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Dfp4 Assignment Of Rents

Most modern real estate loan documents will include a separate "Absolute Assignment of Leases and Rents." What is the purpose for this and why is it worded this way? The answer lies in the history of the law surrounding collateral devices.

The Lien Theory
Most states follow the "lien theory" of mortgages. While the roots go way back in our common law, the basic concept is simple. The borrower owns the collateral and is entitled to operate it to make a profit without interference from the lender – until an event of default occurs in the loan documents. While this concept seems relatively simple – it can lead to some sticky questions, particularly with an otherwise non-recourse loan situation where only the collateral (both the real estate and the cash it generates) is the source of repayment.

Notice Requirements
Mortgages and Deeds of Trust often address leases and rents as an addition to the overall collateral package. In respect of the "lien theory," many states hold that the debtor is entitled to all rents earned until some event of default and notice from the lender. Absent some other documentation, rents earned before the notice are the debtor’s and the lender is not entitled to them. The issue of when a debtor received such notice cutting off its right to hold rents becomes an important issue, both as to rents in the door and those coming in the future.

"Absolute" Assignment Documents
Real estate lending lawyers began to draft around this problem. The Absolute Assignment of Leases and Rents provides that the debtor makes an absolute (as opposed to collateral only) assignment of the rents for so long as the debt remains unpaid. The debtor is typically granted a "license" to collect and spend the rents until a default occurs, resulting in the automatic termination of the license. If the device works, the intent is to avoid the ambiguities arising around the time of default and to provide a bright line allowing the lender to capture more of the rent.

How Absolute is Absolute?
Most courts will respect this arrangement reached between sophisticated parties, but the concept has not been well tested in the stressed environment we may be entering. If the assignment was absolute, what is the effective principal of the loan or – what was the effective consideration paid for the loan (the de facto interest amount). If the assignment was absolute, how did the debtor and borrower treat this disposition on their respective tax returns at the time the loan closed? Questions abound.

What to do?
Send those notices of default as soon as you know you need to in order to trigger the traditional lien theory right to receive rents – and argue for more under the absolute assignment.


Q: What is the difference between a general assignment of rents and leases and a specific assignment of rents and leases, and when should I include them in my term sheet for a commercial real estate financing of an Ontario property?

A: In situations where a borrower owns real property in Ontario that either is or will be leased to third party tenants, a lender should consider obtaining either a general assignment of rents and leases or a specific assignment of rents and leases in addition to a mortgage on the secured property. Like a mortgage, an assignment of rents and leases should be registered against title to the subject property, and in addition, should be registered under the applicable personal property security legislation as the rents and leases that are being secured by the assignment fall within the definition of personal property under that legislation. [1]

An assignment of rents and leases, be it a general assignment of rents and leases or a specific assignment of rents and leases, provides a lender with two principal benefits which may be realized by the lender after an event of default:

  1. it permits the lender to receive the rent payments that the borrower/landlord would otherwise be entitled to, and this revenue stream from the tenants is a significant asset that should be secured; and,
  2. it permits the lender to step into the shoes of the borrower/landlord and exercise all of the rights and remedies available to the landlord to ensure that the full benefit and value of the lease is realized by the lender, which includes for example, the right to demand payment in the event of non-payment of rent by a tenant and to assign the lease to a purchaser in the event of a power of sale proceeding.

The only difference between a general assignment of rents and leases and a specific assignment of rents and leases is the revenue streams and leases to which they apply. A general assignment of rents and leases applies to all present and future rental income and leases in respect of a particular property. Once in place, a general assignment of rents and leases gives the lender a right to the rental income and the ability to exercise all of the rights of the landlord under a lease in respect of all leases of the property, including but not limited to any new leases, subleases or assignments of lease entered into after the assignment is granted and registered. In contrast to this, a specific assignment of rents and leases only applies to leases which are specifically listed in the document. In the event that any of the specifically listed leases expire or are terminated, and/or a new lease or sublease is put in place, the specific assignment of leases will not apply to this new lease or sublease and the lender will have no right to the rental income or rights resulting from the new lease or sublease.

In most lending situations, the lender will prefer a general assignment of rents and leases as it provides the most comprehensive security. The lender will have security over all rental income, and be able to exercise the rights of the landlord, regardless of who the tenants are in the future, or what leases the borrower has in place at the time of default under the terms of the loan or credit facility. However, where there is a principal or anchor tenant that represents a preponderance of the rental income, and/or the borrower objects to a general assignment of rents and leases securing all rents and leases as too broad a security interest, the lender may only be interested in securing the rental income and landlord rights associated with a specific principal or anchor lease, or a particular group of leases. In such a situation, a specific assignment of rents and leases may be a reasonable compromise position for a lender to adopt. Alternatively, in situations where multiple lenders are taking security in a particular parcel of real property, specific assignments of rents and leases allow the various lenders to divide the rental income and leases among themselves, with each lender only obtaining security in a specifically agreed upon lease or group of leases.

The above is a general overview of general and specific assignments of rents and leases.

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