Collection of Rent by Lender before Foreclosure
Rents and proceeds (rents that have been paid) are key elements of the mortgage lender’s collateral. Typically mortgage lenders have obtained assignments of rent. However, before June 17, 2011, Texas had no statutory guidance regarding how to obtain a valid, perfected security interest in or possession of rents or proceeds before foreclosure. These issues were left to the courts. Texas applies the lien theory of mortgages to real property, including rents, proceeds, and leases. Taylor v. Brennan, 621 S.W.2d 592, 594 (Tex. 1981); see also, In the Matter of Village Properties, Ltd., 723 F.2d 441, 445 (5th Cir. 1984); In re Spears, 352 B.R. 83, 89 (Bankr. N.D. Tex. 2006). A valid foreclosure of title to the underlying real property would pass title to the rents to the purchaser at foreclosure. Before such a foreclosure, a mortgage lender could obtain possession of rents only by holding an absolute assignment of rents. Taylor, 621 S.W.2d at 594. An absolute assignment carried with it a number of problems, including possible reduction of the loan obligation by an amount of the value of the rents and proceeds absolutely assigned to the mortgage lender. Taylor, 621 S.W.2d at 594. For a more extensive discussion of the foregoing issues, see Edward Walker, Drafting Assignments of Rent under the Texas Assignment of Rents Act, in Advanced Real Estate Drafting Course, State Bar of Texas, Austin (2012).
All of this left Texas lawyers in a quandary about how best to obtain a perfected lien or security interest in rents from mortgaged real estate, obtain possession of rents before foreclosure, and avoid the attendant risks.
§ 9.1:2Enactment of Texas Property Code Chapter 64
In response to the issues created by the Taylor decision and the problems that resulted from efforts to address those issues, and based on the recommendation of the Texas Assignment of Rents Act Committee of the Real Property, Probate and Trust Law Section of the State Bar of Texas, in 2011 the Texas legislature enacted Texas Property Code chapter 64, Assignment of Rents to Lienholder, also known as the Texas Assignment of Rents Act (TARA). See Acts 2011, 82d Leg., R.S., ch. 636 (S.B. 889), eff. June 17, 2011. Upon the enactment of TARA, all assignments of rent in Texas became collateral, regardless of the form the assignment takes in the security instrument. Tex. Prop. Code § 64.051(b). Except for the automatic creation of assignments of interest in each security instrument, TARA is retroactive. See Acts 2011, 82d Leg., R.S., ch. 636, § 3(a) (S.B. 889), as amended by Acts 2013, 83d Leg., R.S., ch. 453, § 12(a) (S.B. 848), eff. June 14, 2013. TARA provides detailed guidelines for obtaining a perfected security interest in and the collection of rents and proceeds by an assignee before consummation of a foreclosure. TARA was amended effective June 14, 2013, to make technical corrections. Acts 2013, 83d Leg., R.S., ch. 453 (S.B. 848), eff. June 14, 2013.
§ 9.2Assignment of Rents Forms
It is not essential to have an express assignment of rents. TARA provides that an enforceable security instrument automatically creates an assignment of rents arising from real property securing an obligation under the security instrument, unless the security instrument provides otherwise. Tex. Prop. Code § 64.052(b). If, for example, an enforceable deed of trust is recorded in the county in which the real property securing an obligation is located, a perfected security interest will be created automatically in the rents arising from that property. Debtors and their tenants may prefer to leave the automatic assignment of rents unmodified. However, assignees may prefer to modify the assignor- and tenant-protective provisions of TARA outlined below.
Assignees desiring to modify the application of assignor- or tenant-protective provisions of TARA must obtain written agreements from the assignor or tenant to each such modification. Form 9-1 in this manual contains provisions modifying the assignor- and tenant-protective provisions of TARA as well as other terms lenders have obtained from debtors before enactment of TARA. See also Edward Walker, Drafting Assignments of Rent under the Texas Assignment of Rents Act, in Advanced Real Estate Drafting Course, State Bar of Texas, Austin (2012); Lorin Williams Combs & Jeffrey Warren Matthews, Texas Annotated Assignment of Rents, Mortgage Lending Institute, University of Texas, Austin (2012). Form 9-1 is an abbreviated version of an annotated assignment of rents and lease appended to Drafting Assignments of Rent under the Texas Assignment of Rents Act.
Alternatively, an assignee may incorporate an express assignment of rents into the State Bar of Texas’s deed of trust form using form 9-2. Form 9-2 may be adapted, mutatis mutandis, and inserted into any other form of deed of trust assignment of rents or security agreement.
It is essential to understand the provisions of TARA before using any of the forms associated with this chapter. The forms will not address all of the parties’ concerns and each form must be adapted to the facts and circumstances of the mortgage loan transaction in question.
§ 9.3Texas Assignment of Rents Act
Chapter 64 of the Texas Property Code does not contain a short title. For convenience, this chapter refers to that chapter 64 as “TARA.”
Reference to the definitions contained in TARA is indispensible to understanding and using TARA. The following are some of the more important definitions:
Assignment of rents means a transfer of an interest in rents in connection with an obligation secured by real property from which the rents arise. Tex. Prop. Code § 64.001(2). The definition contains carve-outs for assignments of rent made under section 306.101 of the Texas Finance Code, which are sometimes referred to as equity kickers, and true sales of rents, which means a transfer of rents that is not a disguised secured transaction. The first exception refers to a form of assignment of rent that is intended as noninterest additional consideration that may be charged in connection with qualified commercial loans. See section 306.101 of the Texas Finance Code, which provides in pertinent part:
The parties to a qualified commercial loan agreement may contract for the following charges: . . . (4) an option or other right created by contract, conveyance, or otherwise, to participate in or own a share of the income, revenues, production, or profits: (A) of an obligor or of an affiliate of an obligor; (B) of any segment of the business or operations of an obligor or of an affiliate of an obligor; or (C) derived or to be derived from ownership rights of an obligor or of an affiliate of an obligor in property, including any proceeds of the sale or other disposition of ownership rights.
