Rents and profits
Rents from the lease of personal property are proceeds under Article 9 (U.C.C. 9-102(a)(64)(A)). Consider, for example, the rents received by a car or equipment rental company for the lease of automobiles or equipment that serve as collateral. As with other proceeds, the consensual lien on the original collateral extends automatically to the rents even without mention in the security agreement (U.C.C. 9-315 (a)(2)).
Real property is frequently leased, to either commercial or residential tenants, and the income stream produced by the payment of rent is liquid and often substantial. Where a lender is secured by real property that is or may be leased, the lender may be vitally interested in collecting rents accuring after default and prior to foreclosure; the amount of rents accruing pending foreclosure may cover a substantial part of a shortfall that might be expected to result from foreclosure. (In MDFC Loan Corp. v. Greenbrier Plaza Partners, for example, the lender sought to obtain post-default rents of approximately $400,000 following foreclosure of the property for approximately $7.6 million on a debt of approximately $11.6 million.) But the road to this objective has been riddled with potholes. For in contrast to the law of Article 9, under which a lien on personal property collateral automatically extends to rents as proceeds, a mortgage or deed of trust on real property does not convey an interest in rents absent an explicit provision to that effect. The debtor's ownership of real property carries with it the right to possession of the real property, and the collection and retention of rents, even after default, is considered incident to the right of possession. Thus, absent provision in the security instrument, the secured party is not entitled to rents until the lender lawfully obtains possession of the property, even in the case where, subsequent to default and prior to foreclosure, the lender has obtained judicial appointment of a receiver to protect the real property against injury pending foreclosure. Absent voluntary surrender, the debtor will lose possession only upon lawful eviction by the purchaser at a foreclosure sale. Rents collected in the meantime will belong to the debtor.
To obtain an interest in rents in addition to a lien on the real property, the lender must obtain the debtor's explicit written agreement to that effect, either in the security instrument itself (mortgage or deed of trust) or in a separate document (frequently referred to as an Assignment of Rents and Profits). Language creating such an interest may take one of several forms. A clause may make an assignment of rents and profits "as additional security." See, for example, the language in paragraph 10 of our sample deed of trust ("that as additional security, Trustor hereby give to and confers upon Beneficiary the right, power and authority, during the continuance of these Trusts, to collect the rents, issues and profits of said property") (emphasis added). Alternatively, a clause may make an "absolute" assignment. See, for example, the language in the instrument considered in MDFC Loan Corp. v. Greenbrier Plaza Partners ("[t]rustor hereby absolutely and unconditionally assigns and transfers to Beneficiary all the income . . . of the Property") (emphasis added). Note, however, that while an absolute assignment of rents and profits technically permits the assignee to collect rents and profits immediately, in the context of a real property secured transaction, the creditor (assignee) usually permits the debtor to collect and use rents and profits absent default. See, for example, the language in MDFC Loan Corp. v. Greenbrier Plaza Partners ("[n]otwithstanding anything to the contrary . . ., so long as no default by Trustor in the payment of any indebtedness secured hereby . . . shall exist and be continuing, Trustor shall have the right to collect all income . . . from the Property and to retain, use and enjoy the same.") Such additional language makes the assignment a "conditional absolute assignment."
In California, for deeds of trust, mortgages, or separate assignments executed on or after January 1, 1997, any language of grant or assignment of rents, such as the language quoted above, will be effective to create a present security interest in the rents (i.e. a security interest that is effective from the moment of execution and delivery of the document by the debtor). Cal. Civ. Code 2938(a). Moreover, in California, where a lender has obtained an interest in rents through such language in a deed of trust, mortgage, or separate assignment executed on or after January 1, 1997, the lender (an "assignee" of the rents) will be entitled to collect rents accruing after default, without obtaining possession of the real property, by taking one of several itemized "enforcement" steps. Cal. Civ. Code 2938(c). Finally, the lender's interest in the rents will be deemed "perfected" (giving priority to the lender's claim over the claims of subsequent creditors and over the claim of a debtor's trustee in bankruptcy) upon recordation of the security instrument or the separate assignment).
Of course, until well into the 21st century, lawyers in California must contend with rents and profits clauses executed prior to January 1, 1997, and lawyers in other jurisdictions must contend with other applicable common law or statutory authority applicable to such clauses. Such authority may draw distinctions between the rights of the lender to collect post-default rents under a clause assigning rents to the lender as "additional security" and the rights of the lender to collect post-default rents under a conditional absolute assignment. For example, under a clause assigning rents as additional security, the lender may not be entitled to post-default rents unless it secures possession of the property voluntarily (becoming a "mortgagee in possession") or secures the appointment of a receiver to collect the rents. The secured party may prefer the appointment of a receiver to the option of becoming a mortgagee in possession, because a mortgagee in possession will be liable to a debtor for incompetent management of the property pending foreclosure. Under a conditional absolute assignment, the lender may also be entitled to post-default rents, without obtaining possession of the property, upon demand made to the debtor for such rents. But even in such a case, the lender must be sure to make its demand (see In re GOCO Realty Fund I, in which the lender failed to make such a demand and the debtor therefore properly used post-default rents for the payment of retainers to legal counsel in anticipation of filing bankruptcy) or take another available enforcement step (see MDFC Loan Corp. v. Greenbrier Plaza Partners in which the lender obtained the appointment of a receiver).