delivery (plus indorsement) , 303, 106 By assignment Warranties Implied The transferor is the person entitled to enforce the instrument All signatures are authentic and authorized Instrument has not been altered Instrument is not subject to a defense or claim in recoupment Transferor has no knowledge of an insolvency proceeding against maker Implied Certificate is genuine and has not been altered Transferor knows of no fact that might impair the validity of the security Absence of any adverse claim Any indorsement authorized Transfer otherwise effective Varies; matter of evidence 7/

17 Credit recourse against indorser Full unless disclaimed None unless expressly undertaken Varies; matter of evidence Rights of transferee Possible holder in due course, taking free of claims and most defenses Possible protected purchaser taking free of claims and possible purchaser for value, taking free of most defenses Usually no greater than rights of transferor. But see Enron Corp. v. Springfield Assocs., L.L.C. (In re Enron Corp.), 2007 WL (S.D.N.Y. 8/27/07); see Restatement (Second) of Contracts 15 ST NT (1981) 7/

18 PROMISSORY NOTE 1 $ Nashville, Tennessee January 27, 2012 FOR VALUE RECEIVED, John E. Murdock III ("Maker") promises to pay to the order of Matthew W. Kavanaugh ("Payee") the sum of One Hundred and No/100 Dollars ($100.00), together with interest thereon at the fixed rate of ten percent (10%) per annum (based upon a 360-day year and actual days elapsed). Interest in arrears shall become due on the first day of each month commencing February 1, All remaining principal, interest, and expenses outstanding hereunder shall become due on January 27, All amounts due under this Promissory Note are payable at par in lawful money of the United States of America, at the principal place of business of Payee in Los Angeles, California, or at such other address as the Payee or other holder hereof (herein "Holder") may direct. If any payment of interest is not made within fifteen (15) days of its due date, a late charge equal to five percent (5%) of such payment shall become due. Holder's right to impose a late charge does not evidence a grace period for the making of payments hereunder. The occurrence of any of the following shall constitute an event of default under this Promissory Note: (a) the failure of Maker to make any payment when due under this or any other obligation to Holder (time is of the essence of this Promissory Note); (b) the institution of proceedings by Maker under any state insolvency law or under any federal bankruptcy law; (c) the institution of proceedings against Maker under any state insolvency law or under any federal bankruptcy law, if such proceedings are not dismissed within thirty (30) days; (d) Maker's becoming insolvent or generally failing to pay his debts as they become due; or (e) the occurrence of any event or presence of any condition that causes Holder in good faith to feel insecure regarding the likelihood of its receiving orderly and complete payment according to the terms of this Promissory Note without proceeding against any collateral or seeking payment from any surety or guarantor. Upon the occurrence of an event of default, as defined above, Holder may, at its option and without notice, declare all principal and interest provided for under this Promissory Note, and any other obligations of Maker to Holder, to be presently due and payable, and Holder may enforce any remedies available to Holder under any documents securing or evidencing obligations of Maker to Holder. Holder may waive any default before or after it occurs and may restore this Promissory Note in full effect without impairing the right to declare it due for a subsequent default, this right being a continuing one. Upon default, the remaining unpaid principal balance of the indebtedness evidenced hereby and all expenses due Holder shall bear interest at the highest rate permissible under applicable law. Prepayment of principal or accrued interest may be made, in whole or in part, at any time without penalty. Any prepayment(s) shall reduce the final payment(s) and shall not reduce or defer installments next due. 7/ Page 1 of 2