Tex. Fin. Code § 306.101(b). The second carve-out recognizes that parties may still intend an actual, bona fide transfer of title to rents and may arise in connection with bankruptcies where 11 U.S.C. § 541 or 11 U.S.C. § 363(b)(1) comes into play. Both carve-outs will continue to be absolute assignments of rent. If an equity kicker is obtained by a mortgage lender, it would be prudent to cite the exception in Property Code section 64.001(2).
Assignor means a person who makes a security agreement that creates an assignment of rents arising from the real property or that person’s successor in interest with respect to the real property. Typically this will mean the borrower. Tex. Prop. Code § 64.001(3).
Assignee means a person entitled to enforce a security instrument. Typically this will mean the lender or creditor in a mortgage loan transaction. Tex. Prop. Code § 64.001(21).
Proceeds means personal property that is received, collected, or distributed on account of an obligation to pay rents. Tex. Prop. Code § 64.001(8).
The definition of security instrument cross-references instruments, as defined in the Property Code section 51.0001, and also includes any agreement containing an assignment of rents. See Tex. Prop. Code §§ 64.001(11), 51.0001 (defining security instrument as a deed of trust, mortgage, or other contract lien on an interest in real property). Thus, security instrument could be a deed of trust containing an assignment of rents, a security agreement containing a grant of a security interest in rents, or a separate document with an assignment of rents. Whether the assignee elects to have a separate assignment or an assignment melded into another instrument will not change the effect of TARA on the assignment.
Tenant includes a person who has an obligation to pay for the right to possess or occupy, or for possessing or occupying, real property, picking up not only tenants but subtenants and licensees. Tex. Prop. Code § 64.001(14).
Rents are defined very broadly to mean consideration payable for the right to possess or occupy real property, rental interruption insurance proceeds, claims arising out of a default in payment for the right to possess or occupy real property, consideration payable to terminate an agreement to possess or occupy real property, consideration payable to an assignor for payment or reimbursement of operating expenses or improvements, and any other consideration that constitutes rents under Texas law other than TARA. Tex. Prop. Code § 64.001(9). Rents do not include consideration paid under an oil and gas lease, mineral lease, or other conveyance of a mineral estate.
The Code Construction Act, including definitions of terms like person, applies to the construction of TARA, except as otherwise expressly provided in the Texas Property Code. See Tex. Prop. Code § 1.002; Tex. Gov’t Code ch. 311.
Use of the terms defined in TARA when preparing assignments of rent can assist in the interpretation of those assignments by attorneys, the courts, and the parties.
§ 9.3:3Manner of Giving Notice
The giving of notice in accordance with TARA is critical to the exercise or enforcement of rights and obligations under an assignment of rents or TARA, including obtaining possession of rents or proceeds before foreclosure. Notice under TARA may be given by any of the following methods:
1.In the manner required for a nonjudicial foreclosure on title to real property. See Tex. Prop. Code §§ 64.002(a)(1), 51.002(e). This allows a combined notice for nonjudicial foreclosure and notice for TARA purposes.
2.Deposit the notice, properly addressed, with the United States Postal Service or a commercially reasonable delivery service (such as Federal Express or UPS). See Tex. Prop. Code § 64.002(a)(2).
3.Any means agreed upon by the persons sending and receiving the notice. See Tex. Prop. Code § 64.002(a)(3).
To avoid conflicts, assignees may want to require that all notices with regard to the assignment of rents be sent in accordance with the deed of trust securing the obligation. TARA does not expressly prohibit modification of its terms and requirements. The phrases except as otherwise provided by a document signed by, as otherwise agreed, unless otherwise agreed, and similar provisions in TARA are signals that the parties may agree to terms others than those expressly set out in TARA. See, e.g., Tex. Prop. Code §§ 64.055(d), 65.059(a), 64.060(d).
§ 9.3:4Determining Address for Notice
TARA also provides rules for determining the address for notice depending on whether notice is to the assignee (mortgage lender), assignor (debtor or borrower), or tenant. The following rules determine the address for notices under TARA:
Assignee: The address for notices to an assignee is the address of the assignee agreed in the security instrument or other document between the parties as the address for notices to the assignee, unless a more recent address for notices has been given by the assignee to the person giving the notice in accordance with subsection 64.002(a) or as agreed in a security instrument or other document signed by the assignee. Tex. Prop. Code § 64.002(b)(1).
Assignor: The address for notices to an assignor is the address of the assignor agreed in the security instrument or other document between the parties as the address for notices to the assignor or as provided in Texas Property Code section 51.002, unless a more recent address for notices has been given by the assignor to the person giving the notice in accordance with subsection 64.002(a) or as agreed in a security instrument or other document signed by the assignor. Tex. Prop. Code § 64.002(b)(2).
Tenant: For notices to a tenant, section 64.002(b)(3) provides:
(A) if there is an address for notices to the tenant in a signed document between the tenant and the person giving the notice, the person giving the notice shall use that address unless a more recent address for notices has been given by the tenant in accordance with that document;
(B) if an address for notices described by Paragraph (A) does not exist, but the tenant’s agreement with the assignor has an address for notices to the tenant and the person giving the notice has received a copy of that document or has actual knowledge of the address for notices specified in that document, the person giving the notice shall use that address; or
(C) if an address for notices described by Paragraphs (A) and (B) does not exist, the person giving the notice shall use the tenant’s address at the real property covered by the security instrument.
