Technology

 Property

 Technology Property Editor: Gerald J. Hoenig, 8495 Caney Creek Landing, Alpharetta, GA 30005, ghoenig@mindspring.com.Guest Editors: Keith H. Mullen and James R. Nowlin III, Winstead Sechrest & Minick P.C., 5400 Renaissance Tower, 1201 Elm Street, Dallas, TX 75270-2199. Contact Mullen at kmullen@winstead.com or Nowlin at jnowlin@winstead.com.

 Technology—Property provides information on current technology and microcomputer software of interest in the real property area. The editors of Probate & Property welcome information and suggestions from readers.

eChange Is Our Friend: The eMortgage

Information technology has clearly changed many aspects of our personal and professional lives. In the way we shop, communicate, travel, recreate, entertain, and even vote, information technology touches and affects every aspect of daily life. It (or “IT”) has radically altered the manner in which lawyers work and deliver services to clients. Indeed, the scope and pace of that change seems to be accelerating. Changing information technology is more than a friend: for better or for worse, it is now a constant companion.

The reach of information technology, of course, extends into the commercial real estate finance industry. Within the industry, information is no longer collected, analyzed, and shared using labor-intensive, paper-based tools. The migration of valuable information from paper to an electronic medium has allowed real property to compete and be traded on an equal footing with traditional investments in companies selling goods and services. Indeed, it is increasingly clear that information technology has become the backbone of the thriving commercial mortgage-backed securities industry (CMBS), which now claims over 25% of all commercial real estate mortgages in the United States. For the first time, commercial real estate debt is a publicly traded commodity.

This sea change will soon transform the medium for documenting real estate loans from paper to electronic (the “eMortgage”). The eMortgage is “a mortgage where the critical loan documentation—specifically the promissory note, assignments and security instruments—are created electronically, transferred electronically and ultimately stored electronically.” This definition is from Mortgage Industry Standards Maintenance Organization (MISMO), Glossary of Terms, Version 1.1, and is available at www.mismo.org. The eMortgage is not a scanned-in document image. Instead, it is a specific electronic file of the security instrument package that is consented to, recorded, assigned, and stored electronically. In essence, the eMortgage is the electronic embodiment or manifestation of the security instrument. The “hard” or “wet ink” closing binder is transformed into electronic dots and dashes. The development of the eMortgage will change the manner in which all parties to real estate loan transactions conduct business.

A Changing Industry

The real estate finance industry is hard at work changing over to paperless electronic transactions. The real estate industry understands that an electronic process results in faster and more accurate sharing of information during the underwriting, closing, servicing, and secondary market phases of real estate lending. A faster closing process, in turn, allows loan pricing to be more accurate and responsive to secondary market pricing. Other processing benefits include reduced duplication of tasks and less documentation. In addition, risk is reduced because quality control and regulatory compliance can be performed electronically during the life of the loan. By reducing operational inefficiencies, costs are lowered and liquidity is increased, with the result being increased competitiveness if not higher profitability. Furthermore, with an increase in the quantity and quality of information available to investors, the value (or price) of the product (the loan) to the investors will be more easily determined, reducing the discount for uncertainty. On a broader scale, lenders are investigating technologies such as business process management, rules engines (which automate decision making through a process), and electronic document and content management (all processes that leverage the benefits of a paperless process) to make the next technological leap in improving lending operations. The industry focus is about becoming leaner, faster, and smarter, with the added benefit of transparency for investors, rating agencies, and regulators. With this purpose in mind, the company with the best process and the best information wins. Accordingly, Douglas Duncan, the chief economist of the Mortgage Bankers Association, notes that “technology is altering the structure, products and processes of the U.S. real estate finance system.”

Industry views the eMortgage as a key component in going paperless. The eMortgage will change the process of closing and selling loans, the means by which loan information is collected, and the scope of information available to investors. Understanding the eMortgage will ease the transition to a paperless process. Undoubtedly, the eMortgage will be a positive and fundamental change in a real estate lawyer’s professional life.