19 Maker and all sureties, guarantors, endorsers and other parties to this instrument hereby consent to any and all renewals, waivers, modifications, or extensions of time (of any duration) that may be granted by Holder with respect to this Promissory Note and severally waive demand, presentment, protest, notice of dishonor, and all other actions and notices that might otherwise be required by law. All parties hereto waive the defense of impairment of collateral and all other defenses of suretyship. Maker and all sureties, guarantors, endorsers and other parties hereto agree to pay reasonable attorneys' fees and all court and other costs that Holder may incur in the course of efforts to collect the debt evidenced hereby or to protect Holder's interest in any collateral securing the same. The validity and construction of this Promissory Note shall be determined according to the laws of Tennessee applicable to contracts executed and performed within that state. The provisions of this Promissory Note may be amended or waived only by instrument in writing signed by the Holder and Maker. This Promissory Note has been issued on the date stated above. John E. Murdock III PAY TO THE ORDER OF WILLIAM L. NORTON Matthew W. Kavanaugh 7/ Page 2 of 2

20 PROMISSORY NOTE 2 $ Nashville, Tennessee January 27, 2012 FOR VALUE RECEIVED, John E. Murdock, Inc. ("Maker"), a Tennessee corporation, promises to pay to the order of Matthew W. Kavanaugh ("Payee") the sum of One Hundred and No/100 Dollars ($100.00), together with interest thereon at the fixed rate of ten percent (10%) per annum (based upon a 360-day year and actual days elapsed). Interest in arrears shall become due on the first day of each month commencing February 1, All remaining principal, interest, and expenses outstanding hereunder shall become due on January 27, All amounts due under this Promissory Note are payable at par in lawful money of the United States of America, at the principal place of business of Payee in Los Angeles, California, or at such other address as the Payee or other holder hereof (herein "Holder") may direct. If any payment of interest is not made within fifteen (15) days of its due date, a late charge equal to five percent (5%) of such payment shall become due. Holder's right to impose a late charge does not evidence a grace period for the making of payments hereunder. The transfer of this Promissory Note and participation therein shall be registered upon books maintained by Maker for this purpose. This Promissory Note may be divided into a series of participation interests. The occurrence of any of the following shall constitute an event of default under this Promissory Note: (a) the failure of Maker to make any payment when due under this or any other obligation to Holder (time is of the essence of this Promissory Note); (b) the institution of proceedings by Maker under any state insolvency law or under any federal bankruptcy law; (c) the institution of proceedings against Maker under any state insolvency law or under any federal bankruptcy law, if such proceedings are not dismissed within thirty (30) days; (d) Maker's becoming insolvent or generally failing to pay his debts as they become due; or (e) the occurrence of any event or presence of any condition that causes Holder in good faith to feel insecure regarding the likelihood of its receiving orderly and complete payment according to the terms of this Promissory Note without proceeding against any collateral or seeking payment from any surety or guarantor. Upon the occurrence of an event of default, as defined above, Holder may, at its option and without notice, declare all principal and interest provided for under this Promissory Note, and any other obligations of Maker to Holder, to be presently due and payable, and Holder may enforce any remedies available to Holder under any documents securing or evidencing obligations of Maker to Holder. Holder may waive any default before or after it occurs and may restore this Promissory Note in full effect without impairing the right to declare it due for a subsequent default, this right being a continuing one. Upon default, the remaining unpaid 7/ Page 1 of 2

21 principal balance of the indebtedness evidenced hereby and all expenses due Holder shall bear interest at the highest rate permissible under applicable law. Prepayment of principal or accrued interest may be made, in whole or in part, at any time without penalty. Any prepayment(s) shall reduce the final payment(s) and shall not reduce or defer installments next due. Maker and all sureties, guarantors, endorsers and other parties to this instrument hereby consent to any and all renewals, waivers, modifications, or extensions of time (of any duration) that may be granted by Holder with respect to this Promissory Note and severally waive demand, presentment, protest, notice of dishonor, and all other actions and notices that might otherwise be required by law. All parties hereto waive the defense of impairment of collateral and all other defenses of suretyship. Maker and all sureties, guarantors, endorsers and other parties hereto agree to pay reasonable attorneys' fees and all court and other costs that Holder may incur in the course of efforts to collect the debt evidenced hereby or to protect Holder's interest in any collateral securing the same. The validity and construction of this Promissory Note shall be determined according to the laws of Tennessee applicable to contracts executed and performed within that state. The provisions of this Promissory Note may be amended or waived only by instrument in writing signed by the Holder and Maker. This Promissory Note has been issued on the date stated above. JOHN E. MURDOCK, INC. By: Title: President PAY TO THE ORDER OF WILLIAM L. NORTON Matthew W. Kavanaugh 7/ Page 2 of 2