Tex. Prop. Code § 64.002(b)(3).
§ 9.3:5Other Notice Recommendations
Assignees should (1) include the addresses for notice to assignor and assignee in the security instrument containing the assignment of rents; (2) ensure the addresses for parties contained in all loan documents are identical; (3) require assignors to include a specific provision in all leases, licenses, and similar documents relating to the real property covered or that will be covered by the assignment of rents specifying the address to which notice to tenant for the purposes of TARA should be sent; and (4) prohibit any change in tenant’s address for notice without the assignee’s written consent.
In the case of both assignors and tenants, notice provisions should not permit the use of notice to any address outside the United States because certified mail, which is required by chapter 51 of the Property Code, may not be used outside this country. U.S. Postal Service Domestic Mail Manual § 3.3.2 provides, “Available Destinations Certified Mail may be addressed for delivery only in the United States and its territories and possessions, through APOs and FPOs, or through the United Nations Post Office, New York.”
Notice is deemed to have been received on the earliest of actual receipt, within five days after it is given in accordance with section 64.002(2), or the date on which notice is deemed provided in accordance with an agreement made by the person whom the notice is provided. Tex. Prop. Code § 64.002(c).
§ 9.3:6Automatic Assignment of Rents
One of the most important provisions of TARA is the automatic creation of an implied assignment of rents in each enforceable security instrument, subject to a few exceptions. Section 64.051(a) provides that an enforceable security instrument automatically creates an assignment of rents arising from the real property described in the instrument, unless the instrument provides otherwise or is governed by certain provisions of the Texas Constitution dealing with home equity loans and similar obligations secured by some, but not all, liens affecting homesteads. See Tex. Const. art. XVI, § 50(a)(6)–(8). Accordingly, it is not necessary to have a separate or express assignment of rents since one is automatically implied by TARA, unless it is expressly disclaimed. As noted above, assignors and tenants may prefer to eschew an express assignment of rents in favor of the implied statutory assignment, thus retaining the assignor- and tenant-protective provisions of TARA. However, if an assignee desires to modify the provisions of TARA, an express assignment of rents and provisions addressing the specific details of the modifications desired must be obtained from the assignor or tenant, as the case may be. See forms 9-1 and 9-2 in this manual.
§ 9.3:7Presently Effective Security Interest
Sections 64.051(b) and 64.052(b) form the core of TARA. Section 64.051(b) states that an assignment of rents creates a presently effective security interest in all accrued and unaccrued rents arising from the real property described in the document creating the assignment of rents, regardless of whether the form of the assignment is absolute, conditional, collateral (additional security), or any other form. Tex. Prop. Code § 64.051(b). The security interest is separate and distinct from any other security interest held by the assignee in the real property from which the rent arises. In other words, all assignments of rent are presently effective collateral assignments without regard to the form taken in any document. An exception exists for equity kickers under Texas Finance Code section 306.101 that take the form of an assignment of rent or similar interest. Tex. Prop. Code § 64.001(2).
§ 9.3:8Elimination of Pro Tanto Payment of Obligation
Texas Property Code section 64.051(c) provides that an assignment of rents does not reduce the secured obligation, except to the extent the assignee collects and applies rents to the payment of the secured obligation. In the 2013 amendments to TARA, the legislature included a formal comment to TARA intended to emphasize the elimination of the pro tanto payment of the obligation rule:
The legislature finds that Subsection (c), Section 64.051, Property Code, as added by Chapter 636 (Senate Bill No. 889), Acts of the 82nd Legislature, Regular Session, 2011, was intended by the 82nd Legislature to eliminate confusion arising from language in the Texas Supreme Court’s decision in Taylor v. Brennan, 621 S.W.2d 592 (Tex. 1981), to the effect that an absolute assignment of rents is a pro tanto payment of a secured obligation. In accordance with Subsection (c), Section 64.051, Property Code, as added by Chapter 636 (Senate Bill No. 889), Acts of the 82nd Legislature, Regular Session, 2011, unless the parties expressly agree otherwise, a secured obligation is reduced only if and to the extent that the assignee collects rents and applies the rents to the obligation. Simply taking an assignment of rents does not reduce the secured obligation.
Acts 2013, 83d Leg., R.S., ch. 453, § 11 (S.B. 848), eff. June 14, 2013. The comment does not appear in Texas Property Code chapter 64; the session law amending TARA must be cited. Lenders and borrowers no longer need to engage in arcane legal fictions in order to agree that lenders may contract to obtain possession of rents before a foreclosure of the real property is consummated or be concerned those fictions may raise the specter of usury.
A security instrument creating an assignment of rents may be recorded in the county in which any part of the real property is located in accordance with applicable law. Tex. Prop. Code § 64.052(a). TARA does not specify the manner in which the assignment of rent is to be recorded, but the Property Code provides for the manner in which documents relating to real property must be recorded. See Tex. Prop. Code §§ 11.001, 12.001(a), 13.001(a).
§ 9.3:10Perfection of Security Interest in Rents
On recording of the assignment of rents, the security interest in rents is perfected. Tex. Prop. Code § 64.052(b). Section 64.052(b) prevails over conflicting provisions in the security agreement or other Texas law that prohibits or defers enforcement of the security instrument until the occurrence of a subsequent event, including default, assignee’s obtaining possession of the real property, or appointment of a receiver. Tex. Prop. Code § 64.052(b).
