R. Kymn Harp: ASSIGNMENTS OF RENTS Lenders Beware!


R. Kymn Harp: ASSIGNMENTS OF RENTS Lenders Beware!

R. Kymn Harp: ASSIGNMENTS OF RENTS Lenders Beware!

How can you have any pudding, if you don’t eat your meat?

Pink Floyd

Assignments of Rents. Here’s a topic that doesn’t pop up in light conversation very often.

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

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.

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.

The property owner/mortgagor and the second mortgagee objected.

In summary, the Comerica court held as follows:

1. At common law, it was strictly held that the mortgagee must take actual possession before being
entitled to rents.

2. A clause in a real estate mortgage pledging rents and profits creates an equitable lien upon such
rents and profits of the land, which may be enforced by the mortgagee upon default by taking
possession of the mortgaged property.

3. The possession requirement reflects the public policy in Illinois which seeks to prevent
mortgagees from stripping the rents from the property and leaving the mortgagor and the tenants
without resources for maintenance and repair.

4. Courts will not enforce private agreements that are contrary to public policy.

5. “To obtain the benefits of possession in the form of rents, the mortgagee must also accept the
burdens associated with possession – the responsibilities and potential liability that follow
whenever a mortgage goes into default. The mortgagee’s right to rents, then, is not automatic but
arises only when the mortgagee has affirmatively sought possession with its attendant benefits
and burdens”.

6. A mortgagee may be entitled to rents once a receiver is appointed as an incidence of being in
constructive possession”, since having a receiver appointed constitutes affirmative action by the
mortgagee, under court authorization.

7. In a foreclosure action, the mortgagee is not entitled to rents until judgment has actually been
entered unless the mortgage agreement permits the mortgagee to obtain prejudgment possession.

8. A mere filing of a foreclosure action or request for appointment of a receiver is not sufficient to
trigger a mortgagee’s right to collect rents. The receiver must actually be appointed. “The
mortgagee is not entitled to the rents until the mortgagee or a receiver appointed on the
mortgagee’s behalf has taken actual possession of the real estate after default.

9. Where a mortgagee does not obtain prejudgment possession of the property (through a court
appointed receiver or as a mortgagee in possession), and where rents are collected during a time
while the mortgagor remained in possession of the property, the rents so collected belong to the

In making its ruling, the Comerica court relied on Illinois case law, but, noting that the U.S. Supreme
Court has required bankruptcy courts to apply State law in determining a mortgagee’s entitlement to rents
[Butner v United States, 440 U.S. 48, 99 S. Ct. 914 (1979)], the Comerica court also found relevant
bankruptcy decisions and Federal case law to be thorough and persuasive. Among other cases, the
Comerica court found persuasive the bankruptcy court opinion in In re. J.D. Monarch Development Co.
153 B.R.829 (Bankr. S.D.Ill 1993).

In the case of In re. J.D. Monarch Development Co. 153 B.R.829 (Bankr. S.D.Ill 1993), the bankruptcy
court, applying Illinois law, held as follows:

1. Illinois law recognizes the validity of an assignment of rents included in a mortgage of real

2. Such an assignment creates a security interest in rents that is perfected as to third parties upon
recording the mortgage in the real estate records.

3. As between the mortgagee and the mortgagor, however, the mortgagee is not entitled to the
rents until the mortgagee or a receiver appointed on the mortgagee’s behalf has taken actual
possession of the real estate after default.

4. This is so even though the mortgage instrument contains a specific pledge of the rents.

5. The mortgage does not create a lien upon rents to the same extent that it creates a lien upon
the land. Rather, the inclusion of rents in a mortgage merely gives the mortgagee the right to
collect rents as an incident of possession of the mortgaged property, and the mortgagee, after
default, must take affirmative action to be placed in possession of the property to receive such

6. The requirement that a mortgagee enforce its lien on rents by possession of the real estate
renders an assignment of rents different from security interests in other property.

7. Typically, a perfected lien gives the creditor an interest in a specific piece of property,
whereas an assignment of rents allows the mortgagee to collect rents that come due after the
mortgagee takes control of the property. To obtain the benefits of possession in the form of
rents, the mortgagee must also accept the burdens associated with possession.

Notwithstanding the clarity of the law on this topic, there are lenders, and lenders’ counsel, and
occasionally receivers, who ignore the law or choose to intentionally violate the law by seeking to take
the benefits of rental projects by control of rents without accepting the burdens that come with possession.
They want the good, but not the bad. The dessert, but not the main course. The pudding, but not the meat.

[Hence my opening reference to Pink Floyd: “How can you have any pudding, if you don’t eat your
meat?” Even Pink Floyd understood the public policy applicable to assignments of rents!]

So what is the property owning borrower’s remedy for a lender violating the law by exercising dominion
or control over rents payable to the borrower without first obtaining possession of the project?

How about conversion/civil theft? Let’s check-off the elements:

A proper complaint for conversion must allege the four elements of a cause of action for conversion:

(1) an unauthorized and wrongful assumption of control, dominion, or ownership by a lender over
a borrower’s personalty (identifiable “rents” count); [ X check]

(2) borrower’s right to the rents; [ X check]

(3) borrower’s right to immediate possession of the rents; [ X check]

(4) borrowers’ demand for possession of the rents. [easy to do: X check]

Punitive damages” are available where a defendant willfully or wantonly converts the property of
another. Is there any legitimate doubt – especially in Illinois – especially since the court’s clear and
unequivocal Comerica decision in 1996 – that a lender who unilaterally converts the rents of a borrower
to its own use without taking lawful possession of the rental project does so “willfully or wantonly” in
disregard of the project owners’ rights to those rents?

If a lender is intentionally violating the law as it relates to the security for its loan, particularly as it
relates to an assignment of rents executed within or in conjunction with a mortgage debt, might the
lender also be guilty of “unclean hands” relative to the mortgage security, with the result that a lender
might be equitably barred from foreclosing its mortgage in a court of equity? Stay tuned . . .

The point is not that I wish to prevent a lender from enforcing its legal rights under its loan documents.
The point is, a lender must enforce its legal rights within the bounds of the law, just like everyone else.

I didn’t make the rules, but I will enforce them. If a lender insists on violating the law vis-à-vis one of
my borrower clients, it should expect to suffer the consequences.

This is not a threat – it is a promise.

Thanks for listening.

Published with permission

From the Desk of:
R. Kymn Harp
(312) 456-0378


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