22 REPORT OF THE PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE APPLICATION OF THE UNIFORM COMMERCIAL CODE TO SELECTED ISSUES RELATING TO MORTGAGE NOTES NOVEMBER 14, by The American Law Institute and the National Conference of Commissioners on Uniform State Laws. All rights reserved.

23 PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE Chair John A. Sebert, Chicago, IL Executive Director, Uniform Law Commission Members ALI Designees ULC Designees E. Carolan Berkley, Philadelphia, PA Boris Auerbach, Indianapolis, IN Amelia H. Boss, Philadelphia, PA Patricia Brumfield Fry, Edgewood, NM Stephanie Heller, Brooklyn, NY Carlyle C. Ring, Jr., Washington, DC Lance Liebman, New York, NY Director, The American Law Institute Edwin E. Smith, Boston, MA James J. White, Ann Arbor, MI Linda J. Rusch, Spokane, WA Steven O. Weise, Los Angeles, CA Director of Research Neil B. Cohen, Brooklyn, NY Liaisons Carter H. Klein, Chicago, IL ABA Business Law Section Teresa W. Harmon, Chicago, IL ABA Advisor Emeritus Members William H. Henning, Tuscaloosa, AL Fred H. Miller, Minneapolis, MN The American Law Institute Uniform Law Commission 4025 Chestnut Street 111 N. Wabash, Suite 1010 Philadelphia, PA Chicago, IL i

24 PREFACE In 1961, the American Law Institute and the Uniform Law Commission, the organizations that jointly sponsor the Uniform Commercial Code, established the Permanent Editorial Board for the Uniform Commercial Code (PEB). One of the charges of the PEB is to issue commentaries and other articulations as appropriate to reflect the correct interpretation of the [Uniform Commercial] Code and issuing the same in a manner and at times best calculated to advance the uniformity and orderly development of commercial law. Such commentaries and other articulations are issued directly by the PEB rather than by action of the American Law Institute and the Uniform Law Commission. This Report of the Permanent Editorial Board is such an articulation, addressing the application of the Uniform Commercial Code to issues of legal, economic, and social importance arising from the issuance and transfer of mortgage notes. A draft of this Report was made available to the public for comment on March 29, 2011, and the comments that were received have been taken into account in preparing the final Report. ii

25 REPORT OF THE PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE APPLICATION OF THE UNIFORM COMMERCIAL CODE TO SELECTED ISSUES RELATING TO MORTGAGE NOTES Introduction Recent economic developments have brought to the forefront complex legal issues about the enforcement and collection of mortgage debt. Many of these issues are governed by local real property law and local rules of foreclosure procedure, but others are addressed in a uniform way throughout the United States by provisions of the Uniform Commercial Code (UCC). 1 Although the UCC provisions are settled law, it has become apparent that not all courts and attorneys are familiar with them. In addition, the complexity of some of the rules has proved daunting. The Permanent Editorial Board for the Uniform Commercial Code 2 has prepared this Report in order to further the understanding of this statutory background by identifying and explaining several key rules in the UCC that govern the transfer and enforcement of notes secured by a mortgage 3 on real property. The UCC, of course, does not resolve all issues in this field. Most particularly, as to both substance and procedure, the enforcement of real estate mortgages by foreclosure is primarily the province of a state s real property law (although determinations made 1 The UCC is a uniform law sponsored by the American Law Institute and the Uniform Law Commission. It has been enacted in every state (as well as the District of Columbia, Puerto Rico, and the United States Virgin Islands) in whole or significant part. This Report is based on the current Official Text of the UCC. Some states have enacted some non-uniform provisions that are generally not relevant to the issues discussed in this Report. Of course, the enacted text of the UCC in the state whose law is applicable governs. See note 6, infra, regarding the various different versions of Article 3 of the UCC in effect in the states. 2 In 1961, the American Law Institute and the Uniform Law Commission, the organizations that jointly sponsor the UCC, established the Permanent Editorial Board for the Uniform Commercial Code (PEB). One of the charges of the PEB is to issue commentaries and other articulations as appropriate to reflect the correct interpretation of the [Uniform Commercial] Code and issuing the same in a manner and at times best calculated to advance the uniformity and orderly development of commercial law. 3 This Report, like Article 9 of the UCC, uses the term mortgage to include a consensual interest in real property to secure an obligation whether created by mortgage, trust deed, or the like. See UCC 9-102(a)(55) and Official Comment 17 thereto and former UCC 9-105(1)(j). This Report uses the term mortgage note to refer to a note secured by a mortgage, whether or not the note is a negotiable instrument under UCC Article 3. 1

