UNIFORM ASSIGNMENT OF RENTS ACT
drafted by the
NATIONAL CONFERENCE OF COMMISSIONERS
ON UNIFORM STATE LAWS
and by it
APPROVED AND RECOMMENDED FOR ENACTMENT
IN ALL THE STATES
at its
ANNUAL CONFERENCE
MEETING IN ITS ONE-HUNDRED-AND-FOURTEENTH YEAR
PITTSBURGH, PENNSYLVANIA
July 21-28, 2005
WITH PREFATORY NOTE AND COMMENTS
Copyright ©2005
By
NATIONAL CONFERENCE OF COMMISSIONERS
ON UNIFORM STATE LAWS
October 4, 2005
ABOUT NCCUSL
The National Conference of Commissioners on Uniform State Laws (NCCUSL), now in its 114th year, provides states with non-partisan, well-conceived and well-drafted legislation that brings clarity and stability to critical areas of state statutory law.
Conference members must be lawyers, qualified to practice law. They are practicing lawyers, judges, legislators and legislative staff and law professors, who have been appointed by state governments as well as the District of Columbia, Puerto Rico and the U.S. Virgin Islands to research, draft and promote enactment of uniform state laws in areas of state law where uniformity is desirable and practical.
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DRAFTING COMMITTEE ON UNIFORM ASSIGNMENT OF RENTS ACT
The Committee appointed by and representing the National Conference of Commissioners on Uniform State Laws in preparing this Uniform Assignment of Rents Act consists of the following individuals:
MICHAEL B. GETTY, 1560 Sandburg Terr., Suite 1104, Chicago, IL 60610, Chair
TERRY J. CARE, 333 S. Sixth St., Las Vegas, NV 89101
THOMAS T. GRIMSHAW, 1700 Lincoln St., Suite 3800, Denver, CO 80203
BARRY C. HAWKINS, 300 Atlantic St., Stamford, CT 06901, Enactment Plan Coordinator
THEODORE C. KRAMER, 45 Walnut St., Brattleboro, VT 05301
EDWARD F. LOWRY, JR., 4200 N. 82nd St., Suite 2001, Scottsdale, AZ 85251
ROGER P. MORGAN, 2 Grennan Rd., West Hartford, CT 06107
PATRICK A. RANDOLPH, JR., University of Missouri ‑ Kansas City, School of Law, 5100 Rockhill Rd., Kansas City, MO 64110
EDWIN E. SMITH, 150 Federal St., 21st Floor, Boston, MA 02110-1726
R. WILSON FREYERMUTH, University of Missouri, 215 Hulston Hall, Columbia, MO 65211, Reporter
EX OFFICIO
FRED H. MILLER, University of Oklahoma, College of Law, 300 Timberdell Rd., Room 3056, Norman, OK 73019, President
LANI LIU EWART, Suite 1800, Alii Pl., 1099 Alakea St., Honolulu, HI 96813, Division Chair
AMERICAN BAR ASSOCIATION ADVISOR
IRA J. WALDMAN, 2049 Century Park East, Suite 2800, Los Angeles, CA 90067, American Bar Association Advisor
EXECUTIVE DIRECTOR
WILLIAM H. HENNING, University of Alabama School of Law, Box 870382, Tuscaloosa, AL 35487-0382, Executive Director
Copies of this Act may be obtained from:
NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS
211 E. Ontario Street, Suite 1300
Chicago, Illinois 60611
312/915‑0195
www.nccusl.org
UNIFORM ASSIGNMENT OF RENTS ACT
TABLE OF CONTENTS
Prefatory Note.................................................................................................................................. 1
SECTION 1. SHORT TITLE.......................................................................................................... 7
SECTION 2. DEFINITIONS.......................................................................................................... 7
SECTION 3. MANNER OF GIVING NOTIFICATION............................................................. 15
SECTION 4. SECURITY INSTRUMENT CREATES ASSIGNMENT OF RENTS; ASSIGNMENT OF RENTS CREATES SECURITY INTEREST................................................................................... 17
SECTION 5. RECORDATION; PERFECTION OF SECURITY INTEREST IN RENTS; PRIORITY OF CONFLICTING INTERESTS IN RENTS......................................................................... 22
SECTION 6. ENFORCEMENT OF SECURITY INTEREST IN RENTS.................................... 27
SECTION 7. ENFORCEMENT BY APPOINTMENT OF RECEIVER....................................... 28
SECTION 8. ENFORCEMENT BY NOTIFICATION TO ASSIGNOR..................................... 33
SECTION 9. ENFORCEMENT BY NOTIFICATION TO TENANT......................................... 35
SECTION 10. NOTIFICATION TO TENANT: FORM.............................................................. 40
SECTION 11. EFFECT OF ENFORCEMENT............................................................................ 43
SECTION 12. APPLICATION OF PROCEEDS......................................................................... 45
SECTION 13. APPLICATION OF PROCEEDS TO EXPENSES OF PROTECTING REAL PROPERTY; CLAIMS AND DEFENSES OF TENANT........................................................................................ 46
SECTION 14. TURNOVER OF RENTS; COMMINGLING AND IDENTIFIABILITY OF RENTS; LIABILITY OF ASSIGNOR....................................................................................................................... 49
SECTION 15. PERFECTION AND PRIORITY OF ASSIGNEE’S SECURITY
INTEREST IN PROCEEDS............................................................................................... 53
SECTION 16. PRIORITY SUBJECT TO SUBORDINATION.................................................... 56
SECTION 17. UNIFORMITY OF APPLICATION AND CONSTRUCTION............................ 57
SECTION 18. RELATION TO ELECTRONIC SIGNATURES IN GLOBAL AND
NATIONAL COMMERCE ACT....................................................................................... 57
SECTION 19. APPLICATION TO EXISTING RELATIONSHIPS............................................. 57
SECTION 20. EFFECTIVE DATE............................................................................................... 58
SECTION 21. REPEALS.............................................................................................................. 58
UNIFORM ASSIGNMENT OF RENTS ACT
Prefatory Note
Traditionally, under the title theory of mortgages, a mortgage effected a transfer of legal title to real property as security for the mortgage debt. As an incident of this legal title, the mortgagee obtained the right to collect rents arising from the real property and apply them to the mortgage debt unless the mortgage stated otherwise. By contrast, in the majority of American states that follow the lien theory of mortgages, a mortgage grants the mortgagee only a right of security, capable of being enforced via foreclosure in the event of the mortgagor’s default. Under the lien theory, until such enforcement occurs, a mortgage does not by itself convey to the mortgagee the right to collect rents accruing from the mortgaged real property.
As a result, it has become customary that when a lender makes a mortgage loan on income-producing real property, the lender requires the borrower to execute a document typically entitled an “Assignment of Leases and Rents.” This assignment can serve a number of practical purposes, but its most significant purpose is to provide the mortgagee with a security interest in rents that accrue before the mortgagee can complete a foreclosure proceeding. In many states, the foreclosure process can be quite lengthy, and the mortgage lender faces a heightened risk that while a foreclosure proceeding is pending, the borrower may continue to collect rents and spend them other than to reduce the mortgage debt or paying operating expenses of the real property (a process often referred to as “milking” the rents). By taking the assignment, the lender makes clear its intent to hold a lien upon all future rents produced by the real property, including those that accrue during the period between the mortgagor’s default and the mortgagee’s completion of a foreclosure proceeding. The assignment typically permits the lender to take steps following the borrower’s default to collect rents and apply them to reduce the mortgage debt. These steps may include, among others, the lender’s taking physical possession of the project (becoming a “mortgagee in possession”), obtaining the appointment of a receiver for the project, or notifying tenants to direct all future rent payments to the lender.
State law generally governs the creation and enforcement of security interests in rents. Unfortunately, most states do not have detailed statutory provisions dealing with the creation, perfection, and enforcement of security interests in rents (by contrast to the comprehensive provisions in Uniform Commercial Code Article 9 governing the creation, perfection, and enforcement of security interests in accounts and other personal property payment rights). Thus, the creation and enforcement of security interests in rents tends to be governed by the common law of real property. Not surprisingly, this has produced undesirable variation in the rules governing the creation and enforcement of security interests in rents. Perhaps more significantly, disagreements regarding security interests in rents tend to be resolved in the federal bankruptcy courts, after the owner of mortgaged real property has resorted to bankruptcy to obtain a stay from creditor collection efforts. Bankruptcy courts have proven exceptionally adept at creatively interpreting (or misinterpreting) state law principles — in some cases to disencumber a lender’s security interest in rents altogether, or in other cases to exclude post-bankruptcy rents from the bankruptcy estate.