§ 9.3:11Priority of Conflicting Interests in Rents
TARA establishes the priorities of persons obtaining security interests in the same rents. Tex. Prop. Code § 64.052(c). For example, an assignee holding a perfected security interest in rents has priority over persons subsequently acquiring a judicial lien or filing an assignment of rents covering the same rents. The priority of a perfected interest in rents takes the same priority with respect to future advances as the assignee has with respect to the real property. Tex. Prop. Code § 64.052(d); but cf. Wood v. Parker Square State Bank, 400 S.W.2d 898, 901 (Tex. 1966) (citing Moss v. Hipp, 387 S.W.2d 656 (Tex. 1965)) (advances must be within contemplation of parties when loan originated).
§ 9.3:12Enforcement of Security Interest in Rents—Generally
TARA allows for alternative methods of enforcement of the assignee’s security interest, including methods that allow possession of the rents to be taken by the assignee prior to foreclosure that do not involve seeking receiverships, the courts’ assistance in impounding rents (that is, injunctive relief), or similar actions. This allows assignees to minimize the risks associated with placing the real property into custodia legis, which can prevent or delay exercise of a nonjudicial foreclosure remedy during the pendency of the court proceeding. See Palmer v. Texas, 212 U.S. 118 (1909); First Southern Properties, Inc. v. Vallone, 533 S.W.2d 339, 343 (Tex. 1976); Kirby v. Dilworth & Marshall, 260 S.W. 152, 156 (Tex. Comm’n App. 1924, holding approved).
Because TARA is retroactive, save for section 64.051(a) (implied assignment of rents in each enforceable security instrument), assignments of rent pre-dating the effective date of TARA can be enforced only through use of the procedures outlined in TARA. See Acts 2011, 82d Leg., R.S., ch. 636, § 3 (S.B. 889), eff. June 17, 2011. Agreements contained in assignments of rent pre-dating that effective date should be enforceable in accordance with their terms, to the extent those terms do not conflict with TARA. For example, although an absolute assignment of rents would not be enforceable as an absolute assignment, it would be as a collateral assignment.
TARA provides that an assignment of rents may be enforced by any of the methods described in TARA or any other method sufficient to enforce the assignment under the law of the state of Texas, for example, by nonjudicial foreclosure. See Tex. Prop. Code § 64.053(a). From the date the assignee begins to enforce an assignment of rents, the assignee is entitled to collect all certain rents. Tex. Prop. Code § 64.053(b). Clause (2) of section 64.053(b) provides it is intended to allow assignees to obtain possession of certain unaccrued rent or proceeds that have been paid by the tenant (for example, prepaid rent and deposits). As a general rule, acceleration of rent has not been permitted under Texas law. Stewart v. Basey, 245 S.W.2d 484 (Tex. 1942). The assignee would not be able to obtain possession of unpaid, unaccrued rents. The assignee may only obtain possession of the rents as they become payable by the tenant.
Rents converted to proceeds may become unidentifiable and perfection lost. A prudent assignee may avoid or minimize the risk that proceeds cannot be identified by taking possession of rents as they become proceeds, such as pursuant to a lockbox agreement or deposit account security agreement. See Tex. Bus. & Com. Code § 9.313; see also David P. Derber, Assignment of Rents, Absolute, Collateral or Conditional: Do We or Should We Care?, in Advanced Real Estate Drafting Course, State Bar of Texas, Austin (2000). Assignees should also consider requiring the assignor to deliver all prepaid rents and deposits to the assignee.
§ 9.3:13Enforcement by Notice to Assignor
After default, or as otherwise agreed by the assignor, an assignee may give the assignor notice demanding proceeds that the assignee is entitled to be paid under TARA. Tex. Prop. Code § 64.054(a). TARA does not mandate the specific form notice to the assignor must take.
TARA provides that the date the assignee begins enforcement under section 64.054 against an assignor is the date on which an assignee gives a notice to assignor in accordance with section 64.002. Tex. Prop. Code § 64.054(b). Note that the date enforcement begins with respect to an assignor (the borrower) is the date the assignee provides notice and not the date the assignor receives notice. See Tex. Prop. Code § 64.054(b). Evidence of the date the default notice letter or notice is given by one of the methods should be retained to establish the date the notice is given to the assignor and to fix the date enforcement begins with respect to the assignor. TARA provides multiple methods by which the assignee can provide notice and establish the date enforcement begins. See Tex. Prop. Code § 64.002.
The security instrument should contain provisions to the effect that (1) on demand, the assignor must pay all rents and proceeds to the assignee or as it directs, whether or not a default exists, and (2) notice and cure periods, if any are granted, do not affect, extend, or modify the date enforcement begins. Standard notices of mortgage loan default sent by the mortgage lender’s counsel should contain a notice that demands the assignor pay over rents and proceeds of any rents to which the assignee is entitled. See Tex. Prop. Code § 64.054(b).
An assignee may not enforce an assignment of rents under TARA if the real property constitutes the assignor’s homestead on which was located a one-to-four family dwelling on the date the security instrument was signed and on the date of prospective performance. Tex. Prop. Code § 64.054(c). Lenders should assure the real property from which the rents are derived is not the assignor’s homestead.
