Assignments of Rents and Receiverships

Why do lenders take “assignments of rents” (security interests in rents)? Lengthy foreclosure period  (or bankruptcy may intervene) MR is diverting rents, “milking” the property Management and maintenance are deteriorating, rents are going uncollected

Three types of “assignments of rents” ●“Hard Lockbox”: All rents paid directly to lender from outset. Lender pays debt service, reserves, & expenses, distributes remainder to borrower. (See next slide.) ●”Soft Lockbox”: All rents paid directly to lender, but swept daily to borrower until a “cash trap event” (default, failure of DSCR or other conditions); then becomes “hard.” ●Rents paid to borrower until actuated by lender action after default. (Most common.)

Rent pmts Bank as custodian/ escrowee Tenants The “Hard Lockbox” “Waterfall” Security interest in account ME Op. Expenses Pmts to reserves Debt service MR Cash flow

Lockbox arrangements: A “Hard lockbox” may be required by rating agencies for CMBS loans. A “Soft lockbox” may “go hard” as a result of:  A default by the borrower.  A failure to maintain a specified DSCR.  Other conditions (specified in the loan docs) that indicate trouble in the project.

The “absolute” assignment: ●When would a lender want a “true” absolute assignment (a “hard lockbox”)? Securitized commercial mortgages (”CMBS”) Lender lacks trust in borrower (rare) ●Lenders’ documents often call their assignments “absolute” because of a common misconstruction by bankruptcy courts in the period. These courts confused “perfection” with “enforcement” and held that, with a “security” assignment, there was no “perfection” until ME took affirmative action.

Bankruptcy Code Sec. 544 (the “strong-arm” section) The trustee in bankruptcy shall have the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by-- (1) a perfected judicial lien creditor of the debtor, and … (3) a bona fide purchaser of real property from the debtor.

Thus, if an assignment of rents is unperfected at the time bankruptcy is filed… The trustee in bankruptcy can avoid (defeat) it. How does a lender perfect an assignment of rents? By recording it in the real property records!

Typical language: All of the rents are hereby absolutely and unconditionally assigned to Mortgagee, to be applied by Mortgagee in payment of Indebtedness.... [T]he assignment is an absolute assignment and not merely a security interest. Until terminated by the Mortgagee as herein provided, as a result of an Event of Default, Mortgagor shall have a license to collect and receive all Rents as trustee for the benefit of Mortgagee.

Does this language... ●really constitute an absolute assignment? ●In any realistic sense, it’s just a “security” assignment. ●spell out the mechanism by which ME “enforces” the assignment? ●Isn’t some mechanism necessary?

Cadle Co. v. Collin Creek Phase II Associates, Ltd., 998 S.W.2d 718 (Tex.App.1999 ) Courts are reluctant to construe an assignment of rents clause as an absolute assignment because public policy disfavors such assignments. When an assignment of rents states that it is given as “further security,” there is a strong indication that it is intended as a mere security pledge. A requirement that the mortgagee take some affirmative action in order to secure the rents is also an indication that the assignment is a security pledge rather than an absolute assignment.

Matter of Millette Millette Eastover Bank Assignment of rents (recorded) Millette Judgment lien & garnishment O’Neal Steel

Matter of Millette Was this assignment of rents “absolute” or as “security?” What does it mean to “perfect” a security interest? Had the mortgage lender here “perfected” its interest in the rents? Some further act by the lender is necessary, not to perfect, but to do what?

How to “trigger” or “enforce” a security (collateral) assignment: ●Take possession (risky) ●Bring an action to “impound” or “sequester” the rents ●Get a receiver appointed ●Written demand to MR ●Written demand to the tenants (necessary in any event as a practical matter)

FDIC v. International Property Mgmt., Inc., 929 F.2d 1033 (5 th Cir.1991). The Texas courts have followed the common law rule that a [security] assignment of rents does not become operative until the mortgagee obtains possession of the property, impounds the rents, secures the appointment of a receiver, or takes some other similar action....

Restatement § 4.2: The mortgagee’s right to actual possession of the rents arises upon: (1)satisfaction of any conditions in the mortgage (e.g. default); and (2)delivery of demand to the MR and to any other mortgagees of which ME has notice. [As a practical matter, notice to the tenants is obviously also necessary.]

How does a mortgagee of a security interest in rents perfect it? Rents” are real property; file in the real estate records! But file a UCC Art. 9 financing statement as well.  The judge may be confused  The money in question may not be “rent”!

Are these “rents”? ●Hotel room receipts ●Nursing home residents’ fees ●Boat slip fees at a marina ●Parking lot receipts ●Student dormitory receipts ●Auto raceway gate receipts ●Golf course greens fees

As we’ve seen, there are several ways to “trigger” or “actuate” an assignment of rents. What’s the best way?

Why is a receivership usually the best way to actuate the security interest in rents? You can use a professional property management company. Quick & easy to obtain (often after only an ex parte hearing) Won’t terminate junior leases No tort liability on ME Receiver can make repairs Receiver can evict delinquent tenants and fill vacancies

Vernon’s Tex. Code Ann the court may appoint a receiver only if: (1) it appears that the mortgaged property is in danger of being lost, removed, or materially injured; or (2) the condition of the mortgage has not been performed and the property is probably insufficient to discharge the mortgage debt. The statute formerly also said “In all other cases where receivers have heretofore been appointed by the usages of the court of equity.” This was held to allow a receiver even when there was no allegation of inadequate value to pay the debt, if the mortgage expressly authorized it. Riverside Properties v. Teachers Ins. and Annuity Ass'n of America, 590 S.W.2d 736 (Tex.Civ.App. 1979). But this phrase is no longer in the statute.