To address some of these concerns, the Act seeks to bring consistency to commercial real property transactions by establishing a comprehensive statutory model for the creation, perfection, priority, and enforcement of a security interest in rents. The Act addresses (among others) the following issues:
A security interest in rents is a distinct form of collateral. As stated above, the most significant purpose of an assignment of leases and rents is to provide the mortgagee with a security interest in rents that accrue before the mortgagee can complete a foreclosure proceeding. Most courts have held that while rents arise from and are thus related to the mortgaged real property, an assignment of rents creates an additional source of collateral, distinct from the mortgagee’s lien on the real property itself. In other words, the assignee of rents obtains a lien on the rents that accrue prior to foreclosure, as well as a security interest in the mortgaged real property (which inherently covers those rents that would accrue after a completed foreclosure). Unfortunately, some bankruptcy court decisions have wrongly concluded that rents do not constitute separate collateral, but are “subsumed within the land.” In reaching this conclusion, these courts have held that a bankrupt mortgagor/owner may use rents during the pendency of its bankruptcy, without regard to the lender’s security interest in rents, so long as the mortgaged real property itself is not decreasing in value. To the extent that these decisions purport to be based upon state law, the Act rejects these decisions and confirms the prevailing view that a security interest in rents that accrue prior to foreclosure is an interest that is distinct from the lien on the real property from which the rents arise. For further background, see Act § 4(b), Comment 2.
“Perfection” of a security interest in rents. The Act codifies the principle that an assignment of rents is perfected and effective against third persons upon its proper recordation. The Act thus establishes, as a matter of state law, that once a lender has recorded an assignment of rents, no further action is generally necessary to protect the enforceability and priority of the lender’s security interest in rents against subsequent purchasers or creditors. The Act should thus resolve any remaining ambiguity regarding the enforceability of a lender’s security interest in rents accruing during the pendency of a mortgagor/owner’s bankruptcy case — as the Bankruptcy Code makes clear that the bankruptcy trustee/debtor-in-possession cannot use its “strong-arm” avoiding power, 11 U.S.C. § 544(a), to avoid a security interest that was properly perfected prior to bankruptcy. The Act would thus reject existing case law that suggests that a security interest in rents is “inchoate” or ineffective until the lender takes affirmative action after default to obtain possession of the real property, impound the rents, secure the appointment of a receiver, or some other similar action. For further background, see Act § 5, Comment 2.
“Absolute” assignments of rents. Often, an assignment of leases and rents will state that the assignor is making an “absolute” transfer of rents, even though the context of the transaction (and often the terms of the assignment itself) indicate that the assignor is making the assignment only as security for repayment of the mortgage obligation. Mortgage law has long established that instruments purporting to make an absolute conveyance of title nevertheless constitute equitable mortgages if the surrounding circumstances demonstrate that the parties are using title to secure payment of a debt. Consistent with this long-established principle, the Act establishes that an assignment of rents executed in conjunction with and to secure payment of a mortgage debt creates only a security interest in rents, even if the assignment purports to constitute an absolute transfer of the rents. For further background, see Act § 4(b), Comment 3.
Appointment of a receiver. In some states, comprehensive statutory provisions address the circumstances in which a court should appoint a receiver for mortgaged real property. In many states, however, there is little statutory guidance. As a result, standards governing the appointment of receivers in most states are defined judicially, and tend to vary somewhat from jurisdiction to jurisdiction — and, within many jurisdictions, from judge to judge. Some decisions require that the mortgagee’s security be inadequate or that the real property be subject to existing or threatened waste; others require a showing of mortgagor insolvency. By contrast, many courts will appoint a receiver in any circumstance in which the mortgage contains a receivership clause authorizing such an appointment after default. The Act establishes consistent standards to govern the appointment of a receiver for mortgaged real property, including the effectiveness of a receivership clause. For further background, see Act § 7, Comments 1-8.
Characterization of real property revenues. In many commercial real property developments (e.g., office buildings, retail shopping centers, apartment complexes), the owner and occupiers of the development stand in a landlord-tenant relationship, based upon the execution of leases covering portions of the development. Because the common law has treated unaccrued rents as an interest in real property (an incorporeal hereditament), there is no question that in these cases, the sums paid by tenant occupiers constitute “rent.” Thus, a mortgage lender taking a security interest in those “rents” must comply with the provisions of real property law in order to obtain and enforce that security interest — i.e., the mortgage lender must have the mortgagor execute and deliver an instrument sufficient to convey an interest in “rents” and must record that instrument in the public real property records. In many other developments, however, the occupiers are not “tenants,” but merely licensees (e.g., nursing home residents, persons occupying garage spaces or marina slips, hotel guests, and the like). Court decisions involving security interests in the revenues paid by such occupiers have disagreed over the proper characterization of these revenues — with some treating them as “rents” in the nature of real property, and others treating them as “accounts” subject to the provisions of Uniform Commercial Code Article 9. These decisions have created uncertainty regarding both the proper way to create and perfect a security interest in these occupancy revenues, as well as the appropriate treatment of a security interest in those revenues generated during the pendency of a bankruptcy case. The Act establishes that rents include any sum paid by a tenant, licensee, or other person for the right to possess or occupy the real property of another. For further background, see Act § 2, Comment 12.
Enforcement by notification to assignor/owner. The traditional weight of case authority required that an assignee of rents could enforce its security interest in rents only by taking steps sufficient to divest the assignor of control over those rents. Under this approach, it did not suffice for the assignee to make a demand upon the mortgagor/assignor to turn over rentals as they were collected. These decisions reflected a concern that as long as the mortgagor was collecting and retaining net rentals, third party claimants (such as trade creditors to whom the mortgagor might make payments) could be easily misled by the mortgagor’s control over those cash proceeds. The Act rejects this approach and permits an assignee to enforce its security interest in rents by giving a notification demanding that the assignor turn over any rents that it may collect following the notification — and thus an assignor who fails to turn over any such rents to the assignee is liable for conversion of those rents. For further background, see Act § 8, Comment 1.
Enforcement by notification to tenants. The Act seeks to facilitate the enforcement of a security interest in rents by allowing the assignee to give a notification to tenants demanding that the tenants make future rent payments directly to the assignee. The Act addresses the liability of the tenant for making payments to the assignor following receipt of such a notification, the need for a tenant to have adequate opportunity to seek counsel regarding the legal effect of the notification, and the possibility of a tenant receiving a notification from multiple rents assignees. The Act also provides a standard form notification suitable for use by assignees. For further background, see Act § 9, Comments 1-7.
Mortgage creates a security interest in rents by default. Under Uniform Commercial Code Article 9, a security interest in personal property automatically extends to proceeds of that property unless the security agreement provides otherwise. Because Article 9 defines “proceeds” to include whatever is received upon disposition (including a lease) of the collateral, a security interest in personal property collateral automatically extends to rentals arising from that collateral. Article 9’s treatment of personal property rents as “proceeds” reflects the presumed intention of lender and borrower that the lender’s security interest should extend to sums (e.g., rents) that reflect a return upon the economic value of the collateral.
By contrast to Article 9’s clear and straightforward coverage of “proceeds,” real property law has been less clear regarding the mortgagee’s interest in rents. Under the title theory of mortgages, the mortgagee’s title to the real property automatically included the right to collect and apply rents arising from the real property to the mortgage debt (unless the mortgage itself provided otherwise). Thus, the mortgagee in a title theory state implicitly acquired an interest in the rents arising from the real property, regardless of whether the mortgagee received an explicit assignment of rents. By contrast, under the lien theory of mortgages, the mortgagee did not automatically acquire the right to collect and apply rents as an incident of the mortgage. For this reason, most commercial real property mortgage lenders require the mortgagor to make an assignment of rents in order to give the mortgagee an unquestioned interest in rents that accrue prior to the completion of a foreclosure.