§ 9.3:14Enforcement by Notice to Tenant—Form of Notice
Notice to the assignor alone may not stop tenants from paying rents to the assignor, which may fail or refuse to perform its obligations under the assignment of rents and TARA. Section 64.055(a) provides that, after default, or as otherwise agreed by the assignor, the assignee may give notice to a tenant demanding the tenant pay to the assignee all unpaid accrued rents and all unaccrued rents as they accrue. Notice to tenant must comply with section 64.055. See form 9-1 in this manual. The actual notice to tenant must substantially comply with the form of the Notice to Pay Rents to Person Other than Landlord (NPROL) described in section 64.056 and must be signed by assignee or its agent or representative. Tex. Prop. Code § 64.055(a). Form 9-3 is an example of the statutory NPROL form. A NPROL that substantially complies with the statutory form satisfies section 64.055. Tex. Prop. Code §§ 64.055, 64.056. A copy of the NPROL sent to a tenant must be given to the assignor. Tex. Prop. Code § 64.055(a).
It is essential that the assignor continuously provide the assignee with up-to-date rent rolls containing the name and address and copies of each lease for notice purposes of each tenant. An assignee cannot send an effective NPROL to a tenant as required by TARA unless the assignee has the most current name and address of that tenant.
TARA does not prohibit changes to the statutory form of NPROL. Provided the NPROL remains substantially similar in form to the statutory model, the parties may agree to modify it. For example, an assignee may not wish to wait until a default has occurred as a condition to obtaining rents and proceeds. Paragraph 2 of the statutory NPROL may be modified provided both the tenant and the assignor have agreed to waive the requirement. See Tex. Prop. Code § 64.054(a). Note also that the tenant must agree because the statutory form NPROL contains the requirement for a default to exist. Form 9-4 is an example of a modified NPROL, which among other revisions, deletes the requirement that the assignee state a default exists. The tenant and the assignor must agree to this and other revisions to the statutory form NPROL. Tenant consent to revisions to the NPROL form might be accomplished through a tenant estoppel letter or revisions to the assignor’s standard lease form.
An assignee may prefer to have rents turned over immediately by the tenant on receipt of a NPROL rather than delaying payment as allowed by TARA.See Tex. Prop. Code § 64.055(d). The assignee must obtain an agreement from the tenant to waive the application of section 64.055(d) and immediately turn over all rents and proceeds the assignee is entitled to collect under section 64.054. See form 9-4, paragraph 3.
An assignee of rents with priority over another assignee of rents may wish to delete paragraph 8 of the statutory form NPROL. See form 9-4, paragraph 8. This modification requires consent of the tenant, assignor, and each competing assignee of rents that has previously sent the tenant a NPROL. See Tex. Prop. Code §§ 64.055(c)(1), 64.056.
As to the tenant, the assignee begins enforcement on the date on which the tenant receives a NPROL that complies with section 64.055(a). Tex. Prop. Code § 64.055(b). Thus, the same notice sent to the assignor and the tenant could have different dates of enforcement depending on the date the assignor is provided notice and the date the tenant receives the NPROL. Assignees should obtain an agreement from each tenant to a “receipt” of the NPROL that occurs very quickly.
Subject to the right to delay payment under section 64.055(d) and any agreement with the assignor or defenses or claims a tenant may have under Texas law other than TARA, after receipt of a NPROL, a tenant is obligated to pay to the assignee giving the notice all unpaid accrued rents and all unaccrued rents as they accrue, unless the tenant has previously received a notice from another assignee of rents given by that assignee in accordance with this section and the other assignee has not canceled that notice. Tex. Prop. Code § 64.055(c)(1). This, of course, sets the stage for arguments between the tenant and the assignee and among competing assignees of rent. Exculpatory provision of loan documents, including guaranties, should be modified to carve out an exception for breach of any limitation or prohibition regarding assignment of rents. Mortgage lenders may find it prudent to treat such breaches as they would treat monetary defaults or fraud.
Except as provided in a document signed by a tenant, the tenant is not obligated to pay the assignee rent that was prepaid to the assignor prior to receipt of a NPROL from the assignee. Tex. Prop. Code § 64.055(c)(2). In other words, if the assignor obtains one month’s rent prior to its accrual, the tenant does not have to pay that rent to the assignee even if it accrues. The assignee will have to look to the assignor for those rents. Assignees may desire to either require all leases to prohibit prepayment of rents or require all prepaid rent to be paid over to the assignee directly or upon receipt by the assignor. If the assignor has collected prepaid rent or other deposits prior to the origination of the loan, the assignee may wish to require the aggregate amount of such rents and deposits be delivered by the assignor to the assignee. Before 2005, such collection of deposits by a creditor might have been considered compensating balances and lead to the reduction of the principal of the loan by the amount in the deposit. First State Bank of Bedford v. Miller, 563 S.W.2d 572 (Tex. 1978). To alleviate that problem, the Texas legislature enacted Tex. Fin. Code § 276.003(b), which provides such deposits are not considered a reduction of the amount of proceeds of the extension of credit, i.e., the principal.
Unless the tenant occupies the premises as the tenant’s primary residence, the tenant that pays rent to the assignor is not discharged from the obligation to pay rents to the assignee. Tex. Prop. Code § 64.055(c)(3). Thus, a tenant could have to pay the same rent obligation twice. An attorney representing a tenant, which has received a NPROL, other than a tenant who occupies the premises as the tenant’s primary residence, should advise the tenant not to pay rents to the landlord. An attorney representing a tenant who occupies the premises as the tenant’s primary residence and who has received a NPROL should advise the tenant that he will be protected by paying rents either to the assignee or to the landlord. If the collateral real property is residential, the case for use of a lockbox by the assignee is strengthened.
If a tenant that has received a NPROL pays the rents then due to the assignee, the tenant’s obligation to pay rents is satisfied to the extent of the payment made. Tex. Prop. Code § 64.055(c)(4). An attorney representing a tenant that has received a NPROL should advise the tenant to pay rents due to the assignee. In every case, the tenant should keep careful records and receipts with respect to each such payment.
