• The New Texas Assignment of Rents Act and its Impact on Future Real Estate Loan Transactions
  • August 17, 2011 | Authors: Gary Rachlin; Michael D. Rubenstein; David J. Weiner
  • Law Firm: Liskow & Lewis A Professional Law Corporation - Houston Office
  • On June 17, 2011, Governor Perry signed into law—effective immediately—Senate Bill No. 889, which adds a new chapter to the Texas Property Code. Chapter 64 of the Texas Property Code, also known as the Texas Assignment of Rents Act (the “Act”), now governs the enforcement of assignments of rents in connection with Texas real property, the perfection and priority of security interests in rents, and the attachment and perfection of security interests in proceeds from rents. Most notably (and as described in more detail below), the Act does the following:

    • It creates the presumption of a collateral assignment of rents in all Texas deeds of trust—without the need for an express assignment—absent language to the contrary contained in such instruments;

    • It eliminates the legal concept in Texas of an “absolute assignment of rents” in the loan context;

    • It sets out a mechanism by which lenders can “trap” rents before tenants can pay such rents to the borrower; and

    • It provides a means by which multiple lenders can address conflicting claims to particular rents.

    The Act defines an assignment of rents as “a transfer of an interest in rents in connection with an obligation secured by real property from which the rents arise” but specifically excludes what are commonly referred to as equity kickers and true sales of rents. The Act also includes a fairly expansive definition of what constitutes rents.

    The Act creates a presumption that any deed of trust, mortgage or other contract lien instrument (other than home equity loans/lines of credit, reverse mortgages or manufactured home conversions/refinancing) creates an assignment of rents unless the instrument expressly states otherwise. This means that there is no longer any requirement for an “assignment of rents” section to deeds of trust or a separate “assignment of rents” instrument to file in order to actually create a security interest in rents. Practice Note: Prudent practitioners will continue to spell out the specific terms governing assignments of rents, as the Act defers to the written agreement of the parties in many respects.

    The key change in Texas law made by the Act is in Section 64.051(b), which states that an assignment of rents creates a presently effective security interest in all accrued and unaccrued rents arising from the applicable real property, “regardless of whether the document is in the form of an absolute assignment, an absolute assignment conditioned on default or another event, an assignment as additional security, or any other form.” This means that, under Texas law, there is no longer such a thing as an absolute assignment of rents in a loan context.

    A security interest in rents is perfected by recording the assignment of rents in the county in which the real property is located. Even if the assignment of rents includes language that the security interest will not become effective until the occurrence of a subsequent event, the security interest will nevertheless have priority over any other subsequently perfected lien or security interest.

    Under the Act, a lender-assignee may provide notice to the borrower-assignor after a default (or as otherwise agreed by the assignor) demanding that the assignor pay to the assignee the proceeds of any rents either that are accrued and unpaid or that accrue on or after the date of the notice, unless the real property then constitutes the assignor’s homestead. The date on which the assignee begins enforcement of its assignment of rents against the assignor is the date on which the assignee provides such notice. The Act spells out several requirements for methods of notice but also defers to notice methods specifically agreed upon in a written instrument. The assignor has 30 days after its receipt of such notice (or another time period set forth in an instrument signed by the assignor and approved by the assignee) within which to turn over any proceeds of such rents. Failure by the assignor to timely turn over the proceeds entitles the assignee to recover both the amount of such proceeds plus (if agreed in writing) reasonable attorney’s fees, without first having to foreclose any security interest in the real property. Practice Note: Counsel for lender-assignees may want to specifically address this issue in their deeds of trust by having the assignor waive this thirty-day grace period in writing. Additionally, always check to make sure that the deed of trust includes an express provision entitling the lender-assignee to recover attorneys’ fees in connection with the enforcement of the deed of trust.

    After a default (or as otherwise agreed by the assignor), an assignee may provide notice (by a method set forth in the Act) to a tenant of real property subject to an assignment of rents demanding that the tenant pay to the assignee all rents that either are accrued and unpaid or accrue on or after the date of such notice. The date on which the assignee begins enforcement of its assignment of rents, with respect to the tenant, is the date that the tenant receives such notice. The Act even provides a specific form of notice to tenants (in Section 64.056); and any notice from an assignee to a tenant must be substantially in that form. After the date of the notice, the tenant must pay all rents to the assignee (but not rents prepaid prior to tenant’s receipt of the notice), unless the tenant has previously received a similar notice from another assignee of rents. (This issue is addressed more fully below.) Unless otherwise agreed in writing by the tenant, a tenant does not have to pay rents to the assignee until the earlier of (a) the tenth day after the next regularly scheduled rental payment is due or (b) the thirtieth day after the tenant receives the notice. Unless otherwise agreed by a tenant, the assignee’s right to collect rents is subject to the terms of the lease and to any claims or defenses the tenant may have against the assignor-landlord for nonperformance of the lease. Practice Note: Counsel for lender-assignees would be wise to obtain subordination and attornment agreements from commercial tenants by which the tenants agree (i) not to prepay rent more than 30 days in advance, (ii) to waive the grace period for payment of rents to the assignee and (iii) to waive any claims or defenses against the assignee as it pertains to the assignee’s right to collect rents. This approach may not be practical, however, for residential properties like large apartment projects.

