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Rents Collected by a Borrower Before a Mortgage Default may be Recoverable by the Lender

By Timothy M. Koltun / Dec 16, 2013

A recent, unpublished decision of the Michigan Court of Appeals, 7800 W. Outer Road Holdings, LLC v. College Park Partners, L.L.C. ("College Park"), held that a mortgage lender, through a court appointed receiver, could seize rents collected prior to the occurrence of a default under the mortgage that were in the borrower's bank account at the time of default.  No court is bound to follow this decision because it was unpublished and there are no published decisions in Michigan addressing the issue of whether a mortgagee may recover rents under leases of real property that (a) are collected by the mortgagor prior to a default under the mortgage and (b) are then held by the mortgagor and have not been applied or distributed by the mortgagor.  However, the rationale of the court in College Park could be asserted by mortgage lenders to claim a right to recover not only rents held by the mortgagor at the time of default that were collected prior to a default under the mortgage, but rents that were collected prior to a default and previously applied or distributed.

Prior to the enactment of the current Michigan Assignment of Rents statute, a mortgagee could not, under Michigan law, obtain the rents derived from mortgaged property until the expiration of the period of redemption following a foreclosure of the mortgage.  The Michigan Assignment of Rents statute provides that while the assignment of rents is valid as between the mortgagor and mortgagee when the mortgage is recorded, the assignment does not become binding upon the mortgagor until a default occurs under the mortgage.  The Assignment of Rents statute does not distinguish between rents accruing or collected before a default under the mortgage and rents accruing or collected after a default under the mortgage.  The mortgage and separate assignment of rents analyzed by the court in College Park gave the mortgage lender the right to collect all rents upon the occurrence of an event of default under the mortgage, without any limitation as to whether such rents accrued or were collected before or after such default.

The court in College Park appears to have based its decision to permit the receiver to seize rents in the borrower's bank account that were collected prior to a default under the mortgage based upon both the language of the loan documents and the Assignment of Rents statute.  The court held that because the loan documents did not restrict the ability of the lender to collect rents only to those that were received after a default and were clear that the lender was entitled to all rents upon default under the mortgage, the loan documents were unambiguous and the court would enforce them as written.  The court further held that the Assignment of Rents statute does not prevent recovery of rents collected before default and would not read into the statute that which was not within the legislature's intent as reflected by the language of the statute.

The logical extension of the court's holding in College Park is that a lender, pursuant to an assignment of rents, may recover from the borrower (or, if applicable, guarantors), rents collected by the borrower prior to a default under the mortgage even though such rents are not then held by the borrower but have previously been applied or distributed.  We do not believe that a court would allow a lender to recover rents received by the borrower prior to an event of default that were used to pay debt service or other charges payable to the lender, and we question whether a court would allow a lender to recover rents that have been applied to ordinary and/or necessary expenses of operating the property, given that such expenditures maintain and preserve the value of the property that secures the lender's loan.  It is not unusual for loan documents to provide that income from the collateral is to be used to pay current debt service and necessary operating expenses before they can be utilized for other purposes and the presence of such provisions should prevent a lender from contending that it was entitled to recover rents applied for such purposes.

There are lessons to be learned from College Park for both the lender and the borrower and their respective counsel.  A lender or its counsel will want to make sure the loan documents are broad and cover all rents regardless of when they are collected or accrued, and do not limit any enforcement action related to rents to those that were collected after a default under the mortgage.  The borrower and its counsel need to carefully review the assignment of rents provisions, including the lender's rights with respect to rents, and attempt to limit them to rents collected after a default.  Careful attention must also be paid to the recourse carve-outs of non-recourse loans to make sure that any personal liability with respect to rents is restricted to rents collected after a default under the mortgage.

If you have any questions about this topic, you may contact Timothy Koltun at (313) 965-8326 or tkoltun@clarkhill.com .  Tim is the Practice Group Leader for Clark Hill's Real Estate Practice Group covering seven states and twelve offices.