A tenant’s obligation to pay rents to the assignee continues until the earliest date the tenant receives a court order directing the tenant to pay the rents in a different manner, a signed notice that a prior perfected security instrument has been foreclosed, or a signed document from the assignee canceling its NPROL, whichever occurs first. Tex. Prop. Code § 64.055(c)(5).
If an assignee who has priority (senior assignee) has agreed to allow a subordinate assignment of rents with respect to the rents to another assignee (junior assignee), the agreement between assignees should provide:
1.The junior assignee will not send any NPROL to any tenant without the express, prior written consent of the senior assignee.
2.The junior assignee should grant the senior assignee an irrevocable power of attorney coupled with an interest to send notices or cancellations of notices on behalf or in the name of the junior assignee to tenants, assignors, or others, including notice of any NPROL given by the junior assignee.
3.If a NPROL is sent by the junior assignee, on written notice from the senior assignee, the junior assignee shall immediately give notice to the tenant in the form of a signed document cancelling the junior assignee’s notice, that is, the NPROL or requirement to pay rents to the junior assignee.
4.The junior assignee should grant the senior assignee an irrevocable power of attorney to give notice to the tenant cancelling the junior assignee’s NPROL if the junior assignee fails or refuses to do so promptly on demand by the assignee.
Unless the tenant has otherwise agreed in a document signed by the tenant, a tenant that has received a NPROL is not in default for nonpayment of rents accruing within thirty days after the date the notice is received before the earlier of (1) ten days after the date the next regularly scheduled rental payment would be due or (2) thirty days after the date the tenant receives the notice or NPROL. Tex. Prop. Code § 64.055(d). Assignees might wish to require that assignments of rent mandate that all leases and similar documents expressly waive the benefits of section 64.055(d) and that the tenant shall be liable for all rents not paid to the assignee after the tenant receives the NPROL. The assignment of rent and each lease should provide the address for tenant notice and the date the tenant is deemed to have “received” the NPROL or other notice. All addresses for notice must be restricted to an address within the United States if notice is to be given by certified mail. That address should not be changed without the written consent of the assignee. The method for notice should also be specified and is not limited to those expressly mentioned in section 64.002. Other methods may be required in the assignment of rents or leases. Tex. Prop. Code § 64.055(a)(3).
When a junior assignee receives notice from a senior assignee it is enforcing its interest in the rents by notice to the tenant or that the senior assignee has conducted a foreclosure of title to the real property from which the rents arise, the junior assignee must immediately give a notice to the tenant cancelling all earlier NPROLs. Tex. Prop. Code § 64.055(e).
§ 9.3:15Assignee Protective Provisions
TARA contains assignee-protective provisions that ameliorate many of the pre-TARA concerns of mortgage lenders that obtained assignments of rent or leases. Tex. Prop. Code § 64.057. The enforcement of an assignment of rents by notice to the assignor or the tenant, the application proceeds by an assignee under section 64.059 after enforcement, the payment of expenses under section 64.058, or an action under section 64.060 do not—
1.make the assignee a mortgagee in possession;
2.make the assignee an agent of the assignor;
3.constitute an election of remedies;
4.make the secured obligation unenforceable;
5.limit any right available to the assignee with respect to the secured obligation, e.g. nonjudicial foreclosure; or
6.bar a deficiency judgment.
§ 9.3:16Application of Rents by Assignee
Unless otherwise agreed by the assignor, an assignee that collects rents under TARA or a judgment under section 64.060 must apply rents in the following order, as specified under section 64.058: (1) the assignee’s enforcement expenses, including reasonable attorney’s fees; (2) the assignee’s expenses to protect or maintain the real property subject to the assignment of rents; (3) payment of the secured obligation; (4) payment of any obligation secured by a subordinate security interest or other lien on rents, if before distribution of the proceeds assignee receives a signed notice from the holder of the interest or lien demanding payment of the proceeds; and (5) to the assignor. See Tex. Prop. Code § 64.058. If an assignee does follow the statutory application requirements, it should include a provision in the assignment of rents specifying the order in which the assignee desires the rent and proceeds to be applied. Care should be taken to assure the order chosen is consistent with the deed of trust and other loan documents. If a senior assignee permits a junior assignee, the senior assignee should obtain a written agreement from the junior assignee specifying how the senior assignee wishes rents and proceeds to be applied or distributed.
§ 9.3:17Application of Rents to Expenses of Protecting Real Property
Unless otherwise agreed by the assignee, an assignee that collects rents or proceeds following enforcement by notice to the assignor or tenant is not obligated to apply the rents to payment of expenses of protecting or maintaining the real property from which the rents arise. Tex. Prop. Code § 64.059(a).
§ 9.3:18Claims and Defenses of Tenants
Unless otherwise agreed by a tenant, the right of the assignee to collect rents from the tenant is subject to the terms of any agreement between the assignor and tenant or any claim or defense arising from the assignor’s nonperformance of that agreement. Tex. Prop. Code § 64.059(b). Assignees may wish to have tenants waive the provisions of TARA making the tenant’s obligation to pay rents to the assignee subject to any agreement with the assignor or any claim or defense the tenant may have under TARA or any other law of the state of Texas. Tex. Prop. Code § 64.055(c). See form 9-5 in this manual for suggested provisions modifying an assignor’s lease form to better protect an assignee. Revise the provisions to fit the lease form and circumstances of the subject transaction.