    Unless otherwise agreed by the assignor, an assignee must apply rents collected in connection with its enforcement of its assignment of rents (1) first, to reimbursement of its expenses of enforcing its assignment of rents (including reasonable attorney’s fees), (2) second, if agreed to by the assignee, to reimbursement of its expenses to protect and maintain the real property, (3) third, to payment of the secured obligation, (4) fourth, if the assignee receives prior notice thereof, payment of obligations secured by subordinate security interests in the rents and (5) fifth, any surplus to the assignor.

    A subordinate creditor has no obligation to a priority assignee to turn over rents that the subordinate creditor receives after delivering notice to a tenant unless and until the subordinate creditor receives a signed notice from the priority assignee informing the subordinate creditor of the priority assignee’s enforcement of its assignment of rents and the priority thereof. Within 30 days after the date of the notice from the priority assignee (or as otherwise agreed by the creditors), the subordinate creditor is to turn over any proceeds it receives from the tenant to the priority assignee (but not rents received prior to such notice); and any subsequent proceeds received by the subordinate creditor are to be turned over to the priority assignee within ten days after its receipt from the tenant (or as otherwise agreed by the creditors). Practice Note: Counsel for lender-assignees should expressly provide in the loan documents that the borrower-assignor may not grant any subordinate security interests in rents or proceeds without the lender-assignee’s prior written consent and may wish to expand the list of “bad boy” carve-outs in loan documents (including guaranties) to include the breach of any limitation or prohibition regarding assignments of rents, treating such breaches similarly to fraud. Furthermore, to the extent that any subordinate security interests are consented to, counsel for the priority assignee should require an intercreditor agreement whereby the subordinate assignee agrees (a) not to send any notices to tenants requiring payment of rents to the subordinate assignee, (b) to hold all rents and proceeds it collects or receives (if any) in trust for the benefit of the priority assignee and (c) to turn over such rents and proceeds to the priority assignee immediately, without notice or demand.

    An assignee’s security interest in rents attaches to identifiable proceeds. If the security interest is perfected, the assignee’s security interest in identifiable cash proceeds is also perfected. However, if proceeds are not identifiable, then the attachment, perfection and priority of the assignee’s security interest in the proceeds will be governed by the Uniform Commercial Code provisions of the applicable jurisdiction. Practice Note: Counsel for lender-assignees may wish to have all rents paid directly into a lock box or other segregated deposit account with such lender-assignee.

    The Act essentially overturns the decision in Taylor v. Brennan, 621 S.W.2d 592 (Tex. 1981), in which the Texas Supreme Court acknowledged that an assignment of rents, if specifically worded as such, could function as an absolute assignment of title to rents upon the happening of a specified condition, such as a default. Language was also added to the Act in order to eliminate confusion over a portion of the Taylor decision regarding an absolute assignment of rents being a pro tanto reduction in the secured obligation, which had created significant usury concerns for many lenders. Under the Act, an assignment of rents does not reduce the secured obligation except to the extent the assignee actually collects rents and applies the rents to the secured obligation.

    Despite the fact that Texas law no longer recognizes an absolute assignment of rents, the practical impact of this change is rather limited in the context of bankruptcy. In In re Amaravathi Limited Partnership, 416 B.R. 618 (Bankr. S.D. Tex. 2009), the court was called upon to decide “whether the assignment of rents granted by the Debtors to [the lender] removed the post-petition rents from property of the estate.” Id. at 621. The lender took the position that the assignment was absolute under Texas law, which meant that the Debtors had no further interest in the rents. The court held that the rents were property of the estate notwithstanding Texas law. The court’s decision was based on two separate determinations. First, the Bankruptcy Code unambiguously states that the rents are property of the estate. Id. at 623 (citing 11 U.S.C. § 541(a)(6)). Second, the court concluded that, as a matter of Texas law, an absolute assignment effects an immediate transfer of only legal title. The debtor retains equitable title to the future rents, which passes to the lender only upon collection. Id. at 631. Because the bankruptcy estate includes property in which the debtor has only an equitable interest, the Court concluded that all post-petition rents were property of the estate, which the Debtors could spend in accordance with the provisions of the Code.

    Thus, even if Texas law continued to recognize the absolute assignment, a bankruptcy would undermine the “absolute” nature of any assignment.

    The Act does not affect the following with respect to assignments of rents executed prior to June 17, 2011: (i) the enforceability or perfection of any previously enforceable or perfected security interest in rents or proceeds or the priority of any security interest or (ii) the priority of any enforceable and perfected security interest the priority of which had previously been established. Of course, the Act does not affect any actions or proceedings commenced prior to June 17, 2011.