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.
By Joan E. Lewis-Heard, Esq.
Senior Associate; SwedelsonGottlieb
For those community associations whose CC&Rs provide for assignment of rents from a tenant in the event an association owner who is renting their unit or home is delinquent in the payment of assessments, an association may collect the rent directly from the tenant to pay delinquent assessments.
If done properly, this can be done without a court order or the expense of a court appointed receiver. In order to do this, the following is required: 1) the CC&Rs must have an assignment of rents clause; 2) a lien for the delinquent assessments should be recorded to secure the debt; and 3) a statutory Demand to Pay Rent to a Party Other than Landlord, pursuant to Section 2938 of the Civil Code, is required to be delivered by mail or by hand to each tenant of the property and the landlord/owner. Follow this link for the required text of the demand to pay rent to party other than landlord.
It is an important part of the process for the association to take all of the steps necessary to record a Notice of Delinquent Assessment (Lien). Once the Lien is recorded, this gives the Association “secured party” status and hence, the Association would be considered the “secured party” pursuant to the Lien and the “assignee” pursuant to the assignment of rents provision in the CC&Rs.
Throughout the process, it is most important that close attention is paid to: 1) statutory obligations; 2) the association’s CC&Rs assignment of rents provision; 3) securing the indebtedness, i.e., by recording a Lien should your association’s CC&Rs allow same; and 4) by making sure that both the tenant and landlord/owner are notified when the assessments are brought current such that the assignment of rents should no longer be in effect.
Further, pursuant to Civil Code Section 2938(g), if the association enforces the assignment by way of a Demand to Pay Rent (without the appointment of a receiver) and the tenant complies, the delinquent landlord/owner may make written demand upon the association to pay the reasonable costs of protecting and preserving the property, including payment of taxes and insurance and compliance with Building and Safety codes, if any. The association’s obligations under this provision cannot exceed the amount of rents received pursuant to the assignment. Therefore, the association’s obligation to protect the property by payment of taxes and insurance, etc. does not exceed the amount that it actually receives pursuant to the assignment of rents.
It is important for an association, prior to the time a landlord/owner becomes delinquent, to obtain a copy of the lease agreements landlord/owners have with their tenants. As an aside, it is important that the lease agreement generally incorporate the association’s governing documents and that the tenant agrees to abide by same. More importantly with respect to an assignment of rents, the association would have no real way of knowing how much rent to expect in the event of an assignment of rents if the association does not have a copy of the lease agreement. For instance, the tenant could say “I’m just paying $200 in rent,” when in actuality they are paying $2,000 in rent, still paying $1,800 to the landlord/owner and only paying $200 to the association pursuant to the assignment.
Bottom line, the procedure is properly completed, the assignment of rents provision, if contained in the CC&Rs, is a powerful tool to collect past-due assessments without the need for court intervention. However, if not done properly, it can raise threats of tort liability against the association by the landlord/owner such as interference with contract, etc. While threats of legal action and actual legal action may still be the result even if the assignment of rents is done properly, the association would have an appropriate defense to that action and the appropriate legal grounds upon which to have a court order the assignment of rents pursuant to Civil Code Section 2938.
If your CC&Rs do not have an assignment of rents provision, you may want to consider amending your CC&Rs.
For help with the assignment of rents procedure, contact Joan Lewis-Heard at SwedelsonGottlieb at 800-372-2207.