If an assignor collects rents an assignee is entitled to collect under TARA, unless an agreement to the contrary is obtained, the assignor must turn the proceeds over to the assignee within thirty days after notice from the assignee under section 64.054 or such period as may be provided in the security instrument or other document signed by the assignor and approved by the assignee, less any expenses authorized by a security instrument or other document signed by the assignee. Tex. Prop. Code § 64.060(a). An assignee may wish to require the assignor to waive any right to delay turnover of or withhold any amount permitted under section 64.060(b) for expenses. The assignment of rents could provide that on the giving of a NPROL, the tenant shall (1) immediately turn the proceeds over to the assignee and (2) not deduct any portion of the rents for any purpose notwithstanding any other provision of the assignment of rents or other loan document, but shall pay all rents to the assignee.
Unless otherwise agreed, a junior assignee is not obligated to turn over proceeds it collects before it receives notice from a senior assignee. Tex. Prop. Code § 64.060(d). However, that same junior assignee must turn over any proceeds it collects after it receives the notice from a senior assignee on or before thirty days after it receives such notice. The assignor is also required to turn over proceeds it receives subsequently within ten days of such receipt. Tex. Prop. Code § 64.060(d). A senior assignee that consents to the assignment of a junior security interest in rents should require that the junior assignee agree to hold all rents it collects in trust for the benefit of the senior assignee and to turn those rents and other proceeds over to the senior assignee without notice or demand immediately on receipt by the junior assignee.
§ 9.3:20Civil Action against Assignor
In addition to any other remedy under TARA or other state law, if an assignor fails to turn over proceeds to the assignee as required by TARA, the assignee may recover from the assignor in a civil action the proceeds or an amount equal to the proceeds the assignor was obligated to turn over to the assignee, plus reasonable attorney’s fees and costs to the extent provided for in an agreement between the assignee and the assignor and not prohibited under state law other than TARA. Tex. Prop. Code § 64.060(b).
Such a civil action may be maintained either with or without an action to foreclose the security interest the assignee may have in the real property. Tex. Prop. Code § 64.060(c). This should help ameliorate the risk such an action might be held to place the real property in custodia legis and thus prevent or delay a nonjudicial foreclosure without the court’s consent. First Southern Properties, Inc. v. Vallone, 533 S.W.2d 339 (Tex. 1976). An action to enforce the right to possession of rents or proceeds should not be construed as seeking the courts’ assistance with respect to the underlying real property.
§ 9.3:21Attachment, Perfection, and Priority of Assignee’s Security Interest in Proceeds
An assignee’s security interest in rents attaches to identifiable proceeds. Tex. Prop. Code § 64.061(a). If the security interest in rents is perfected, the security interest in cash proceeds is perfected. Tex. Prop. Code § 64.061(b). In other situations, whether a security interest is perfected, the effect of perfection or nonperfection, and priority is governed by chapter 9 of the Texas Business and Commerce Code or the comparable provisions of the UCC of another applicable jurisdiction. Tex. Prop. Code § 64.061(c). For the purposes of TARA, cash proceeds are identifiable if they are maintained in a segregated deposit account or, if commingled with other funds, to the extent they can be identified by a method of tracing, legal or equitable, permitted under state law with respect to commingled funds. Tex. Prop. Code § 64.061(d). Clearly, continuous identification of proceeds is essential to the continued perfection of the assignee’s security interest.
Assignees of rent may wish to require deposit of all rents and proceeds into a lockbox or other deposit account pursuant to a lockbox agreement, deposit account control agreement, or similar agreement to assure that all rents and proceeds can be traced and that the perfected security interest in those rents remains perfected. For an excellent article on this topic, including forms, see David P. Derber, Assignment of Real Estate Rents—Protecting the Lender’s Interest, Bernard O. Dow Leasing Institute, University of Texas, Austin (2005).
TARA does not preclude subordination by agreement by a person entitled to priority. Tex. Prop. Code § 64.062. An assignee that holds a priority security interest in rents could agree to subordinate that interest. For example, if a creditor brings new financing to a project, an existing creditor may subordinate its security interest in rents.
§ 9.3:23Retroactive Application of TARA
Except with respect to the automatic creation of an assignment of rent in enforceable security instruments under Texas Property Code section 64.051(a), TARA is applied retroactively to (1) enforcement of an assignment of rents, (2) priority and perfection of a security interest in rents, and (3) attachment and perfection of a security interest in proceeds, regardless of whether the assignment of rent was signed and delivered before the effective date of TARA (June 17, 2011). See Acts 2011, 82d Leg., R.S., ch. 636, § 3(a) (S.B. 889), as amended by Acts 2013, 83d Leg., R.S., ch. 453, § 12(a) (S.B. 848), eff. June 14, 2013; see also, In re MRI Beltline Industrial, L.P., 476 B.R. 917 (Bankr. N.D. Tex. 2012). Because section 3(a) of Senate Bill 889 (2011) addressed procedural matters within the police powers of the state of Texas, TARA should pass constitutional muster. See Tex. Const., art. I, § 16; Barshop v. Medina County Underground Water Conservation District, 925 S.W.2d 618, 633–35 (Tex. 1996); but see Robinson v. Crown Cork & Seal Co., 335 S.W.3d 126 (Tex. 2010).
Security instruments signed and delivered before June 17, 2011, do not automatically have an implied assignment of rents. See Acts 2011, 82d Leg., R.S., ch. 636, § 3(c) (S.B. 889), as amended by Acts 2013, 83d Leg., R.S., ch. 453, § 12(c) (S.B. 848), eff. June 14, 2013.
