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Chem1102 Assignment Of Rents

Effective on June 17, 2011, Texas enacted the Texas Assignment of Rents Act (“TARA”) and, in doing so, has codified the common law concept that an assignment of rents given as security for a real estate loan is deemed to be the grant of a security interest in rents, even if given in the form of an absolute assignment.  Texas now joins a number of other states that have enacted legislation largely patterned after the Uniform Assignment of Rents Act (“UARA”) which was promulgated in 2005 by the National Conference of Commissioners of Uniform State Laws.[1]  The TARA has been added to the Texas Property Code (the “Property Code”) as a new Chapter 64.  The TARA is intended to clarify the process for creating, perfecting, and enforcing a security interest in rents. 

In 1981, the Texas Supreme Court held in Taylor v. Brennan, 621 S.W.2d 592 (Tex. 1981) that a security interest in rents does not become operative until the lender takes affirmative steps to enforce the security interest.  In regards to collateral assignments of rents, the Texas Supreme Court stated “that an assignment of rentals does not become operative until the mortgagee obtains possession of the property, or impounds the rents, or secures the appointment of a receiver, or takes some other similar action.”  Taylor v. Brennan, 621 S.W.2d at 594.  One negative consequence of Taylor v. Brennan for mortgage lenders was that in a priority contest between a mortgage lender with a recorded, but unenforced assignment of rents, and a judgment lien creditor that had obtained and served a writ of garnishment on rents, the judgment lien creditor would have priority.   

Lenders generally responded by requiring that their borrowers enter into absolute assignments of rents generally stating that the lender was the owner of any rental income at the time it was paid, regardless of whether the lender ever actually took possession of the rental income.  Absolute assignments, however, pose a different, albeit substantial, type of risk to mortgage lenders.  Namely, a true absolute assignment of rents could be construed to constitute a pro tanto payment of the loan obligation.  In the context of a mortgage loan, it could be argued that rents collected and kept by a property owner should be credited against the owner’s debt to the lender, even though the lender did not actually receive rent payments, because the lender “owns” the funds.  This pro tanto reduction concept has been addressed in several bankruptcy cases; although, the harsh results of a pro tanto reduction do not appear to have been applied in any reported bankruptcy decision or Texas decision.  In any event, the TARA (i) establishes that rents not actually received by a mortgage lender are not to be credited against the property owner’s debt, (ii) establishes that a lender with a recorded mortgage has priority and perfection of its lien on rents upon the filing of the mortgage, and (iii) sets out a statutory means of notice and enforcement of a lien against rents. 

The collateral assignment versus absolute assignment issue has been disputed in bankruptcy cases over the years.  While the general recognition that an assignment of rents is merely a security interest in rents prior to affirmative action by the lender typically prevails, mortgage lenders have continued to assert absolute ownership of rents under an assignment of rents.  See, e.g., In re Amaravathi Limited Partnership, 416 B.R. 618 (Bankr. S.D. Tex. 2009).  In essence, lenders have argued that rents subject to an absolute assignment from debtor‑owned property were not “property of the estate” and lender action to collect rents postpetition was not affected by the automatic stay.  The TARA will likely put an end to such fights in the future in Texas.

The TARA applies to all existing real estate loan transactions and includes the following highlights:

  • An enforceable security instrument secured by real property automatically creates an assignment of rents arising from the property unless the security instrument provides otherwise or the security instrument is governed by sections of the Texas Constitution relating to homestead home equity loans, homestead reverse mortgages, or financing related to a manufactured home used as a homestead.  Property Code, § 64.051(a).
  • An assignment of rents creates a security interest in all accrued and unaccrued rents arising from the real property.  Property Code, § 64.051(b).
  • An assignment of rents does not reduce the secured obligation, except to the extent that the lender actually collects the rents and applies (or is obligated to apply) the collected rents to the secured obligation.  Property Code, § 64.051(c).
  • Upon recordation in the county real property records, the security interest in the rents is perfected, and has priority over the rights of any subsequently acquired interest in the rents or the real property.  Property Code, § 64.052.
  • A lender may enforce an assignment of rents by notice to the obligor, notice to any tenant, or another method sufficient to enforce the assignment under other Texas law.  On and after the date of enforcement, the lender is entitled to collect all accrued, unpaid and future rents.  Property Code, § 64.053.
  • As to the obligor/owner, a lender’s enforcement is effected by providing a notice demanding that the obligor pay over the proceeds of any rents.  Property Code, § 64.054(a).
  • As to any tenant, enforcement is effected by providing the tenant a notice demanding that the tenant pay to the lender all unpaid accrued rents and all unaccrued rents as they accrue.  A copy of this notice must be provided to the obligor.  Property Code, § 64.055(a).
  • After a tenant receives an enforcement notice, subject to available defenses, the tenant must pay to the lender all unpaid accrued rents and all unaccrued rents as they accrue, unless the tenant has previously received a notice from another assignee of rents.  Property Code, § 64.055(c)(1).
  • A lender that collects rents following enforcement under the TARA is not obligated to apply the collected rents to the payment of expenses of protecting or maintaining the subject real property; however, a tenant’s continuing obligation to pay any rents will remain subject to the terms of the underlying lease agreement and any claims or defenses of the tenant arising from the landlord’s non-performance under the lease agreement.  Property Code, § 64.059.
  • Section 64.056 of the Property Code sets forth the specific form of notice to a tenant that will trigger enforcement of the assignment of rents as to the tenant. 
  • Enforcement of an assignment of rents, the application of proceeds, or the turnover of rents to the lender does not (1) make the lender a mortgagee in possession of the real property, (2) make the lender an agent of its obligor, (3) constitute an election of remedies that would preclude a later action, (4) make the secured obligation unenforceable, (5) limit any right available to the lender with respect to the obligation, or (6) bar a deficiency judgment.  Property Code, § 64.057.

The TARA will have in impact upon all assignments of rents that relate to Texas real estate.  Perhaps that impact will be most dramatic in bankruptcy cases, as debtors and lenders will likely no longer fight over the nature and effect of an assignment of rents in the context of cash collateral, property of the estate and the automatic stay.

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[1]        The TARA is substantially shorter than the UARA, reflecting the deletion of various UARA provisions, including provisions regarding the enforcement of assignments of rents through receiverships. 

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