Particularly with respect to commercial real property, rents reflect the economic return received by the owner in exchange for a temporal disposition of the right to possess and occupy the real property. This explains why a mortgagee on income-producing real property almost inevitably require the mortgagor to execute and deliver an assignment of rents (either as part of, or in addition to, the mortgage). In this regard, commercial practice demonstrates that rents from real property are and should be viewed as a form of proceeds of the real property — and should receive treatment comparable to the treatment Article 9 accords to proceeds of personal property collateral. In order to promote desirable consistency between Article 9 and real property law, the Act establishes that a mortgage creates a security interest in rents by default (e.g., unless the mortgage provides otherwise), even if the mortgage does not by its express terms create an assignment of rents. For further background, see Act § 4(a), Comment 1.
Expenses of operating and preserving the real property. Often, commercial leases obligate the tenant to pay a sum characterized as “additional rent.” This sum is typically determined by the tenant’s pro rata share of the cost of real property taxes, insurance, and maintenance expenses (or the increase in such costs or expenses beyond an established baseline amount), and serves to reimburse the landlord for the payment of these expenses. Leases customarily characterize the tenant’s obligation to pay these sums as “rent,” and assignments of leases and rents typically require the landlord/assignor to grant a security interest in these sums. Based upon these customary practices, the Act treats such sums as “rents.”
California’s comprehensive assignment of rents statute places an affirmative obligation on the assignee to use whatever rents it collects to pay the reasonable expenses of operating and maintaining the real property. By contrast, under the traditional rule prevailing in most states, the landlord’s obligation to pay these expenses — even if the obligation is expressed or implied into its tenant leases — does not bind the lender as a successor until the lender acquires possession or ownership of the real property (by becoming a mortgagee in possession or purchasing the premises at foreclosure). A prudent lender may choose to apply collected rents to the payment of real property taxes, insurance, and project maintenance in order to protect its own security. Nevertheless, under the traditional view, a lender that collect rents without taking actual or constructive possession of the real property may apply those rents to the mortgage debt without any obligation to apply such sums to the payment of taxes, insurance, or property maintenance.
If the assignor/landlord fails to pay real property taxes or insurance or fails to perform its obligations with respect to project maintenance, a tenant injured by such failure may have a claim or defense with respect to its continuing liability for rents. Although the assignee has no affirmative obligation to pay these real property-related expenses prior to obtaining possession or ownership of the real property, the Act does make clear that the assignee’s ability to collect rents from tenants is subject to any such claim or defense that the tenant may have based upon the assignor’s nonperformance (absent an enforceable agreement not to assert such a claim or defense). For further background, see Act § 13, Comments 1-2.
Coordination with Uniform Commercial Code Article 9. The Act provides that a perfected security interest in rents extends automatically into the identifiable proceeds received upon collection of rent. In the typical case, however, “proceeds” of rents will constitute personal property. This means that conflicting interests may arise in the same proceeds — the assignee’s interest by virtue of this Act, and another person’s by virtue of other law such as Article 9 of the Uniform Commercial Code. The Act provides a set of rules to establish priority between such conflicting interests. To ensure the coordination of this Act with Article 9, this Act generally treats the assignee’s “proceeds” interest as if it had arisen under Article 9 and applies Article 9’s priority rules. For example, the Act protects a third person to whom an assignor transfers money that constitute proceeds of rents, so long as the transferee is not acting in collusion with the assignor to violate the rights of the assignee. Cf. U.C.C. § 9-332(a). For further background, see Act § 15, Comments 1-4.
UNIFORM ASSIGNMENT OF RENTS ACT
SECTION 1. SHORT TITLE. This [act] may be cited as the Uniform Assignment of Rents Act.
SECTION 2. DEFINITIONS. In this [act]:
(1) “Assignee” means a person entitled to enforce an assignment of rents.
(2) “Assignment of rents” means a transfer of an interest in rents in connection with an obligation secured by real property located in this state and from which the rents arise.
(3) “Assignor” means a person that makes an assignment of rents or the successor owner of the real property from which the rents arise.
(4) “Cash proceeds” means proceeds that are money, checks, deposit accounts, or the like.
(5) “Day” means calendar day.
(6) “Deposit account” means a demand, time, savings, passbook, or similar account maintained with a bank, savings bank, savings and loan association, credit union, or trust company.
(7) “Document” means information that is inscribed on a tangible medium or that is stored on an electronic or other medium and is retrievable in perceivable form.
(8) “Notification” means a document containing information that this [act] requires a person to provide to another, signed by the person required to provide the information.
(9) “Person” means an individual, corporation, business trust, estate, trust, partnership, limited liability company, association, joint venture, public corporation, government, or governmental subdivision, agency, or instrumentality, or any other legal or commercial entity.
(10) “Proceeds” means personal property that is received or collected on account of a tenant’s obligation to pay rents.
(11) “Purchase” means to take by sale, lease, discount, negotiation, mortgage, pledge, lien, security interest, issue or reissue, gift, or any other voluntary transaction creating an interest in property.
(12) “Rents” means:
(A) sums payable for the right to possess or occupy, or for the actual possession or occupation of, real property of another person;
(B) sums payable to an assignor under a policy of rental interruption insurance covering real property;
(C) claims arising out of a default in the payment of sums payable for the right to possess or occupy real property of another person;
(D) sums payable to terminate an agreement to possess or occupy real property of another person;
(E) sums payable to an assignor for payment or reimbursement of expenses incurred in owning, operating and maintaining, or constructing or installing improvements on, real property; or
(F) any other sums payable under an agreement relating to the real property of another person that constitute rents under law of this state other than this [act].
(13) “Secured obligation” means an obligation the performance of which is secured by an assignment of rents.
(14) “Security instrument” means a document, however denominated, that creates or provides for a security interest in real property, whether or not it also creates or provides for a security interest in personal property.
(15) “Security interest” means an interest in property that arises by agreement and secures performance of an obligation.
(16) “Sign” means, with present intent to authenticate or adopt a document:
(A) to execute or adopt a tangible symbol; or
(B) to attach to or logically associate with the document an electronic sound, symbol, or process.
(17) “State” means a state of the United States, the District of Columbia, Puerto Rico, the United States Virgin Islands, or any territory or insular possession subject to the jurisdiction of the United States.
(18) “Submit for recording” means to submit a document complying with applicable legal standards, with required fees and taxes, to the appropriate governmental office under [insert reference to the recording act of this state].
(19) “Tenant” means a person that has an obligation to pay sums for the right to possess or occupy, or for possessing or occupying, the real property of another person.
Comment
1. “Assignee.” The term “assignee” means the person entitled to enforce an assignment of rents. Consistent with standard agency principles, the term “assignee” would include an authorized agent of the assignee.
2. “Assignment of rents.” The Act uses the term “assignment of rents” to mean the transfer of an interest in rents, rather than the document by which the transfer is made. Any document sufficient to effect a transfer of a security interest in rents constitutes an assignment of rents under the Act. As a result, a mortgagee need not use a separate document to create an assignment of rents, but can merely incorporate into the mortgage document language that creates an assignment of rents. See Act § 4, Comment 4.
For sake of simplicity, the Act uses the term “assignment of rents” even though the document creating such an assignment is usually termed “Assignment of Leases and Rents” and effectively transfers to the assignee an interest in the leases covering the real property (as well as an interest in the rents payable under those leases). The focus of the Act is to govern the creation, perfection, and enforcement of security interests in rents. By using the term “assignment of rents,” the Act is not intended to bifurcate a tenant’s obligation to pay rents from the lease under which the tenant’s obligation to pay rents arises.
3. “Assignor.” The term “assignor” means a person that makes an assignment of rents or the successor owner of the real property subject to the assignment. Consistent with standard agency principles, the term “assignor” would include an authorized agent of the assignor. Thus, for example, if the document creating an assignment of rents provided that a notification given pursuant to that assignment was to be given to the assignor’s lawyer, notification to the lawyer would suffice to constitute notification to the assignor.
4. “Cash proceeds.” The term “proceeds” means personal property that is collected on account of a tenant’s obligation to pay rents covered by this Act. See Comment 10. The term “cash proceeds” means proceeds that are in the form of cash, checks, funds in a deposit account, and the like.
5. “Day.” The Act defines “day” as a calendar day.
6. “Deposit account.” This definition is similar to that contained in U.C.C. Section 9-102(a)(29). The term uses the term “bank” in a fashion comparable to the definition contained in U.C.C. Section 1-201(b)(4).
7. “Document.” The definition of “document” is media-neutral and comparable to the definition used in Section 102(3) of the Uniform Residential Mortgage Satisfaction Act. Because this Act uses the term “record” in its customary fashion under real property law — i.e., as a verb to describe the act of filing an instrument of conveyance with the recorder’s office — the Act does not use the term “record” as a noun, and instead uses the term “document.”
