Assignments of Rents – Lenders Beware!
Assignments of Rents. Virtually every commercial real estate financing includes an assignment of rents – either as a separate instrument, or in the mortgage, or both. We think we know what it means, and what protection it provides. But do we?
Assignments of Rents. What could assignments of rents possibly have to do with Pink Floyd?
It has been suggested on occasion, only half-jokingly, that I don’t like lenders. That is really not true. Lenders are valuable participants in the commercial real estate market. Without lenders, few of my clients could buy, develop or own commercial real estate projects. Commercial lenders provide valuable liquidity to the market (usually) and allow commercial real estate developers and investors to leverage available resources.
For years, I have described commercial lenders and their borrows as “friendly adversaries”. Friendly, because they need each other. Adversarial, because their interests are not always completely aligned. They are each necessary complements to the other.
In good times, all typically works well, with lenders and borrowers sharing a common goal -financing a viable commercial project that makes each of them an attractive return. start renting business
In troubled times, like we have seen over the past several years, lenders and borrowers can find themselves at odds. The current economic downturn has been particularly brutal because the commercial real estate market has seen an unprecedented collapse in property values and tenant rental revenue. Lenders often blame the borrower, because the loan has ended up in default. Realistically, for most commercial real estate borrowers, there is little if anything they could have done to prevent a default, save not acquiring and financing the project in the first place – which, in hindsight, most borrows wish, as much as most lenders wish, had been the case. But neither borrowers nor lenders foresaw the dramatic financial debacle we have been experiencing since 2008.
Still, we are where we are. Commercial real estate borrowers are holding projects with substantially lower values than existed five or six years ago, and may be in default of their mortgage loans. Not unreasonably, commercial real estate lenders want their money back.
Assuming the lender has properly documented and administered its commercial real estate loan, the lender should be in the driver’s seat. All else being equal, with a properly documented and administered commercial loan, a lender has a powerful arsenal of enforcement tools at its disposal.
That said, lenders must still comply with the law. Assuming they can pass the test of having a properly documented loan that has been properly administered in a manner that does not violate the rights and interests of the borrower, the mere fact that a lender is owed millions of dollars and has a secured interest in the borrowers project (including, yes, an assignment of rents) does not mean a lender can do whatever it wishes to collect its loan without regard to applicable law.
Do I dislike lenders? No. What I abhor are lenders and their attorneys who ignore the law – which already wildly favors lenders – and take steps in direct contravention of the law to collect their loans. With the legal enforcement deck already stacked in their favor, there is no excuse for lenders to overreach and violate the law in their enforcement efforts. When they do, they should fully expect that I will object on behalf of my borrower clients and seek to hold them accountable. We will pursue compensatory and punitive damages, when appropriate, petition to have their unlawful actions reversed, and will press to have their equitable remedies, including their equitable remedy of foreclosure, curtailed or barred.
Follow the law, and a lender should expect to get what the law provides. Violate the law, and a lender should expect to suffer the consequences.
Enforcement of an Assignment of Rents is a case in point. The law in Illinois, and in most other states, is crystal clear. It is an extension of common law doctrine that has developed over centuries. If a lender is going to require an Assignment of Rents, and plans to enforce the Assignment of Rents, it is incumbent upon the lender to know the law governing Assignments of Rents.
The leading case in Illinois on the effect and enforceability of an Assignment of Rents provision, whether in the mortgage or in a separate document, is Comerica Bank-Illinois vs. Harris Bank Hinsdale, et al, 284 Ill.App.3d 1030, 220 Ill.Dec. 468, 673 N.E.2d 380 (1st. Dist. 1996).
The Comerica case involved a dispute between a property owner/mortgagor and a first and second mortgagee as to who was entitled to collect the rents from shopping center tenants after the mortgagor’s default in payment of the a first mortgage and second mortgage.
The assignment of rents provision in the mortgage provided that, after a default, Comerica could collect rents from the property without taking possession of the property, and without exercising other options under the mortgage.
Comerica, the first mortgagee, sent a notice to tenants that the mortgagor was in default under its mortgage and that under the assignment of rents provision in its mortgage Comerica was entitled to collect the rents. Thereupon Comerica began collecting rents.