The Effect on Receivers of the New Assignment of Rents Law
By Edythe L. Bronston
Effective January 1, 1997, a new California assignment of rents law went into effect, as new Civil Code Section 2938, superseding former Civil Code Sections 2938 and 2938.1. (The legislation was introduced as Senate Bill 947.). The purpose of the law is to provide lenders with a clear path for enforcement of their rights to rents upon a borrower�s default and to provide certainty for the attorneys preparing assignment documents. As the new legislation allows for a lender�s self help in collecting rents which represent their security, many receivers have expressed concern as to the future need of lenders for a receiver and, if there is such a need, the extent of a receiver�s power to collect rents under a lender�s deed of trust or separate assignment of rents.
Prior to the enactment of the new law there had been much controversy over the characterization of rents as security: whether they were �absolute� and therefore �owned� by the lender, or �conditional� and not amenable to collection without the lender�s having taken certain steps to perfect its rights prior to enforcement. The concept of �perfection� has been the subject of extensive discussion and conflicting judicial opinion, especially in the bankruptcy context. The subject has been further confused by lenders� and commentators� fear that by accepting rents, including rents collected by a receiver, a lender might be found after the fact to have violated the one action rule of C.C.P. �726.
The new statute settles these issues. All assignments of rents, no matter how they are denominated, are now characterized as assignments as additional security. This does away with the fiction of a lender�s ownership of those rents, with a license back to the borrower to collect them so long as the loan is not in default. By discontinuing the �absolute� assignment, there is only one method of �perfection� of a lender�s rights to the rents, which is now statutorily recognized to be by recordation (of the deed of trust or separate assignment of rents). In addition, the statute provides four permissible methods of enforcement: (1) by appointment of a receiver; (2) by the lender obtaining possession of the rents; (3) by delivery of a demand to the tenants for payover of the rents; and (4) by delivery of a demand to the borrower for payover of the rents. The statute actually sets forth a form of notice to tenants which is specifically required to be used . The demand is effective upon actual receipt by the tenant. In the case of multiple demands, the tenant does not have the burden to determine which of competing lenders has priority; lenders must adjust their rights among themselves under subdivisions (f) and (h). A non-residential tenant who fails to pay rent to the lender in accordance with the lender�s demand is subject to double exposure for payment of rents. (This is not the case with residential tenants.)
Following one of the stated enforcement methods, the lender is entitled to all accrued and uncollected rents and all rents accruing after enforcement. Presumably, this means that a receiver�s appointing order should allow the receiver to collect unpaid rents which were due prior to his or her appointment. (Before enactment of the statute, some commentators believed that to collect such rents exposed a lender to a claim of violation of the one action rule and the possibility of loss of its security or, in an extreme case, to loss of the entire debt.) The new statute makes it clear that neither the collection of rents or their application to the debt will subject a lender to loss of its lien, render the obligation unenforceable, or otherwise limit the lender�s rights with respect to its collateral. This means that application of rents to a debt does not result in a lender�s loss of its right to a deficiency judgment after a judicial foreclosure sale.
In addition, pursuant to C.C. �2938(f), leases, rents, issues, and profits of real property include the cash proceeds of same. The enforcing lender has priority over third party recipients of proceeds to the extent that those proceeds are identifiable by segregation or, if they are commingled, by tracing . Upon a senior creditor�s demand to a previously collecting junior creditor, should the junior subsequently collect rents, the senior creditor has the right to immediate turnover of those funds. The enforcing lender, however, has no right to proceeds transferred in the operation of the borrower�s business, subject to fraudulent conveyance and other applicable law.
Subdivision (g) of the new statute is the most likely reason that lenders will continue to seek receivers. Where a lender is successful in collecting the rents, the borrower or any of its other assignees can demand that the collecting lender use those rents for the �reasonable costs of protecting and preserving the property�, including payment of taxes and insurance and compliance with building and housing codes. The collecting lender then becomes obligated to do so, and that obligation continues until the lender either ceases to collect the rents or has a receiver appointed to do so. Without the appointment of a receiver, the obligation to operate and manage the property remains that of the borrower. While the collection of rents will no longer cause a lender to be deemed a mortgagee in possession, this commentator believes that most lenders will opt out of the �direct collection� authority due to subdivision (g), which may well result in a lender ultimately being held to a higher standard of care.
The new legislation is not applicable to any contracts entered into before January 1, 1997. The parties to loan modifications can elect to have the new statute apply, however.
Section 4 of Senate Bill 947 added a new subsection to C.C.P. �564(b), which is the statute under which most receiverships are instituted. Subsection (b)(11) now gives statutory authority for the appointment of a receiver under an assignment of leases, rents, issues, or profits pursuant to new Civil Code Section 2938(g).
Uniform Assignment of Rents Act
By Ira J. Waldman
Article 9 of the Uniform Commercial Code (UCC) provides a comprehensive legal regime for creating, perfecting, and enforcing security interests in personal property. The goal of the Uniform Assignment of Rents Act (UARA), adopted by the Uniform Law Commission in 2005, was to provide a similarly comprehensive legal regime for the creation, perfection, and enforcement of security interests in rents from real property.