8. “Notification.” The Act permits an assignee to enforce an assignment of rents by giving a notification to the assignor (Section 8) or by giving a notification to tenants of the assignor (Section 9). In any circumstance in which the Act requires notification to be given to a person, any such notification shall be in the form of a document, as defined in Section 2(7), and shall contain the information required by the specific section authorizing that notification.
9. “Person” includes both natural persons (individuals) and all forms of legally recognized public and private organizations.
10. “Proceeds.” In this Act, the term “proceeds” means whatever is collected from a tenant on account of the tenant’s obligation to pay rent. In most instances, these proceeds will be in the form of cash or checks. The Act provides that a security interest in rents extends automatically to any proceeds of those rents so long as those proceeds are identifiable. Section 14(b), (c).
It is possible that an assignee may claim a security interest in proceeds of rents and that another creditor or person may also claim a conflicting interest in those proceeds by virtue of other law, particularly Article 9 of the Uniform Commercial Code. The Act provides priority rules in Section 15 to address such potential priority conflicts.
11. “Purchase” is defined in the same manner as in Uniform Commercial Code Section 1-201(b)(29), and includes any voluntary transaction creating an interest in property.
12. “Rents.” In many commercial real property developments (e.g., office buildings, industrial parks, retail shopping centers, and apartment complexes), the owner stands in a landlord-tenant relationship with the occupiers of the development, based upon the execution of leases covering portions of the development. Because the common law has treated unaccrued rents as an interest in real property (an incorporeal hereditament), the right to collect sums paid by tenant occupiers undoubtedly constitutes “rent” in the nature of real property. Thus, a mortgage lender taking a security interest in “rents” must comply with the provisions of real property law in order to obtain and enforce that security interest. In other words, the mortgage lender must have the mortgagor execute and deliver an instrument sufficient to convey an interest in “rents” and must record that instrument in the appropriate real property records.
In many other developments, however, the owner does not stand in a landlord-tenant relationship with the user/occupier of real property because that user/occupier is only a licensee. Examples of this type of project include nursing homes, parking garages, golf courses, landfills, marinas, stadiums/arenas, student dormitories, and hotels/motels. If the development’s occupier is a licensee and not a tenant, a significant classification problem arises — whether the right to collect sums from project occupiers is “rent” governed by real property law (such that the lender would obtain and record an assignment of rents in the real property records), or is instead an “account” governed by Article 9 of the Uniform Commercial Code (such that the lender would create a security interest in present and after-acquired accounts and perfect that interest by filing a financing statement covering accounts in the Article 9 filing system).
In theory, a lender could moot the resolution of this characterization question simply by (a) making sure that its loan documents create a security interest in both “rents” and “accounts,” and (b) recording/filing evidence of those interests in the respective filing systems. This “belt and suspenders” approach would appear to give the lender a perfected security interest in the right to collect unaccrued occupancy charges, regardless of how a court resolved the characterization question.
Unfortunately, Bankruptcy Code § 552(a) complicates this analysis. Section 552(a) generally provides that any pre-petition security agreement covering after-acquired property does not affect property that the bankruptcy estate acquires post-petition. By itself, section 552(a) would suggest that a lender’s security interest in pre-petition revenues would not attach to post-petition revenues (which would, in turn, mean that those revenues would not constitute the lender’s cash collateral). Congress drew a careful distinction, however, between property received by the debtor post-petition and post-petition proceeds of pre-petition collateral. This distinction is reflected in section 552(b), which provides that a valid and properly perfected pre-petition security interest in collateral will attach to any rents, profits, and proceeds of that collateral that are received by the debtor post-petition. The protection accorded to secured creditors by section 552(b) makes the resolution of the “what revenues are ‘rents’?” question critical for the commercial real property mortgage lender. If post-petition project revenues are “rents,” “profits,” or “proceeds” of the real property, the lender’s security interest attaches to those revenues. If not, then section 552(a) extinguishes the lender’s interest in post-petition project revenues.
Most of the bankruptcy cases addressing this characterization question involved hotels and security interests in hotel room revenues. Before 1994, a few decisions sensibly treated hotel room revenues as the functional equivalent of tenant rents and concluded that § 552(b)’s protection for “rents” preserved a lender’s properly perfected interest in post-petition hotel room revenues. See, e.g., In re S.F. Drake Hotel Assocs., 131 B.R. 156, 158-61 (Bankr. N.D. Cal. 1991), aff’d, 147 B.R. 538 (N.D. Cal. 1992); In re Mid-City Hotel Assocs., 114 B.R. 634, 638-642 (Bankr. D. Minn. 1990). Most courts, however, concluded that post-petition hotel room revenues were accounts (personal property) and were neither “rents,” “profits,” nor “proceeds” of the real property. See, e.g., In re Northview Corp., 130 Bankr. 543, 548 (9th Cir. BAP 1991); In re Investment Hotel Properties, Ltd., 109 Bankr. 990, 994-97 (Bankr. D. Colo. 1990). These courts typically applied the formalistic reasoning that room revenues could not be “rents” because hotel guests were not “tenants.” As a result, many bankruptcy courts routinely invalidated lenders’ claimed interests in post-petition hotel revenues. The formalistic invalidation of a hotel lender’s interest in post-petition room revenues was particularly inappropriate, as hotel room revenues are economically identical to the “rents” paid by tenants under apartment, office, or industrial leases. See, e.g., R. Wilson Freyermuth, Of Hotel Revenues, Rents, and Formalism in the Bankruptcy Courts: Implications for Reforming Commercial Real Estate Finance, 40 UCLA L. Rev. 1461 (1993). Recognizing the absurdity of these decisions, Congress amended section 552(b) in 1994 to preserve the lender’s interest in post-petition “fees, charges, accounts, or other payments for the use or occupancy of rooms and other public facilities in hotels, motels, or other lodging properties.”
This amendment provided a practical solution to the classification problem with respect to hotels and other “lodging properties,” but it did not address a wide variety of other income-generating developments. Courts have generally concluded that golf course greens fees do not constitute “rents,” “profits,” or “proceeds” of the real property. See, e.g., In re McKim, 217 B.R. 97 (Bankr. D.R.I. 1998); In re GGVXX, Ltd., 130 B.R. 322 (Bankr. D. Colo. 1991). Likewise, courts have refused to characterize stadium/arena revenues as rents. See, e.g., Klingner v. Pocono International Raceway, Inc., 433 A.2d 1357 (Pa. Super. 1981); In re Zeeway Corp., 71 B.R. 210 (9th Cir. Bankr. 1987). By contrast, courts have treated revenues from parking garages as rents, see, e.g., In re Ashford Apartments Ltd. Partnership, 132 B.R. 217 (Bankr. D. Mass. 1991), and have treated landfill dumping fees as rents. See, e.g., In re West Chestnut Realty of Haverford, Inc., 166 B.R. 53 (Bankr. E.D. Pa. 1993), aff’d, 173 B.R. 322 (E.D. Pa. 1994). Courts have split on the characterization of marina slip fees, with some characterizing these as “rents” depending upon the duration of use and others characterizing such fees as accounts subject to Article 9. Compare In re Northport Marina Assocs., 136 B.R. 911 (Bankr. E.D.N.Y. 1992) (fees paid by marina users for assigned slip for six months or more were in nature of “rents,” while fees paid by transitory users were “accounts”) with In re Harbour Pointe Ltd. Partnership, 132 B.R. 501 (Bankr. D.D.C. 1991) (fees generated by marina treated as “rents”) and In re Hamlin’s Landing Joint Venture, 77 B.R. 916 (Bankr. M.D. Fla. 1987) (same).
In Section 2(12)(A), the Act takes the view that “rents” should include all sums payable for the right to possess or occupy the real property of another. A person “possesses” the real property of another if that person has a possessory interest in that real property (e.g., the interest of a tenant under a lease). A person “occupies” the real property of another if that person has a contractual right that permits them to occupy the real property of another to the exclusion of persons other than the owner. Thus, the Act defines the term “rents” to include all sums paid by a person in order to acquire the right to possess or occupy the real property of another.
The Act also provides that the term “rents” includes any right to payment on account of the actual possession or occupation of the real property of another. Thus, the right to collect from a tenant at sufferance for the period in which that tenant holds over following the termination of its lease constitutes “rents,” even if the landlord chooses to treat the holdover tenant as a trespasser and institute eviction proceedings.
