New legislation clarifies, strengthens assignment of rents

New Michigan legislation will clarify and strengthen how commercial rents are handled if a landlord defaults on a commercial mortgage and/or lands in bankruptcy court.

Typically, when a lender makes a loan on real estate that is producing income or rent, the lender requires the borrower to enter into an assignment of rents. With the passage of the Michigan Uniform Assignment of Rents Act, our state joins six other states in closing loopholes and spelling out specifics when it comes to the assignment of rents.

The act, which passed the legislature in June and became law on Sept. 22, replaces legislation from the 1920s and 1950s, making the responsibilities of all interested parties extremely clear. Vagueness in the old laws made it possible for a landlord facing one of these issues to continue collecting rent from tenants but not pass the monies along to its lender.

The lack of clarity also made it difficult for tenants to understand their rent obligations in the face of a landlord foreclosure or bankruptcy. Did they need to continue paying rent? To whom – their landlord or the lender?

The act puts an end to those questions by detailing the rights and obligations of tenants, landlords and lenders, moving Michigan a step closer to national best practices. The act brings consistency to the creation, perfection and enforcement of a security interest in rents.

The act spells out all the details.

A little background might be helpful here: commercial mortgages typically contain provisions for assignment of rent or lenders require a separate assignment of rents agreement as collateral for a commercial loan. When a landlord runs into financial trouble, its lender can then step in legally and collect rent from tenants.

Such provisions act like a security blanket for the lender, who gets the financial benefit of the landlord’s lease in case the landlord is unable to pay its loan to the lender. Sounds straightforward, right?

But vagaries in the two original pieces of legislation resulted in the disappearance of these assignment of rent provisions if the lender foreclosed on the mortgage in some bankruptcy courts. The older public acts did not cover the process very well, failing to proscribe notice provisions and lacking enforcement tools.

The act cleans up these and other issues by:

Defining rent: The initial legislation lacked specificity. The new law defines rent to be inclusive of all the items a tenant may be paying in addition to leasing the space. These could include parking, utilities, concessionaire’s fees, etc.

Clarifying requirements: The act makes it clear you can include the assignment of rents within a mortgage, and it creates a separate and distinct secured interest of the lender. Previously, it was not clear whether this would be fully enforceable.

Providing notice provisions: Again, the older laws failed to explain how lenders should notify tenants of their new obligations. The new law is explicit on this process, directing lenders on how to notice tenants and spelling out the obligations once tenants have been notified. The act even offers a notice form the lender may use. Tenants then have a right to consult an attorney but must continue to meet the obligations of their lease after a specified time period.

Clarifying payment details: The new law spells out helpful specifics for lenders and tenants. The new law applies retroactively to any prior mortgages and assignments of rents that were previously entered into and/or recorded at the register of deeds. It also provides that the interest in those rents is separate from the actual real estate, which can provide the bank or credit union with security for its loan.

Providing collection teeth: Lenders can now point to clear rules about tenant obligations when it comes to paying rent. The act also provides that an assignment of rents is perfected and effective against third parties upon recording of the document at the register of deeds. This helps establish priority with regard to a lender’s interest in the rent stream.

Characterizing rent in bankruptcy: The new act also clarifies that an assignment of rents, even in the event of default, is not an absolute transfer of all rights in the rents. This allows a debtor in bankruptcy to utilize the rents as cash collateral, if the rights of the lender are protected, under the bankruptcy code.

Michigan has taken a tremendous step forward in providing clarity for lenders and tenants with the recent passage of the Michigan Uniform Assignment of Rents Act.

Rob M. Davies is a partner in the law firm Warner Norcross + Judd LLP where he concentrates his practice on commercial finance and real estate matters. He can be reached at rdavies@wnj.com.