Most states do not have a comprehensive statute concerning rents derived from real property. Thus, for the most part, the common law governs, resulting in different and confusing rules, depending on whether a particular state is a “title theory” state (where a mortgage or deed of trust “transfers” legal title in the real property to the mortgagee, permitting the mortgagee to collect rents absent an agreement to the contrary) or a “lien theory” state (where a mortgage does not transfer legal title and the mortgagee does not have such a right to collect rents, absent an agreement so providing). Most commercial loan transactions include, either within the mortgage instrument itself or by a separate assignment document, an assignment of the rents to the lender. Historically, the mortgage provisions or a separate document has taken the form of either an “absolute” assignment, an “absolute” assignment for security purposes, or a security (or collateral) assignment. These various iterations of the assignment have resulted in unusual and varied judicial decisions, most often in the bankruptcy courts, concerning the nature and meaning of an “absolute” assignment (can there be an assignment that truly assigns ownership of the rents absolutely to a mortgagee, as some lenders have claimed?), the perfection of a security interest in rents (is it perfected by recording or enforcement?), and the enforcement actions, if any, entitling the mortgagee to ownership of, or the right to collect, the rents.
The drafting committee and its various advisors and observers represented all of the various stakeholders with a potential interest in a uniform act and included the participation of lawyers involved in developing a comprehensive assignment of rents statute in the state of California, as well as lawyers involved in the drafting of the UCC, in order to avoid potential inconsistencies between the UARA and UCC. In the capable hands of Reporter Wilson Freyermuth, professor at the University of Missouri–Columbia Law School, the UARA accomplishes the following:
- clarifies when perfection of a security interest in rents occurs, overriding the morass of case law concerning such “perfection”—perfection consists of recordation in the land records in accordance with state law, not enforcement of the assignment post-default, and priority is then established;
- sets forth a variety of enforcement actions permitted by assignees postdefault to establish entitlement to receive the rents (accrued and unpaid, as well as rents accruing in the future);
- establishes the right to rents of competing interest holders and provides rules for payment by (and protection of) tenants that receive conflicting notices regarding enforcement of an assignment of rents;
- eliminates the notion that there can be an “absolute” assignment of rents in connection with a real estate secured loan transaction—every assignment connected to a loan creates only a security interest in the rents;
- broadens the definition of rents to include any sum paid by a tenant, licensee, or other person for the right to possess or occupy the real property of another;
- provides rules to deal with potential conflicts with Article 9 regarding priority of rights to the proceeds of rents (personal property, cash in an account, and so on) as between an assignee of the rents and a secured creditor with a competing security interest in the proceeds as a result of an Article 9 security interest; and
- provides for the circumstances when an assignee who receives the rents may or must apply the rents for property protection or maintenance purposes.
Use of the rents by an assignee who enforces an assignment of rents generated the most discussion out of all the issues presented to the drafting committee. Although the common law may permit an assignee to retain the proceeds and reduce its loan, there was a vocal constituency whose perspective was that the proceeds should be required to be used for property protection or maintenance purposes, at least at some point in time following enforcement of the assignment and collection of the rents.
After considerable debate the resulting provision generally permits the assignee to use the proceeds of the rents, when collected, in accordance with its loan documents, with the qualification that the right of the assignee to do that is subject to the terms of any agreement between the assignor and tenant (generally, the lease) and any defenses or claims that the tenant might have to payment of the rents to the assignee as a result of nonperformance of the assignor’s obligations under the lease or other occupancy agreement. In other words, let the common law and the contracts between or among the parties govern. If a tenant did not protect itself in its contract with its landlord, or if the tenant waived its rights in a contract with a lender (for example, through an estoppel certificate or a subordination, nondisturbance, and attornment agreement), then so be it.
But, to offer some degree of protection for the rights of a tenant, even to one that did not protect itself contractually, the UARA permits a tenant to obtain the appointment of a receiver if the nonpayment of property-related expenses harmed or could harm the tenant’s interest in the property (there is an understanding that state law on the subject of receivers may need to be modified to accommodate this action).
Thus far, the UARA has been enacted in Nevada and Utah, with several pending enactments on the horizon. It is certainly a balanced and thoughtful approach to the issues involved in real estate secured lending and the entitlement to and use of rents generated from the real estate and merits strong consideration even in those states that have an existing assignment of rents law.
This article is a reprint of “Uniform Laws Update - Property - Uniform Assignment of Rents Act” Co-Editor Kieran Marion ; Guest Editor Ira Waldman, Probate & Property, 24:2. Copyright 2010 © by the American Bar Association. Reprinted with permission. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
Ira J. Waldman is a partner with Cox, Castle & Nicholson LLP in Los Angeles, California, and served as the American Bar Association Advisor to the drafting committee on the Uniform Assignment of Rents Act. He is a member of the American College of Real Estate Lawyers and serves on the Joint Editorial Board for Uniform Real Property Acts.
© Copyright 2010, American Bar Association.