The application of subsection (12)(A) is demonstrated by the following illustrations:
Illustration 1. ABC Life Insurance Company holds an assignment of rents on the Friendly Shopping Center. Grocer signs a 20-year lease for an anchor tenancy within the Friendly Shopping Center. The lease provides that Grocer will pay base rent and (depending upon sales) percentage rent. Sums payable from Grocer under the terms of the lease (whether for base rent or percentage rent) constitute “rents” within the meaning of the Act.
Illustration 2. ABC Life Insurance Company holds an assignment of rents on the Friendly Hotel. Heinsz is a guest of Friendly Hotel for three nights. Although Heinsz has no possessory interest in a particular hotel room vis-a-vis the owner of Friendly Hotel, Heinsz does “occupy” the room in a fashion that essentially excludes third persons. Sums payable for the room occupancy charges that Heinsz incurs for his stay are “rents.” Sums payable for charges that Heinsz incurs for additional hotel-related services (such as room service meals, dry cleaning or laundry services, or the like) would not constitute “rents,” as they are not incurred in exchange for the right to occupy the room.
Illustration 3. ABC Life Insurance Company holds an assignment of rents on the Friendly Nursing Home, where Davis is a resident. Although Davis may not have a possessory interest in the room vis-a-vis the owner of Friendly Nursing Home, Davis does “occupy” the room in a fashion that essentially excludes third persons. Sums payable for the room occupancy charges that Davis incurs for his stay are “rents.” Sums payable for medical treatment, medication, physical therapy, or the like would not constitute “rents,” as they are not incurred in exchange for the right to occupy the room.
Illustration 4. First Bank holds an assignment of rents on the Friendly Marina. Smith has a contract with Friendly Marina pursuant to which he pays a monthly fee for a slip at which he may dock his yacht. The monthly fees payable by Smith under this agreement are “rents.”
Illustration 5. First Bank holds an assignment of rents on Friendly Parking Garage. Smith has a contract with Friendly Parking Garage pursuant to which he pays $150 per month for a reserved parking space. Sums payable by Smith for this parking space constitute “rents.”
Illustration 6. First Bank holds an assignment of rents on Friendly Golf Course. Smith pays greens fees to play at Friendly Golf Course. Sums payable on account of Smith’s greens fees are not right “rents,” as Smith does not “occupy” the real property but is merely using it in a temporary and essentially nonexclusive fashion.
In jurisdictions adopting this Act, there will remain certain developments for which the definition of “rents” does not unambiguously resolve the classification dilemma. For example, consider a stadium that stages athletic or entertainment events. On the one hand, one might characterize as “rents” the right to collect admission fees from patrons, on the ground that while patrons do not have a possessory interest, they may “occupy” a stadium seat in a more or less exclusive fashion (as two persons cannot literally occupy the same seat simultaneously). On the other hand, one might characterize the right to collect admission fees as “accounts” governed by Uniform Commercial Code Article 9, on the ground that patrons have merely a temporary interest that is more appropriately characterized as “use” rather than “occupancy.” In such cases, a prudent lender may choose to follow the “belt and suspenders” approach — taking both an assignment of rents (and recording it in the real property records) and an Article 9 security interest in present and after-acquired accounts (and perfecting it by filing an Article 9 financing statement) — in order to assure that it has a perfected security interest in the revenues generated by the project.
Subsections (12)(B) through (E) define rents to include sums payable that leases or occupancy agreements often characterize as “rents,” as well as the right to collect sums that constitute an economic substitute for rents that might otherwise have accrued or been collected. These include the sums payable under a policy of rental interruption insurance; claims arising out of a default in the payment of rents (e.g., liquidated damages); sums payable in order to terminate a lease or occupancy agreement; and sums payable for the purpose of paying or reimbursing the assignor’s payment of expenses incurred in owning, operating and maintaining the real property (such as taxes or insurance) or in constructing or installing improvements.
In any particular state, a court or legislature might choose to define particular sums payable as “rents” even though such sums would not be covered by subsection (12)(A) through (E). Under subsection 12(F), such sums would constitute “rents” under this Act.
13. “Secured obligation.” The term “secured obligation” covers any obligation the performance of which is secured by an assignment of rents.
14. “Security instrument.” This definition is similar to that used in Section 102(19) of the Uniform Nonjudicial Foreclosure Act, and recognizes that the title given to a document by its parties is not dispositive of whether the document is a security instrument. Instead, the key issue is whether the document creates a security interest in real property. The definition thus covers a mortgage, deed of trust, deed to secure debt, or any other document used by the parties to create a security interest in real property.
15. “Security interest.” Under the Act, a security interest arises in any transaction, regardless of its form, in which a person receives or retains an interest in property for the purpose of securing an obligation owed to that person. Thus, the term “security interest” as used in this Act would cover both a security interest in “rents” taken by an assignee as well as a security interest in the proceeds of rents taken by a secured party under Article 9 of the Uniform Commercial Code.
16. “Sign.” This definition is media-neutral and comparable to that contained in Uniform Commercial Code § 2-103(1)(p).
17. “Submit for recording.” This definition is comparable to that contained in Section 102(21) of the Uniform Residential Mortgage Satisfaction Act. To “submit for recording” means that the person has submitted a document that has complied with the appropriate legal requirements for the document submitted, along with required fees and taxes, to the appropriate recording official. Whether an assignment of rents that is submitted for recording is actually recorded or otherwise binds third parties is determined by the state’s recording act.
18. “State.” This definition is the standard definition of the term as used in uniform acts.
19. “Tenant.” For purposes of this Act, a “tenant” is any person that holds a right to possess or occupy the real property of another, or who actually possesses or occupies that real property, and is thereby obligated to pay rents. The Act defines “rents” to include sums payable by certain occupants of real property that do not have a possessory interest in the real property and thus do not stand in a landlord-tenant relationship with the assignor. Although the Act treats such a licensee as a “tenant” for the purposes of this Act, it does not render such a licensee a tenant within the meaning of the state’s landlord-tenant law. Thus, for example, nothing in this Act would grant a licensee the benefit of the state’s forcible entry and detainer statutes, the benefit of an implied warranty of habitability, or any other right recognized under the state’s general law of landlord and tenant.
SECTION 3. MANNER OF GIVING NOTIFICATION.
(a) Except as otherwise provided in subsections (c) and (d), a person gives a notification or a copy of a notification under this [act]:
(1) by depositing it with the United States Postal Service or with a commercially reasonable delivery service, properly addressed to the intended recipient’s address as specified in subsection (b), with first-class postage or cost of delivery provided for; or
(2) if the recipient agreed to receive notification by facsimile transmission, electronic mail, or other electronic transmission, by sending it to the recipient in the agreed manner at the address specified in the agreement.
(b) The following rules determine the proper address for giving a notification under subsection (a):
(1) A person giving a notification to an assignee shall use the address for notices to the assignee provided in the document creating the assignment of rents, but, if the assignee has provided the person giving the notification with a more recent address for notices, the person giving the notification shall use that address.
(2) A person giving a notification to an assignor shall use the address for notices to the assignor provided in the document creating the assignment of rents, but, if the assignor has provided the person giving the notification with a more recent address for notices, the person giving the notification shall use that address.
(3) If a tenant’s agreement with an assignor provides an address for notices to the tenant and the person giving notification has received a copy of the agreement or knows the address for notices specified in the agreement, the person giving the notification shall use that address in giving a notification to the tenant. Otherwise, the person shall use the address of the premises covered by the agreement.
(c) If a person giving a notification pursuant to this [act] and the recipient have agreed to the method for giving a notification, any notification must be given by that method.
(d) If a notification is received by the recipient, it is effective even if it was not given in accordance with subsection (a) or (c).
Comment
1. Methods of giving notification. This section specifies the methods for giving any notification required by this Act. Under subsection (a), notices required by the Act may be transmitted by first-class United States mail or via a commercial reasonable delivery service. Subsection (a) also permits notices to be given by electronic mail, facsimile, or other form of electronic transmission, but only if the recipient agreed to receive notification in that manner and only at the address specified in that agreement. Such an agreement may arise either by express written provisions or by virtue of an established course of conduct between the giver and recipient of the notification (such as the consistent delivery and receipt of previous formal notices).
Proper dispatch, not receipt, satisfies the obligation to give notification. The person asserting that notification was given has the burden of proof that notification was given in accordance with the provisions of this section.