TARA does not affect—
1.any action commenced before June 17, 2011 (see Acts 2011, 82d Leg., R.S., ch. 636, § 3(b) (S.B. 889), as amended by Acts 2013, 83d Leg., R.S., ch. 453, § 12(b) (S.B. 848), eff. June 14, 2013);
2.the enforceability of an assignee’s security interest in rents or proceeds if, immediately before June 17, 2013, that security interest was enforceable (see Acts 2011, 82d Leg., R.S., ch. 636, § 3(d) (S.B. 889), as amended by Acts 2013, 83d Leg., R.S., ch. 453, § 12(d) (S.B. 848), eff. June 14, 2013);
3.the perfection of an assignee’s security interest in rents or proceeds if, immediately before June 17, 2011, that security interest was perfected (see Acts 2011, 82d Leg., R.S., ch. 636, § 3(d) (S.B. 889), as amended by Acts 2013, 83d Leg., R.S., ch. 453, § 12(d) (S.B. 848), eff. June 14, 2013); or
4.the priority of an assignee’s security interest in rents or proceeds with respect to the interest of another person if, immediately before the effective date of TARA, the interest of the other person was enforceable and perfected, and that priority was established (see Acts 2011, 82d Leg., R.S., ch. 636, § 3(d) (S.B. 889), as amended by Acts 2013, 83d Leg., R.S., ch. 453, § 12(d) (S.B. 848), eff. June 14, 2013).
§ 9.3:24Conforming Amendments to Texas Business and Commerce Code
TARA amended the exclusions to the scope of chapter 9 of the Texas Business and Commerce Code by defining real property leases and rents by cross-reference to TARA. See Acts 2011, 82d Leg., R.S., ch. 636, § 1 (S.B. 889), eff. June 17, 2011. It will remain for the courts to determine how to simultaneously apply Texas Business and Commerce Code section 9.109(d)(11), as amended by TARA, and section 64.061(c), which, as noted above, provides that chapter 9 of the Texas Business and Commerce Code governs for the purpose of determining whether a security interest in proceeds is perfected, the effect of perfection or nonperfection, and priority of an interest in proceeds. The only change to section 9.109(d)(11) would be the cross-reference to the definitions in TARA. See Tex. Bus. & Com. Code § 9.109(d)(11) (“This chapter does not apply to: . . . (11) the creation or transfer of an interest in or lien on real property, including a lease or rents, as defined in Section 64.001, Property Code.”). However, section 9.109(d) would continue to exclude creation or transfer of an interest in or lien on real property, including leases and rents.
In other words, chapter 9 of the Business and Commerce Code would continue to exclude from its coverage the creation or transfer of an interest in or lien on real property, including a lease or rents. However, except for security interests in identifiable cash proceeds under Texas Property Code section 64.061, chapter 9 would govern the perfection, the effect of perfection or nonperfection or a security interest in proceeds, and the priority of security interests in proceeds. While creation and transfer of a security interest in proceeds are distinct from perfection, the effect of perfection or nonperfection, and the priority of a security interest in proceeds, there will be a strong temptation, if not inclination, for the courts and attorneys to conflate the concepts in the Texas Business and Commerce Code with those in Texas real property, mortgage, and foreclosure laws, including chapter 51 of the Property Code.
§ 9.3:25No Good-Faith Requirement under TARA
TARA does not contain a “good faith” provision. This is consistent with existing Texas common law treatment of loan transactions. The Texas Supreme Court rejected implied contractual obligations of good faith in connection with lenders. FDIC v. Coleman, 795 S.W.2d 706 (Tex. 1990); English v. Fischer, 660 S.W.2d 521 (Tex. 1983). Because enforcement of an assignment of rents may in some circumstances necessitate recourse to the Texas Business and Commerce Code, assignees would still be prudent to include a disclaimer of any duty of good faith or other fiduciary duty to the assignor or any tenant in each assignment of rents.
TARA does not provide for a separate procedure for foreclosing on rents or proceeds in which an assignee holds a security interest. If the rents have not been paid (unsevered) or converted to proceeds, then the rents will follow the real property in either a nonjudicial or judicial foreclosure. If the rents have been paid or converted to proceeds (severed), then foreclosure must be accomplished in accordance with chapter 9 of the Texas Business and Commerce Code. Note however, that chapter 9 provides, in pertinent part:
If a security agreement covers both personal and real property, a secured party may proceed:
(1)under this subchapter as to the personal property without prejudicing any rights with respect to the real property; or
(2)as to both the personal property and the real property in accordance with the rights with respect to the real property, in which case the other provisions of this subchapter do not apply.
Tex. Bus. & Com. Code § 9.604(a) (emphasis added). The definition of “security agreement” under chapter 9 is broad and appears to include an assignment of rents: “ ‘Security agreement’ means an agreement that creates or provides for a security interest.” Tex. Bus. & Com. Code § 9.102(a)(74). To avoid any question, mortgage lenders should include a statement in each assignment of rents that it constitutes a security agreement with respect to personal property described in the assignment of rents.
Combs, Lorin Williams, and Jeffrey Warren Matthews. “Texas Annotated Assignment of Rents.” In Mortgage Lending Institute, 2012. Austin: University of Texas School of Law, 2012.
Derber, David P. “Assignment of Real Estate Rents, Absolute, Collateral or Conditional: Do We or Should We Care?” In Advanced Real Estate Drafting Course, 2000. Austin: State Bar of Texas, 2000.
Walker, Edward F. “Drafting Assignments of Rent under the Texas Assignment of Rents Act.” In Advanced Real Estate Drafting Course, 2012. Austin: State Bar of Texas, 2012.