Legal Framework for Change: UETA and ESIGN

It is no surprise that a change of this magnitude requires significant adjustments in both the basic legal underpinnings and the terms describing them. Some of the important terms include:

This “new” language empowers us to start understanding the eMortgage.

Conceptually, the eMortgage touches on the core or basic elements of creating contracts. The first step in the process of providing uniform rules to govern electronic transactions was the passage in 1999 of the Uniform Electronic Transactions Act (UETA) by the National Conference of Commissioners on Uniform State Laws (NCCUSL). See Uniform Electronic Transactions Act (1999), which is available at www.ncsl.org/programs/lis/
CIP/ueta.htm. Generally, UETA’s objective is to allow electronic transactions to be just as enforceable as transactions memorialized on paper with “wet ink” signatures.

UETA § 7 contains several basic rules supporting electronic commerce: (1) a signature (or a record) “may not be denied legal effect or enforceability under state law solely because it is in electronic form”; (2) the effect or enforceability of a contract may not be attacked “solely because an electronic record was used in its formation”; (3) any legal requirement for a writing will be satisfied by an electronic record; and (4) an electronic signature will satisfy any legal signature requirement.

UETA § 16 introduces the concept of “transferable records.” Other sections of UETA identify notes and associated documents as transferable records when in electronic form. Generally, promissory notes may be negotiable, which turns in part on whether the note is the single, unique embodiment of the obligations and rights in the note. UETA addresses this need for the “unique token” quality of the electronic note and establishes that a transferable record exists when there is a single authoritative copy of the record (existing and unaltered) in the “control” of a person. Under UETA
§ 16(d), this “control” person is a “holder” for purposes of transferring or negotiating that record under the Uniform Commercial Code.

Specifically, UETA applies only to transactions in which the parties agree to conduct the transaction in an electronic format. UETA is intended to be content neutral, leaving unchanged the substantive rules of law and leaving open the technology for verification of the integrity or identity of the documents.

After the introduction of UETA, almost every state (and the District of Columbia) adopted its own version of UETA. Not surprisingly, some states also included non-uniform provisions, or established new regulatory overlays. These state provisions, and the slow pace of state adoption, undermined a basic premise of electronic commerce: uniformity. Consequently, in June 2000, Congress enacted the Electronic Signatures in Global and National Commerce Act (ESIGN), which addresses the use of electronic records and signatures in interstate and foreign commerce. See Electronic Signatures in Global and National Commerce Act, Pub. L. No. 106-229, 114 Stat. 464, which is available at www.ftc.gov/os/2001/06/esign7.htm.

Just as with UETA, ESIGN is an overlay statute that is intended to be content neutral and points to a general objective of ensuring the validity and legal effect of electronic contracts. ESIGN supersedes local law in a state that does not implement UETA. In states that have enacted a uniform version of UETA, the provisions of ESIGN may be superseded in whole or in part. Under ESIGN, an electronic signature cannot be denied solely because it is in an electronic form. Generally, many provisions of ESIGN are similar (or even identical) to provisions in UETA. (Note that ESIGN imposes special requirements on parties in the context of consumer protection laws (from a desire to preserve laws governing consumers’ rights to receive certain information in writing)). Taken together, UETA and ESIGN provide the legal ladder for the climb up to the eMortgage.

Key Concepts: Consent and Control

Under both UETA and ESIGN, a party to a commercial loan must expressly agree to the use of electronic records and signatures. This agreement must expressly permit the treatment of an electronic record as a “transferable record.” Perhaps most importantly for a lender desiring to sell a loan, UETA and ESIGN give the purchaser of an eMortgage rights and defenses analogous to those of a “holder” or a “holder in due course” under the Uniform Commercial Code based on the concept of “control” of the transferable (electronic) record.

Both UETA and ESIGN list safe harbor requirements for a showing of “control,” which can be summarized as follows:

 

• A single, “authoritative” copy of the transferable record, which is unique, identifiable, and unalterable (with limited exceptions) must exist.

• The authoritative copy identifies the person asserting control as the person to whom the record was issued (or the person to whom the record was most recently transferred).

