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New Texas Law Clarifies Banks’ Rights to Rents

EFFECTIVE June 17th a new Texas law, which applies to all existing real estate loan documents and transactions, drastically clarifies Texas law as to assignment of rents in commercial real estate finance transactions. 

The Key features are:
  • all assignments of rents executed in connection with real estate loans are “collateral” assignments deemed to grant only a security interest in rents, even if they are in the form of an absolute assignment

  • every enforceable commercial deed of trust recorded in Texas after the enactment of the statute is interpreted to include an assignment of rents

  • the assignment of rents is perfected when the deed of trust is recorded

  • upon default, the lender is entitled to collect all uncollected rents and all pre-paid rents from the borrower by giving the borrower notice

  • upon default, the lender is entitled to collect all unpaid rents from commercial tenants and the tenants will remain liable for the rent if they pay the borrower/landlord instead of the lender after receiving notice

  • upon default, the lender is entitled to collect rents, subject to very specific notices, without foreclosing on the underlying commercial real estate collateral
See more HIGHLIGHTS following the discussion below.

New Chapter 64 of the Texas Property Code, entitled “Assignment of Rents to Lienholder” which became effective on June 17, 2011, brings much needed clarity to the law of assignment of rents.  It applies to all existing assignments of rents in real estate loans and supersedes any terms in the documents which are inconsistent with the statute, but there are several areas where the parties can improve their rights from the statutory provisions.  

Texas law has now aligned itself with the majority of states in which an assignment of rents is always an assignment of a security interest in rents, or a collateral assignment, even if the document is in the form of an absolute assignment.  Previously most Texas commercial loan documents stated the assignment of rents was an absolute assignment in which title to the rents was immediately transferred to the lender but that the lender granted the borrower a license to collect and use the rents until default. Under the new law an “absolute assignment” of rents to a lender with a lien on the underlying real property is deemed a security interest, not a transfer of title to the rents.

The new law clearly defines the rights of borrowers, lenders and tenants with respect to rents upon a borrower default.  Historically, the rights of parties under the common law were often determined by who had title to property. When the Uniform Commercial Code was adopted over 40 years ago, it adopted the principle that when a borrower assigned an interest in personal property as security for a debt under Article 9 of the Uniform Commercial Code, title to the collateral stayed with the borrower prior to foreclosure.  However, the UCC excluded security interest in rents, leaving the interpretation and enforcements of assignments of rents to the common law.  As a result, lenders typically included “absolute assignments” of rents in real estate loan documents in order to claim an ownership of the rents and thus avoid the need for foreclosure after default.

In most states, the courts hold that these “absolute assignments” are legal fictions and were security interests and so title the rents remains in the borrower. But in Texas, court decisions, particularly federal and bankruptcy court decisions interpreting Texas law, reach conflicting results, creating uncertainty and litigation.

Moreover, because the common law did not provide for a filing to perfect a security interest in rents, controversy arose as to how the lender could exercise its rights to the rents upon default, whether the lender was entitled to the rents already collected, and how the rights of tenants were affected.

That is now history in Texas, as of June 17, 2011, the effective date of the new Chapter 64 to the Texas Property Code.

Here are some additional HIGHLIGHTS of the new law:
  • The Act retroactively governs the enforcement, perfection and priority of a security interest in rents, and the attachment and perfection of a security interests in the proceeds.

  • An assignment of rents in a real estate loan transaction creates a security interest in accrued and unaccrued rents relating to the real property regardless of whether the assignment is in the form of a collateral or absolute assignment of rents.

  • An assignment of rents is not effective in a home equity loan or a reverse mortgage and cannot be enforced against the borrower’s homestead if the homestead is a one to four family dwelling and the property was the borrower’s homestead both when the assignment was executed and when the enforcement action is taken.

  • “Rents” includes “consideration payable for the right to possess or occupy, or for possessing or occupying real property.”

  • The security interest is perfected when the document creating the assignment is recorded in the county where the real property is located and takes priority over subsequently recorded liens on the real property.

  • After default, the lender can enforce the assignment by: (1) giving notice to the borrower, (2) giving notice to the tenant(s), or (3) exercising other remedies under Texas law (such as seeking the appointment of a receiver).

  • Upon giving notice, the lender is entitled to all uncollected rents and all pre-paid rents. The lender is not entitled to rents already collected by the borrower, except for pre-paid rents that accrue on or after the date the lender gives notice. The tenant is not obligated to pay to the lender any rent that was prepaid to the borrower (i.e. the landlord) before the tenant received notice from the lender.

  • The lender’s security interest in rents extends to identifiable cash proceeds either in a segregated account or in a commingled account to the extent the proceeds can be traced under methods of tracing, including equitable principles, allowed by Texas law.

  • If the borrower collects rents which the lender is entitled to collect, the borrower must turn those rents over to the lender within 30 days after receiving the lender’s notice but that time period can be shortened by the loan documents.

  • If the borrower does not turn over the rents, the lender can sue the borrower for the rents and for attorneys’ fees provided under the assignment.

  • If a lender enforces the assignment by notifying the tenant(s) to pay the lender directly, careful attention must be paid to the contents of the notice.  The notice must substantially comply with the form of notice specified in the statute and the form must be signed by the lender or the lender’s agent.

  • After the tenant receives the notice, the tenant is obligated to pay rent to the lender and cannot satisfy its obligation to pay rent by paying the landlord (unless the property is the tenant’s primary residence).

  • If the property is the tenant’s primary residence, the tenant can discharge his or her obligation to pay rent by paying either the lender or the borrower i.e. the landlord.

  • The lender does not have an obligation to use the rents to protect or maintain the property (unless otherwise agreed in writing), but the tenant retains any claims or defenses to paying rent that it otherwise has under the lease or under the law, unless the tenant agrees otherwise.

  • The statute allows notice to parties by certified mail, regular mail or by any means agreed to by the intended recipient of the notice. To the extent the statute requires that a notice be signed, the signature can be an electronic signature.

  • Generally, the lender can apply the proceeds to the reimbursement of  reasonable attorneys’ fees and costs of collection, reimbursement of expenses it incurs in protecting or maintaining the property, payment of the secured obligation, payment of subordinated secured creditors who give the lender notice, and any balance to the borrower.
A key feature of the statute is that the rights of the lender, the borrower, and the tenant are fundamentally affected by notice as specified in the statute.  The statute provides flexibility to lenders, borrowers and tenants to agree on means of notice, including electronic notice, as well as to define the address for notice, and to vary the relative rights between the lender and the tenant upon the borrower’s default.

Readers are cautioned that the author is paraphrasing the complex provisions of the new law to provide readers a general understanding, and that they should not rely on this article for specific legal advice but should seek the assistance of counsel. The author has taken the liberty of substituting the terms “borrower” and “lender” for “assignor” and “assignee” respectively.

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