Typically, the document evidencing an assignment of rents contains provisions regarding the manner by which notification shall be sent and the appropriate addresses for notification. Subsection (c) provides that if an agreement between the person giving a notification and the recipient dictates a method of notification other than the methods permitted under subsection (a), any notification must be given by the agreed-upon method.
Under subsection (d), a notification actually given in a manner not authorized by subsection (a) or (c), but received by the recipient, is nevertheless effective under this Act. Thus, for example, personal (by hand) delivery would be effective notification when received by the recipient.
2. Identifying the address for notification. Typically, an assignment of rents contains a provision specifying addresses for notices to the assignor and the assignee. Subsection (b) provides that the respective addresses for notice contained in an assignment of rents will be the default addresses for any notification to the assignor or assignee under this Act. If the intended recipient has provided the person giving a notification with a more recent address, then the Act requires the person giving the notification to use that address. For example, if an assignee gives a notification to the assignor enforcing its interest in rents under Section 8 (which governs enforcement by notification to the assignor), and that notification specifies a new address for future notices to the assignee, the assignor would thereafter be obligated to use that new address in giving any notification required by the Act.
Subsection (b)(3) provides that a tenant’s address for notification will be the address of the leased premises, unless the lease provides an alternative address for notification to the tenant and the notifier either has a copy of the lease or knows of the alternative address.
3. Obligations under the Act triggered by receipt. While a person obligated to give a notification under the Act satisfies the obligation to give that notification by dispatch in accordance with subsection (a), several substantive provisions of the Act effectively require that the intended recipient actually receive notification. For example, although an assignee may give notification to a tenant by mail directing that tenant to pay rents to the assignee, the Act does not legally obligate the tenant to pay rents to the assignee until the tenant receives the notification. See Section 9(b).
SECTION 4. SECURITY INSTRUMENT CREATES ASSIGNMENT OF RENTS; ASSIGNMENT OF RENTS CREATES SECURITY INTEREST.
(a) An enforceable security instrument creates an assignment of rents arising from the real property described in the security instrument, unless the security instrument provides otherwise.
(b) An assignment of rents creates a presently effective security interest in all accrued and unaccrued rents arising from the real property described in the document creating the assignment, regardless of whether the document is in the form of an absolute assignment, an absolute assignment conditioned upon default, an assignment as additional security, or any other form. The security interest in rents is separate and distinct from any security interest held by the assignee in the real property.
Comment
1. Security instrument creates an assignment of rents. Under subsection (a), a security instrument that creates a security interest in real property automatically creates a security interest in the rents arising from that real property, unless the security instrument expressly provides otherwise. In this regard, the Act adopts a default rule comparable to the “proceeds” rules of Uniform Commercial Code Article 9, under which a security agreement covering collateral automatically covers the proceeds of that collateral (including rents from the collateral) unless the agreement provides otherwise. U.C.C. §§ 9-203(f), 9-315(a)(2).
Subsection (a) applies only to a mortgage that is signed and delivered after this Act takes effect. Existing mortgages that do not contain an express assignment of rents will not covered by subsection (a). See Section 20(c). Thus, a mortgage that was signed and delivered before this Act takes effect would not effect an assignment of rents unless it did so by its express terms.
The operation of subsection (a) should not significantly affect the negotiation and documentation of mortgage transactions. In nearly all commercial mortgage transactions, the applicable loan documentation creates an express assignment of rents.
In residential mortgage transactions, most current mortgage documents in “lien theory” states do not contain an express assignment of rents. Nevertheless, the operation of subsection (a) should have no systematic negative effects on residential mortgagors for two reasons. First, because rents typically will not arise if the borrower occupies the mortgaged real property as its primary residence, in most cases the implicit assignment of rents created by Section 4(a) will be of no practical relevance. Second, in the rare case where rents would arise from such property — e.g., where a mortgagor occupies the mortgaged premises as a residence but “rents out” the basement or the attic to a tenant or boarder — the Act’s remedial mechanisms for enforcing the assignee’s interest in rents by notification (either to the assignor or to tenants) would not be available if the assignee holds a security interest in rents solely by virtue of subsection (a). See Sections 8(d) and 9(g). Thus, without obtaining an express assignment of rents, a mortgagee could not obtain control over any rents accruing from a mortgagor-occupied residence unless the mortgagee could demonstrate equitable circumstances justifying the appointment of a receiver for the property. Courts have rarely granted receiverships where the mortgaged real property is mortgagor-occupied residential real property.
In a narrow set of cases, Section 4(a) should operate to the direct benefit of unsophisticated sellers of real property. On occasion, a seller of real property will take back a purchase money mortgage but will not obtain an express assignment of rents — often because the seller may have completed the transaction without benefit of legal counsel and thus did not appreciate the need for a separate assignment of rents. Under Section 4(a), such a seller would obtain a security interest in rents automatically (unless the mortgage disclaimed such an interest), and this would provide the seller with a security interest in any rents collected by the buyer in the event that the buyer leased the property and later defaulted or declared bankruptcy.
Subsection (a) would also have relevance if the United States were to adopt the United Nations Convention on the Assignment of Receivables in International Trade. Under article 4.5(a) of that Convention, the priority choice of law rules for assignments of receivables do not affect the priority of an interest in rents under the law of the state in which the related real property is located if under that law an interest in the real property conveys an interest in the rents. A state which enacts this Act would have the benefit of article 4.5(a), as the security instrument creating a security interest in the real property would automatically create an assignment of the rents, unless the security instrument expressly provides otherwise.
In a Chapter 13 bankruptcy case, Bankruptcy Code § 1322(b)(2) permits a debtor to modify or the rights of a mortgagee (called a “cram-down”), but not if the mortgagee’s claim is “secured only by a security interest in real property that is the debtor’s principal residence” (emphasis added). Prevailing case law suggests that the debtor cannot modify a residential mortgage under Chapter 13 solely because the mortgage also contained an assignment of rents, and that modification of a residential mortgage can occur only if the transaction covered collateral not implicitly related to the mortgage loan. See In re Fernandos, 402 F.3d 147 (3d Cir. 2005) (“[T]he grant of an interest in rents does not render the claim secured by anything other than the real property. Therefore, the protections of § 1322(b)(2) still apply to a mortgage in New Jersey where the debt is also secured by rents.”). Consistent with this view, Section 4(a) should not deprive the residential mortgagee of its protection from cram-down under § 1322(b).
2. Rents as a distinct source of collateral. An assignment of rents permits the assignee to collect rents that accrue between the date of the assignor’s default and the date that the assignee can complete a mortgage foreclosure on the underlying real property. In many states, this foreclosure process can be quite lengthy. In these states, a mortgagee faces a heightened risk that the mortgagor may collect rents and expend the proceeds other than to reduce the mortgage debt or to pay the expenses of operating and maintaining the real property (a process often referred to as “milking” the rents) while a foreclosure proceeding is pending. By taking an assignment of rents, the assignee demonstrates its intention to have a lien upon all future rents arising from the real property, including those accruing prior to the completion of a foreclosure sale — a period that may be extended if the assignor files a bankruptcy petition that stays the foreclosure.
Traditionally, state law has governed the creation and enforcement of security interests in rents. Most frequently, however, disagreements regarding security interests in rents arise in the federal bankruptcy courts. On its face, the Bankruptcy Code appears to recognize that state law has traditionally treated “rents” that accrue between default and foreclosure as a source of collateral that is separate and distinct from the real property that generated those rents. The Bankruptcy Code characterizes rents from mortgaged real property as “cash collateral,” 11 U.S.C. § 363(a), and preserves a secured creditor’s pre-bankruptcy lien on rents that the debtor receives after it files a bankruptcy petition, id. § 552(b). These provisions appear to acknowledge that a pre-bankruptcy assignment of rents creates a distinct security interest in the rents (i.e., distinct from the underlying mortgage lien against the real property itself, at least with respect to rents that accrue prior to completion of a foreclosure).
