Hitting the Wrong Note: An Equity Credit Line Agreement is Not a Negotiable Instrument

Many homeowners in New York, and elsewhere in the United States, secure lines of credit by using the excess equity in their homes as collateral. These lines of credit agreements become second mortgages on the borrower’s home and are available as and when needed by the homeowner. Unlike the loans involved with the homeowner’s first mortgage, however, equity credit lines do not require the homeowner to sign a promissory note, only what is commonly known as a credit line agreement.

As with first mortgages, banks often sell these equity line mortgages on the secondary mortgage market. When a bank sells a first mortgage it assigns the first mortgage and then as part of the assignment it is also required to indorse the promissory note to the purchaser of the first mortgage. The indorsement can be accomplished by either an allonge (a form of assignment) which must be attached to the promissory note or by affixing the indorsement language directly on the body of the promissory note. But when a bank assigns the equity credit line agreement does the bank have to indorse the agreement or attach an allonge to the equity credit line agreement? The answer to that question depends on whether the equity credit line agreement is a negotiable instrument.

Section 3-104 of New York’s Uniform Commercial Code states as follows:
(1) Any writing to be a negotiable instrument within this Article must

(a) be signed by the maker or drawer; and
(b) contain an unconditional promise or order to pay a sum certain in money and no other promise, order, obligation or power given by the maker or drawer except as authorized by this Article; and
(c) be payable on demand or at a definite time; and
(d) be payable to order or to bearer.

Unfortunately, there is no New York case directly addressing the issue of whether an equity credit line agreement is a negotiable instrument. However, in Yin v. Society National Bank Indiana, 665 N.E.2d 58 (Ind. Ct. Appeals 1996) (“Yin”), the Indiana court directly addressed the issue of whether an equity line of credit agreement is negotiable, holding that unless the agreement was an unconditional promise to pay, where the amount advanced under the agreement could be determined with certainty and without reference to other documents, the agreement was not a negotiable instrument. In this regard, an equity line of credit is entirely based on a contingency (an event outside of the Agreement) — whether, in fact, the borrower draws on the credit line. As the court stated in Yin, the key characteristic of a line of credit is that there is no obligation to draw on the line of credit. Consequently, if the borrower never draws on the line of credit, nothing is owed. If the borrower does draw on the line of credit, in order to ascertain the principal owed, one must look beyond the agreement itself in order to calculate the amount owed. Because the amount owed varies, the line of credit contains no sum certain.

In addition, New York recognizes that an instrument is not negotiable if one must refer to an extrinsic fact to determine payment or conditions. Enoch v. Brandon, 249 N.Y. 263, 267 (1928) (“If in the bond or note anything appears requiring reference to another document to determine whether in fact the unconditional promise to pay a fixed sum at a future date is modified or subject to some contingency, then the promise is no longer unconditional”).

Given the reasoning of Yin and similar cases in other jurisdictions, it is likely that a New York court would also hold that an equity credit line agreement is not a negotiable instrument. This does not mean that an equity credit line agreement is not assignable. It simply means that a bank does not have to follow the formalities of indorsement when assigning this type of agreement.

Although beyond the scope of this post, if an equity line of credit agreement is not a negotiable instrument, the bank’s assignee cannot be a holder in due course which means the bank’s assignee may be subject to defenses raised by a borrower who defaults under the agreement. Simply adding an allonge or an indorsement as part of the assignment will not make the equity credit line agreement sound the right note when in fact there is no note to be played.