26 pursuant to the UCC are typically relevant under that law). Accordingly, this Report should be understood as providing guidance only as to the issues the Report addresses. 4 Background Issues relating to the transfer, ownership, and enforcement of mortgage notes are primarily governed by two Articles of the UCC: In cases in which the mortgage note is a negotiable instrument, 5 Article 3 of the UCC 6 provides rules governing the obligations of parties on the note 7 and the enforcement of those obligations. In cases involving either negotiable or non-negotiable notes, Article 9 of the UCC 8 contains important rules governing how ownership of those notes may be transferred, the effect of the transfer of ownership of the notes on the ownership of the mortgages securing those notes, and the right of the transferee, under certain circumstances, to record its interest in the mortgage in the applicable real estate recording office. This Report explains the application of the rules in both of those UCC Articles to provide guidance in: Identifying the person who is entitled to enforce the payment obligation of the maker 9 of a mortgage note, and to whom the maker owes that obligation; and 4 Of course, the application of the UCC rules to particular factual circumstances depends on the nature of those circumstances. Facts raising legal issues other than those addressed in this Report can result in different rights and obligations than would be the case in the absence of those facts. Accordingly, this Report should not be read as a statement of the total legal implications of any factual scenario. Rather, the Report sets out the UCC rules that are common to the transactions discussed so as to provide a common basis for understanding the application of those rules. The impact of non-ucc law that applies to other aspects of such transactions is beyond the scope of this Report. 5 The requirements that must be satisfied in order for a note to be a negotiable instrument are set out in UCC Except for New York, every state (as well as the District of Columbia, Puerto Rico, and the United States Virgin Islands) has enacted either the 1990 Official Text of Article 3 or the newer 2002 Official Text (the latter having been adopted in ten states as of the date of this Report). Unless indicated to the contrary all discussions of provisions in Article 3 apply equally to both versions. Much of the analysis of UCC Article 3 in this Report also applies under the older version of Article 3 in effect in New York, although many section numbers differ. The Report does not address those aspects of New York s Article 3 that are different from the 1990 or 2002 texts. 7 In this Report, such notes are sometimes referred to as negotiable notes. 8 Unlike Article 3 (which has not been enacted in its modern form in New York), the current version of Article 9 has been enacted in all 50 states, the District of Columbia, and the United States Virgin Islands. Some states have enacted non-uniform provisions that are generally not relevant to the issues discussed in this Report (but see note 31 with respect to one relevant non-uniformity). A limited set of amendments to Article 9 was approved by the American Law Institute and the Uniform Law Commission in Except as noted in this Report, those amendments (which provide for a uniform effective date of July 1, 2013) are not germane to the matters addressed in this Report. 9 A note can have more than one obligor. In some cases, this is because there is more than one maker (in which case they are jointly and severally liable; see UCC 3-116(a)). In other cases, there may be an indorser. The obligation 2