Most bankruptcy court decisions have treated post-petition rents as a distinct source of collateral, but a few bankruptcy court decisions have instead concluded that post-petition rents do not constitute distinct collateral because the post-petition rent stream is in fact “subsumed” within the valuation of the real property itself. See, e.g., In re Wrecclesham Grange, Inc., 221 B.R. 978 (Bankr. M.D. Fla. 1997); In re Embassy Properties N. Ltd. Partnership, 196 B.R. 172 (Bankr. D. Kan. 1996); In re Citicorp Park Assocs., 180 B.R. 15 (Bankr. D. Me. 1995); In re Barkley 3A Investors, Ltd., 175 B.R. 755 (Bankr. D. Kan. 1994); In re Mullen, 172 B.R. 473 (Bankr. D. Mass. 1994). These courts have wrongly concluded that a debtor can use post-petition rents without regard to a pre-bankruptcy assignment of rents as long as the mortgage lender’s interest in the mortgaged real property is adequately protected (i.e., as long as the real property itself is not declining in value), even if the real property was worth less than the mortgage debt. To the extent that these decisions rest upon state law, the Act rejects the position that rents accruing prior to foreclosure are “subsumed within the land.” The Act instead confirms that all rents accruing prior to the completion of a foreclosure constitute a source of collateral that is distinct from the real property from which those rents accrued.
3. The “Absolute Assignment of Rents.” As many American states adopted the lien theory of mortgages, some mortgagees began requiring the mortgagor to make an “absolute” assignment of rents. Under a so-called “absolute” assignment of rents, the assignor purported to transfer “title” to unaccrued rents to the assignee, ostensibly placing the assignee in the same legal position as it would have occupied under the title theory of mortgages. Frequently, a so-called “absolute” assignment will specify that it is “not merely for purposes of security” and that the assignor has no title to or interest in unaccrued rents, other than a revocable license (i.e., not a “property” right) to collect such rents prior to default.
Mortgagees have argued that the so-called “absolute” assignment of rents strengthens their position regarding rents in the bankruptcy context. When a debtor files for bankruptcy, all of the debtor’s property becomes property of the bankruptcy estate. 11 U.S.C. § 541(a). The debtor generally may use property of the estate in the course of its bankruptcy proceeding, subject to the obligation to provide adequate protection to a secured creditor holding a lien upon that property. 11 U.S.C. § 363(b). Moreover, a secured party holding a security interest in property of the estate is subject to the automatic stay and cannot enforce its lien or otherwise collect the debt outside of the bankruptcy proceeding. Id. § 362(a). As a result, a debtor that owns income-producing real property gains significant leverage if the post-petition rents constitute property of the estate. By contrast, the mortgagee/assignee would prefer that the law characterize the post-petition rents as property that is not part of the estate, as then the automatic stay would place no limit upon the mortgagee’s ability to collect those rents and apply them to the debt.
If a mortgagee had already completed a foreclosure sale before bankruptcy, the real property belongs to the foreclosure purchaser and thus unaccrued rents would not constitute property of the bankruptcy estate. But if no foreclosure has yet occurred — and thus equitable ownership of the real property remains in the debtor — unaccrued post-petition rents would seem to fit squarely within the broad concept “property of the estate” defined in § 541(a). Nevertheless, in an attempt to boost their leverage in bankruptcy, mortgage lenders have argued that under a so-called “absolute” assignment of rents, “title” to the post-petition rents is in the lender and such rents therefore do not constitute property of the estate. A number of courts have accepted this argument. See, e.g., First Fidelity Bank v. Jason Realty, L.P. (In re Jason Realty, L.P.), 59 F.3d 423 (3d Cir.1995); In re Kingsport Ventures, L.P., 251 B.R. 841 (Bankr. E.D. Tenn. 2000); In re Robin Associates, 275 B.R. 218 (Bankr. W.D. Pa. 2001); In re Carretta, 220 B.R. 203 (D.N.J. 1998); see also NCNB Texas Nat’l Bank v. Sterling Projects, Inc., 789 S.W.2d 358 (Tex. App. 1990) (“The absolute assignment does not create a security interest but instead passes title to the rents. An absolute assignment of rents is not security but is a pro tanto payment of the obligation.”).
The Restatement (Third) of Property — Mortgages and most commentators have rejected this view. In the typical transaction, the assignor executes an assignment of rents and leases contemporaneously with its execution of the mortgage. The assignee does not immediately begin collecting rents from tenants as soon as it takes the assignment, and typically has no intention to do so at any time before the assignor’s default — indeed, the typical assignment expressly acknowledges the assignor’s right to collect and expend the rents before default. Under such an “assignment,” the circumstances demonstrate that the parties intend the rents to secure the repayment of the mortgage debt. In other words, the “absolute” assignment is merely a security device, regardless of its “absolute” characterization. Mortgage law has long established that instruments purporting absolutely to convey an interest in real property nevertheless constitute equitable mortgages when the circumstances demonstrate that the parties are using title to real property to secure a debt. See, e.g., Restatement of Property (Third) — Mortgages § 3.2 (absolute deed intended to secure an obligation constitutes a mortgage); accord Smith v. Player, 601 So.2d 946 (Ala. 1992); Steckelberg v. Randolph, 404 N.W.2d 144 (Iowa 1987). Under this same principle, courts should treat a typical “absolute” assignment of rents as an assignment for security purposes, and the weight of modern judicial authority so provides. See, e.g., In re Cavros, 262 B.R. 206 (Bankr. D. Conn. 2001); In re 5877 Poplar, L.P., 268 B.R. 140 (Bankr. W.D. Tenn. 2001); National Operating, L.P. v. Mutual Life Ins. Co. of New York, 630 N.W.2d 116 (Wis. 2001); In re Guardian Realty Group, L.L.C., 205 B.R. 1 (Bankr. D.D.C. 1997); In re RV Centennial Partnership, 202 B.R. 774 (Bankr. D. Colo. 1996); In re Lyons, 193 B.R. 637, 644 (Bankr. D. Mass. 1996). Under this view, where the underlying real property is property of the estate, post-petition rents would likewise constitute property of the estate. The assignee of those rents, however, would continue to have a security interest in those rents by virtue of Bankruptcy Code § 552(b), and the debtor/assignor would be obligated to provide adequate protection of the assignee’s interest in those rents under Bankruptcy Code § 363.
The Act adopts the view that any assignment of rents creates a security interest in rents, regardless of whether the document creating that assignment is in form denominated an “absolute” assignment. The term “assignment of rents” includes only an assignment of rents made in conjunction with a secured loan, and any such assignment creates a security interest governed by the Act. By contrast, nothing in the Act precludes an owner of real property from making a truly absolute transfer of rents in a transaction that is not a security transaction, such as a “true sale” of rents (in which the owner of the real property transfers full legal, equitable ownership and control of unaccrued rents immediately upon execution and delivery). Such a transfer, however, is not an “assignment of rents” as defined in the Act (unless applicable state law dictates otherwise), and thus the provisions of the Act governing the enforcement of an assignment of rents would not apply to such a transfer.
4. Conveyancing formalities. The Act is not intended to effect any change in the underlying law of states adopting the Act with respect to the formalities necessary to effect a conveyance of an interest in real property. If a document entitled “Assignment of Rents” is not executed in accordance with the formal requirements for an effective conveyance of an interest in real property, it does not effect a “transfer” of an interest in rents and thus the document would not constitute an “assignment of rents” as defined in Section 2(2). The Act does not specify precisely what formalities are necessary for a document to constitute an effective assignment of rents, but leaves this question to other state law. For example, if an assignor has signed and delivered a document entitled “Assignment of Rents,” but the assignee has not yet extended credit to the assignor and state law provides that no transfer of rents occurs until such credit is actually extended, the document would not effect an “assignment of rents” until the credit is actually extended.
The Act uses the term “assignment of rents” to mean the transfer of an interest in rents, rather than the document by which the transfer is made. This definition serves an important purpose in promoting document simplification and transactional efficiency. In many commercial transactions, it has become customary for the lender to require the borrower to execute multiple documents, including both a “mortgage” or “deed of trust” covering the real property and an “assignment of rents and leases” which assigns to the lender all leases covering the mortgaged real property and all rents accruing under those leases. By contrast, in some transactions, lenders have simply incorporated into the mortgage language sufficient to assign to the lender all leases covering the mortgaged real property and rents accruing under such leases, without a separate assignment document. Under this Act, either approach is sufficient to create an assignment of rents. As a result, there is no need to use a separate document to create an assignment of rents. Mortgage lenders may achieve efficiencies in transactional drafting and negotiation merely by incorporating into the mortgage document language that creates an assignment of rents.
SECTION 5. RECORDATION; PERFECTION OF SECURITY INTEREST IN RENTS; PRIORITY OF CONFLICTING INTERESTS IN RENTS.
