Comp2041 Assignment Of Rents

During the past several years, state and federal courts (including bankruptcy courts) have struggled with the issue of what actions must be taken by a mortgagee that holds a recorded assignment of rents in order to obtain title to the rents and directly collect them to the exclusion of the mortgagor. This issue is especially important if a bankruptcy proceeding has been filed by or against the mortgagor because the mortgagee will seek, at the very least, to have the rents characterized as “cash collateral” of the bankruptcy estate under Section 363(a) of the Bankruptcy Code subject to the prior perfected security interest of the mortgagee, which enables the mortgagee to monitor, object to, and restrict the mortgagor’s use and disposition of the rental income during the bankruptcy proceeding and request that it be provided “adequate protection” of such security interest, or else seek (on the basis that the pre-petition actions by the mortgagee have caused title to the rents to pass to the mortgagee) to have the rents declared to be the sole property of the mortgagee and therefore not included as part of the mortgagor’s bankruptcy estate.

Amendments to the Bankruptcy Code in 1994 clarified that “perfection” of a mortgagee’s interest in rental income occurs at the time of recordation of the mortgagee’s assignment-of-rents document or the mortgage containing an assignment-of-rents provision. But an unresolved issue is what additional steps the mortgagee must take to “activate” or “enforce” its contractual right to the rents upon a default by the mortgagor, so as to irrevocably pass title to the rental income to the mortgagee.

Most state and federal courts hold that while the assignment-of-rents clause in a mortgage creates a valid lien on the rents upon recording, the mortgagee must take additional steps to properly “enforce” the clause and obtain “ownership” of the rents. For example, courts have allowed mortgagees to collect rents after the mortgagees have taken affirmative action to take possession of the property by obtaining a court order, an injunction, or having a receiver appointed.

 Some states have attempted to address the perfection/activation issue by enacting statues attempting to clarify that the assignment-of rents clause in a mortgage (or separate assignment-of-rents agreement that is part of the mortgage-loan documents) is effective upon recording of the document. For example, the Conveyances Act in Illinois was amended in 1996 to provide that an assignment-of-rents instrument is perfected upon recordation whether the assignment is absolute, conditional, or intended as security and that “[u]nless otherwise agreed to by the parties, the mere recordation of an assignment does not affect who is entitled, as between the assignor and assignee, to collect or receive rents until the assignee enforces the assignment under applicable law.” However, it seems possible that the portion of the statutory language above that states “unless otherwise agreed to by the parties” may be construed to permit mortgagees to specifically provide in the assignment-of-rents document that the appointment of a receiver, designation of the mortgagee as a mortgagee in possession, or injunction or other affirmative relief by the court is not necessary to enforce the assignment of rents. But there is as yet no case law directly on point that supports this supposition. In fact, in a recent Illinois bankruptcy case, the bankruptcy court reaffirmed the “general rule” that a security interest in rents arising under an assignment of rents, while perfected against third parties upon recordation, does not grant a possessory interest in rents paid after default until affirmative steps are taken by the mortgagee to acquire possession of the property through either foreclosure or the appointment of a receiver pending foreclosure.

 The crazy quilt of assignment-of-rents decisions issued by both state and federal (including bankruptcy) courts over the past several years with respect to the enforceability of assignment-of-rents provisions in mortgage-loan documents highlights the desirability of adopting – sooner rather than later -- the Uniform Assignment of Rents Act (“UARA”) completed by the National Conference of Commissioners on Uniform State Laws in 2005. The UARA, which establishes a comprehensive statutory model for the creation, perfection and enforcement of security interests in rent, has been enacted in Nevada, New Mexico, North Dakota, Texas, and Utah (and was introduced in Massachusetts in 2015). The UARA includes provisions concerning: assignment of rents; appointment of a receiver; enforcement by notices; and coordination with the Uniform Commercial Code.

 

A deed of trust with assignment of rents is the document that underlies the loan on a rental property. The lender's security interest in the property gets created by the deed of trust. The assignment of rents puts teeth in the lender's security interest by giving it the right to collect rents.

The Deed of Trust

Most loans in California are securitized by deeds of trust instead of mortgages. When you take out a loan, you sign a promissory note. The note is a private business arrangement between you and the lender. The deed of trust sets up an arrangement by which the actual ownership of your property sits with an impartial third party, called a trustee. If you, as trustor, fulfill your obligations under the note, the trustee will transfer the deed to you. If you don't, the lender, or beneficiary, can have the trustee transfer ownership of the property to itself.

Assignment of Rents

The assignment of rents clause in the deed of trust gives the lender the right to collect any rents that the property generates if you don't make your loan payments. Having an assignment of rents clause is important for the lender. Leases are technically agreements between you and your tenants. Without your permission, your lender might be unable to collect the rents from the tenants.

Deed of Trust vs. Mortgage

Deeds of trust are differnet from mortgages in one key way. Mortgages have two parties -- you and your lender. Deeds of trust have a third party sitting in the middle. Because of this, foreclosing is much easier. California trust deeds typically do not have a period of redemption, making it possible for your lender to complete the foreclosure process in just a few months.

Alternatives

If you don't want to give your lender a security interest in your property and in your rental income stream, you probably won't be able to use its money to buy the property. You can buy the property with all-cash. Alternately, you could take out unsecured financing, such as a line of credit, or take out financing secured by a different asset.

About the Author

Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.

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