• The authoritative copy is communicated to and maintained by the person asserting control (or its designated custodian).

• Copies or revisions that add or change an identified assignee of the authoritative copy can be made only with the consent of the person asserting control.

• Each copy of the authoritative copy (and any copy of a copy) is readily identifiable as a copy that is not the authoritative copy; and

•  any revision of the authoritative copy is readily identifiable as an authorized (or unauthorized) revision.

 

With UETA and ESIGN in place, electronic signatures are equivalent to paper or “wet” signatures. Accordingly, the legal foundation for the eMortgage has been laid.

Change Agents in the Neighborhood

New laws and a changed legal framework are not a magic formula for the implementation of the eMortgage. Note that the eMortgage is more than simply changing, with the wave of a technology wand or the push of a keyboard button, a pile of paper contained in a closing binder into strings of dots and dashes that can be viewed on your computer screen, and even printed if needed. The eMortgage is a change from a paper-driven process to an electronic process. Conceptually, this change fundamentally alters the role of every player in the mortgage lending industry—and requires consideration of a countless number of different business practices, legal issues, and technologies. A thoughtful glance at the real estate industry reveals that the “advance” agents for the eMortgage are at work, focusing on the “low hanging” fruit, on “hybrid” approaches, or on pursuing important preliminary tasks.

eRecording and eNotarization

In 2004, NCCUSL proposed the Uniform Real Property Electronic Recording Act (URPERA), which attempts to resolve questions relating to the roles of UETA and ESIGN in the states’ real property recording functions. See Uniform Real Property Electronic Recording Act, which is available at www.law.upenn.edu/bll/ulc/urpera/URPERA_Final_\Apr05-1.htm. The goal of URPERA is to create legislation authorizing real property records officials to begin accepting and storing electronic records and to develop systems for searching and retrieving electronic records. Many states have already adopted this model statute, and even separate electronic recording statutes that provide for acceptance of electronic documents (including images) for recording.

URPERA also addresses the issue of the stamp and seal requirements for notaries—it states that the notary is not required to affix a “wet” stamp and seal. Although URPERA § 5 mandates that a statewide body develop data standards and other standards that are needed for electronic recording, currently no eRecording and eNotarization standards exist at the state level. Industry organizations like the Standards and Procedures for Electronic Records and Signatures (SPeRS, www.spers.org), Property Records Industry Association (PRIA, www.pria.us), and the Electronic Financial Services Council (EFSC, www.efscouncil.org) are, however, working on these issues and related concerns such as document security.

MISMO

The Mortgage Industry Standards Maintenance Organization (MISMO, www.mismo.org) is a nonprofit organization founded in 1999 by the Mortgage Bankers Association. MISMO is dedicated to developing, promoting, and maintaining electronic procedures and standards for the mortgage industry and has published an “eMortgage Guide” to shape the eMortgage effort. As part of its work, MISMO has developed a “Logistical Data Dictionary” that contains over 3,500 unique data elements, names, or tags for real estate information used in the real estate lending industry. This organization is “staffed” by numerous volunteers (with a very small staff of paid employees), who even today are working diligently to develop voluntary guidelines, specifications, and XML (platform neutral) data standards and other related tasks—all with the goal of effectuating data exchange and the eMortgage.

MISMO work groups currently are focusing on and implementing a wide range of tasks, including

 

• loan servicing transfers,

• the XML version of the CMSA-IRP,

• Superset Chart of Accounts (which is fundamental to creating standards),

• Electronic Third Party Reports,

• digital signature requirements for commercial entities,

• commercial loan document index,

• eMortgage Closing Guide,

• eMortgage Guide,

• MERS commercial note eRegistry, and

• government housing workgroups.

 

In addition, MISMO has created the “SMART” document, which is specifically designed to create a single electronic file for representing mortgage information using open standard technologies. This specification is a technical framework for representing documents in an electronic format, which links data, the visual representation of the form, and electronic signatures. The SMART document has numerous benefits and improvements for compliance, disclosures, delivery, and recording functions for commercial mortgage loans. MISMO lists the following opportunities and benefits:

The benefits and advantages of the SMART document are that it has different layers or categories of security. Its fundamental attributes and appearance are illustrated on page 57.

