Cimspa Assignment Of Rents

Sixth Circuit Determines that an Absolute Assignment of Rents Perfected Under Michigan State Law Takes Property out of a Bankruptcy Estate  (In Re Town Center Flats, LLC, Case No. 16-1812 — Decided May 2, 2017)

 

If under state law perfection of an absolute assignment of rents is a transfer of property, then such rents could be excluded from property of a debtor’s bankruptcy estate. Debtor Town Center Flats, LLC owns a 53-unit residential apartment complex in Shelby Township, Michigan. Town Center financed construction of the building with a $5.3 million loan from ECP Commercial II LLC. The loan was secured by a mortgage, as well as an agreement to assign rents to the creditor in the event of default (the “Agreement”). Pursuant to the terms of the Agreement, Town Center “irrevocably, absolutely and unconditionally [agreed to] transfer, sell, assign, pledge and convey to Assignee, its successors and assigns, all of the right, title and interest of [Town Center] in … income of every nature of and from the Project, including, without limitation, minimum rents [and] additional rents….” The Agreement purported to be a “present, absolute and executed grant of the powers herein granted to Assignee,” while simultaneously granting a license to Town Center to collect and retain rents until an event of default, at which point the license would “automatically terminate without notice to [Town Center].”

 

On December 31, 2013, Town Center defaulted on its obligation to repay the loan. On December 22, 2014, ECP sent a notice of default and a request for the payment of rents to all known tenants of the Town Center property. The notice complied with the terms of the Agreement and with section 554.231 of the Michigan Complied Laws, which allows creditors to collect rents directly from tenants of certain mortgaged properties. The following day, ECP recorded the notice documents in Macomb County, Michigan, completing the last step required by the statute to make the assignment of rents binding against both Town Center and the tenants of the property. On January 23, 2015, ECP filed a complaint in the Circuit Court for Macomb County, Michigan, seeking foreclosure and requesting the appointment of a receiver to take possession of the Town Center property. Subsequently, on January 31, 2015, Town Center filed a petition for relief under chapter 11 of the Bankruptcy Code. On the petition date, Town Center owed ECP $5,329,329, plus attorney’s fees and costs.

 

At the commencement of the chapter 11 case, ECP and Town Center entered into interim agreement to allow Town Center to continue to collect rent from tenants of the complex, with $15,000 per month used to pay down the debt owed to EPC, and the remainder of the rents to be used for authorized expenses. Town Center defaulted on the interim agreement almost immediately. Consequently, in February 2015, ECP filed a motion to prohibit Town Center from using rents collected after the chapter 11 petition was filed. The bankruptcy court denied the motion, finding that the rents were property of Town Center’s bankruptcy estate because an assignment of rents creates a security interest, but does not change ownership.  Simply stated, Town Center still had an interest in the rents. On appeal, the district court vacated the order of the bankruptcy court, finding that an assignment of rents is a transfer of ownership under Michigan law, and thus the rents should not be included in the chapter 11 estate.  Appeal was then taken to the Sixth Circuit.  

 

Property of an estate in bankruptcy is broadly defined by section 541 of the Bankruptcy Code as all legal or equitable interests of the debtor in property as of the commencement of the case. The Sixth Circuit, citing the Supreme Court’s decision in Butner v. United States, noted that property rights of a debtor in bankruptcy are determined under the law of the state in which the property is located, which in Town Center is Michigan. Turning to Michigan law, the Court cited section 554.231 of the Michigan Compiled Statutes, which provides, in pertinent part: 

 

[I[n or in connection with any mortgage on commercial or industrial property … it shall be lawful to assign the rents, or any portion thereof, under any oral or written leases upon the mortgaged property to the mortgagee, as security in addition to the property described in such mortgage. Such assignment of rents shall be binding upon such assignor only in the event of default in the terms and conditions of said mortgage, and shall operate against and be binding upon the occupiers of the premises from the date of filing by the mortgagee in the office of the register of deeds for the county in which the property is located of a notice of default in the terms and conditions of the mortgage and service of a copy of such notice upon the occupiers of the mortgaged premises.” 