(a) A document creating an assignment of rents may be submitted for recording in the [insert reference to appropriate governmental office under the recording act of this state] in the same manner as any other document evidencing a conveyance of an interest in real property.
(b) Upon recording, the security interest in rents created by an assignment of rents is fully perfected, even if a provision of the document creating the assignment or law of this state other than this [act] would preclude or defer enforcement of the security interest until the occurrence of a subsequent event, including a subsequent default of the assignor, the assignee’s obtaining possession of the real property, or the appointment of a receiver.
(c) Except as otherwise provided in subsection (d), a perfected security interest in rents takes priority over the rights of a person that, after the security interest is perfected:
(1) acquires a judicial lien against the rents or the real property from which the rents arise; or
(2) purchases an interest in the rents or the real property from which the rents arise.
(d) A perfected security interest in rents has priority over the rights of a person described in subsection (c) with respect to future advances to the same extent as the assignee’s security interest in the real property has priority over the rights of that person with respect to future advances.
Comment
1. Recording. An assignee may submit a document creating an assignment of rents for recording in accordance with the requirements of the state’s recording act. The document is “submitted for recording” when it is presented to the appropriate recording official. Whether the recording official must actually record the document depends upon the assignee’s compliance with the substantive and procedural requirements of the recording act. Likewise, the state’s recording act governs whether the document is actually “recorded” or binds third parties under state law. For example, in some states a misindexed instrument is considered to be unrecorded, while in other states a misindexed instrument is considered to be properly recorded. Compare First Citizen’s Nat’l Bank v. Sherwood, 879 A.2d 178 (Pa. 2005) (misindexed mortgage nevertheless gave constructive notice to subsequent purchasers) with Howard Savings Bank v. Brunson, 582 A.2d 1305 (N.J. Super. 1990) (misindexed mortgage did not give constructive notice).
2. Perfection. Under Bankruptcy Code § 544(a) and its “strong-arm” clause, a debtor-in-possession can invalidate (or, in bankruptcy parlance, “avoid”) any security interest that a judgment lien creditor or, in the case of a security interest in non-fixture real property, a bona fide purchaser could have avoided under state law as of the petition date. In the 1980s and early 1990s, bankruptcy courts struggled with the proper impact of § 544(a) upon a mortgagee’s security interest in post-petition rents under an assignment of rents. This struggle derives in part from the confusion generated by the differing terminologies of mortgage law and Article 9 of the Uniform Commercial Code. Under Article 9, a secured party obtains a security interest in collateral by having the debtor execute a security agreement describing that collateral, and “perfects” that security interest by filing an Article 9 financing statement describing the collateral. By “perfecting” its security interest, the Article 9 secured party makes that interest enforceable against subsequent creditors, including judicial lien creditors. U.C.C. § 9-317(a). Because Bankruptcy Code § 544(a) gives the bankruptcy trustee/debtor-in-possession the status of a hypothetical judicial lien creditor under state law, the trustee/debtor-in-possession takes property of the estate subject to any security interest that was properly perfected under Article 9 before the filing of the bankruptcy petition. If the secured party has a properly perfected security interest before the petition date, it is irrelevant whether the secured party had taken any steps to enforce that security interest prior to bankruptcy — the perfected security interest continues to remain effective against the collateral and the trustee/debtor-in-possession cannot avoid that security interest using its § 544(a) avoidance power.
By contrast, mortgage law did not customarily use the term “perfection.” Under mortgage law, recording of a mortgage interest served to make that interest valid as against subsequent creditors and bona fide purchasers of the real property. Analytically, of course, “recording” in this sense is similar to the Article 9 concept of perfection. By analogy, one could argue that if a mortgage lender had taken and properly recorded an assignment of rents before bankruptcy, that mortgage lender should have a security interest in rents that was “perfected” and thus enforceable against third parties. Under this analysis, the trustee/debtor-in-possession could not avoid the mortgage lender’s security interest in rents under § 544(a), and thus the mortgage lender would retain its security interest in post-petition rents under § 552(b). A number of courts in fact adopted this analytical approach, treating post-petition rents as the lender’s cash collateral so long as the mortgagee had properly recorded its assignment of rents before bankruptcy. See, e.g., In re Millette, 186 F.3d 638 (5th Cir. 1999); Steinberg v. CrossLand Mortgage Corp. (In re Park at Dash Point L.P.), 985 F.2d 1008, 1011 (9th Cir. 1993); Vienna Park Properties v. United Postal Sav. Ass’n (In re Vienna Park Properties), 976 F.2d 106, 112-15 (2d Cir 1992).
Unfortunately for lenders, some bankruptcy courts held that § 544(a) permitted the trustee/debtor-in-possession to invalidate a security interest in post-petition rents if the lender had not taken sufficient steps to enforce that interest (e.g., actually collect the rents) prior to bankruptcy. To understand how these decisions confused “perfection” or “enforceability” with “enforcement,” it is helpful to review the distinction between the lien and title theories of mortgage law. Under the title theory, the mortgagee holds “title” to the real property (and thus title to unaccrued rents) by virtue of the mortgage, even before default. By contrast, under the lien theory, a mortgagee holds only a security interest in the real property rather than “title” — and thus a mortgage by itself traditionally gives the mortgagee no interest in unaccrued rents until such time as the mortgagee completes a foreclosure, becomes a mortgagee in possession, or obtains the appointment of a receiver for the real property.
If a mortgagee claims a security interest in rents by virtue of a separate assignment of rents, however, any legal constraints on the mortgagee’s right to collect rents by virtue of the mortgage itself should be irrelevant. Nevertheless, a number of older state court decisions conflated these two situations, holding that even a separate assignment of rents was not effective until the mortgagee took affirmative steps after default to enforce that assignment, such as by obtaining the appointment of a receiver, becoming a mortgagee in possession, or impounding the rents. See, e.g., Taylor v. Brennan, 621 S.W.2d 592, 593-94 (Tex. 1981); Bevins v. Peoples Bank & Trust Co., 671 P.2d 875, 879 (Alaska 1983), Martinez v. Continental Enters., 730 P.2d 308, 316 (Colo. 1986); Sullivan v. Rosson, 119 N.E. 405 (N.Y. 1918). Based upon these decisions, numerous bankruptcy courts concluded that an assignment of leases and rents created only an “inchoate” lien upon rents that was ineffective against third parties if the mortgagee had not taken affirmative steps before bankruptcy to activate that lien. These courts concluded that if a mortgagee had not taken action to divest the mortgagor of control over the property and its rents before bankruptcy — such as by obtaining the appointment of a receiver, taking possession of the real property, or notifying tenants to pay rents directly to the mortgagee — the mortgagee’s security interest in post-petition rents was “unperfected” and subject to avoidance under § 544(a). See, e.g., In re Century Inv. Fund VIII L.P., 937 F.2d 371, 377 (7th Cir. 1991); In re 1301 Conn. Ave. Assocs., 126 B.R. 1, 3 (D.D.C. 1991); First Federal Sav. & Loan Ass’n v. Hunter (In re Sam A. Tisci, Inc.), 133 B.R. 857, 859 (N.D. Ohio 1991); Condor One, Inc. v. Turtle Creek, Ltd. (In re Turtle Creek, Ltd.), 194 B.R. 267, 278 (Bankr. N.D. Ala. 1996); In re Mews Assocs., L.P., 144 B.R. 867, 868-69 (Bankr. W.D. Mo. 1992). Under this view, the debtor-in-possession could use post-petition rents free and clear of any claim by the mortgagee while the debtor remained in bankruptcy.
These diverse interpretations of state mortgage law produced substantial nonuniformity in the treatment of security interests in rents, both from state to state and even from district to district within a particular state. This nonuniformity produced significant criticism among academics, real property practitioners, and commercial mortgage lenders. See, e.g., R. Wilson Freyermuth, The Circus Continues — Security Interests in Rents, Congress, the Bankruptcy Courts, and the “Rents Are Subsumed in the Land” Hypothesis, 6 J. Bankr. L. & Prac. 115, 118 (1997); Julia Patterson Forrester, A Uniform and More Rational Approach to Rents as Security for the Mortgage Loan, 46 Rutgers L. Rev. 349 (1993); Patrick A. Randolph, Jr., Recognizing Lenders’ Rents Interests in Bankruptcy, 27 Real Prop., Prob. & Trust J. 281 (1992).
In response to