Note that while MISMO plays an important role in the eMortgage movement, numerous other influential industry organizations also are focusing on implementing the eMortgage. Some of the organizations include: Mortgage Bankers Association (which founded MISMO), www.mortgagebankers.org; United States Notary Association, www.enotary.org; National Notary Association, www.nationalnotary.org; Property Records Industry Association, www.pria.us; Mortgage Electronic Registration Systems, Inc., www.mersinc.org; National Conference of State Legislatures, www.ncsl.org; Standards and Procedures for Electronic Records and Signatures, www.spers.org; Secure Identity Services Accreditation Corporation, www.sisac.org; Appraisal Institute, www.appraisalinstitute.org; Commercial Mortgage Securities Association, www.cmbs.org; National Association of Realtors, www.realtor.org; Fannie Mae, www.fanniemae.com; Freddie Mac, www.freddiemac.com; American Land Title Association, www.alta.org; and Electronic Financial Services Council, www.efscouncil.org.

MERS, Fannie Mae, and Freddie Mac

Tangible steps toward implementing the eMortgage have been taken in several other industry sectors. Mortgage Electronic Registration Systems, Inc. (MERS) acts as a clearinghouse for tracking the ownership of mortgages in the secondary market. The MERS registry (or “eRegistry”) is built on the ESIGN safe harbor requirements discussed above. MERS tracks and conclusively establishes at a given time the “controller” of an eNote and the location of the “authoritative copy.” In so doing, since 1997, more than 30 million residential mortgage loans have been registered, with more than 24,000 loans registered daily. The eRegistry for commercial mortgage notes became operational in 2003 and is being used at an accelerated pace by influential commercial mortgage lenders.

Fannie May has been accepting a limited number of eMortgages since July 2000, when it purchased two home loans in a purely paperless process. (Even the deeds were paperless.) Since then, Fannie Mae has been working with numerous lenders and technology vendors to pilot eMortgages. The eMortgage is a focal point for Fannie Mae, which has released version 2.0 of its eMortgage Guide, which is available at www.efanniemae.com (search using the term “emortgage” for the “eMortgage Delivery” page). Several lenders already are realizing some of the benefits of the eMortgage. For example, Navy Federal Credit Union (Vienna, Virginia) currently is using electronic signatures to close loans and is one of the dozens of lenders selling electronic loans to Fannie Mae.

In addition, Freddie Mac is committed to the eMortgage and, like Fannie Mae, is an active member in industry organizations like MISMO, MERS, SPeRS, and EFSC. Freddie Mac has issued both its eMortgage handbook and a timeline to assist the industry in understanding its requirements for originating, delivering, and servicing eMortgages that Freddie Mac will purchase. Note that the Freddie Mac eMortgage handbook and timeline are available at www.freddiemac.com (search using the term “emortgage” for the handbook and search using the phrase “emortgage timeline” for the eMortgage timeline). Indeed, both Fannie Mae and Freddie Mac have promulgated provisions for the eNote in their respective uniform instruments.

The Beginning of the End

But does the residential eMortgage movement and experience have any relevance to the commercial mortgage industry? True, certain aspects of residential mortgage lending are markedly different from commercial mortgage lending. Recall, however, that residential mortgage-backed securitization (MBS) furnished the template for implementing CMBS in the commercial mortgage lending industry. For background information, see Peter M. Carrozzo, Marketing the American Mortgage: The Emergency Home Finance Act of 1970, Standardization and the Secondary Market Revolution, 39 Real Prop. Prob. & Tr. J. 765 (2005). Accordingly, CMBS has forever changed commercial mortgage lending. Add in the desire of Wall Street for quality data, the powerful drive for transparency (based on Sarbanes-Oxley), and the benefits of an electronic process and products as described above, and what you can see is the imminent end of the paper commercial mortgage. The beginning of the commercial eMortgage is here and here to stay.