 

Relying on a number of Michigan state court decisions that generally discuss assignment of rents under section 554.231 as ownership transfers, the Court held the rents generated by Town Center’s property were not property of its bankruptcy estate because perfection of the assignment of rents by ECP had transferred ownership to ECP.

 

Two key supplemental points were additionally addressed by the Court. First, the Court determined that Town Center’s right to receive rents once the mortgage is paid is not a residual property right that would serve to somehow supersede ECP’s present ownership interest and bring the rents into the bankruptcy estate. Second, the Court distinguished the Supreme Court’s decision in United States v. Whiting Pools. In that case, personal property had been seized by the Internal Revenue Service in satisfaction of a tax lien was determined to be part of the bankruptcy estate because the debtor retained an ownership interest until sale to a bona fide purchaser. The Sixth Circuit concluded by finding that the bankruptcy court’s decision was motivated by a policy concern that excluding the assigned rents from the estate would effectively foreclose chapter 11 relief for companies like Town Center that own a single property and receive their sole stream of revenue from rents of that property. “We recognize the concern of Town Center—and the bankruptcy court—that single-asset real estate entities may have limited options under [c]hapter 11 in this situation. Michigan law, however, is clear on the matter and governs despite other policy concerns.”

 

Q: What is the difference between a general assignment of rents and leases and a specific assignment of rents and leases, and when should I include them in my term sheet for a commercial real estate financing of an Ontario property?

A: In situations where a borrower owns real property in Ontario that either is or will be leased to third party tenants, a lender should consider obtaining either a general assignment of rents and leases or a specific assignment of rents and leases in addition to a mortgage on the secured property. Like a mortgage, an assignment of rents and leases should be registered against title to the subject property, and in addition, should be registered under the applicable personal property security legislation as the rents and leases that are being secured by the assignment fall within the definition of personal property under that legislation. [1]

An assignment of rents and leases, be it a general assignment of rents and leases or a specific assignment of rents and leases, provides a lender with two principal benefits which may be realized by the lender after an event of default:

  1. it permits the lender to receive the rent payments that the borrower/landlord would otherwise be entitled to, and this revenue stream from the tenants is a significant asset that should be secured; and,
  2. it permits the lender to step into the shoes of the borrower/landlord and exercise all of the rights and remedies available to the landlord to ensure that the full benefit and value of the lease is realized by the lender, which includes for example, the right to demand payment in the event of non-payment of rent by a tenant and to assign the lease to a purchaser in the event of a power of sale proceeding.

The only difference between a general assignment of rents and leases and a specific assignment of rents and leases is the revenue streams and leases to which they apply. A general assignment of rents and leases applies to all present and future rental income and leases in respect of a particular property. Once in place, a general assignment of rents and leases gives the lender a right to the rental income and the ability to exercise all of the rights of the landlord under a lease in respect of all leases of the property, including but not limited to any new leases, subleases or assignments of lease entered into after the assignment is granted and registered. In contrast to this, a specific assignment of rents and leases only applies to leases which are specifically listed in the document. In the event that any of the specifically listed leases expire or are terminated, and/or a new lease or sublease is put in place, the specific assignment of leases will not apply to this new lease or sublease and the lender will have no right to the rental income or rights resulting from the new lease or sublease.

In most lending situations, the lender will prefer a general assignment of rents and leases as it provides the most comprehensive security. The lender will have security over all rental income, and be able to exercise the rights of the landlord, regardless of who the tenants are in the future, or what leases the borrower has in place at the time of default under the terms of the loan or credit facility. However, where there is a principal or anchor tenant that represents a preponderance of the rental income, and/or the borrower objects to a general assignment of rents and leases securing all rents and leases as too broad a security interest, the lender may only be interested in securing the rental income and landlord rights associated with a specific principal or anchor lease, or a particular group of leases. In such a situation, a specific assignment of rents and leases may be a reasonable compromise position for a lender to adopt. Alternatively, in situations where multiple lenders are taking security in a particular parcel of real property, specific assignments of rents and leases allow the various lenders to divide the rental income and leases among themselves, with each lender only obtaining security in a specifically agreed upon lease or group of leases.

The above is a general overview of general and specific assignments of rents and leases.

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