Daily Development for
Wednesday, January 20, 1999

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

MORTGAGES; ASSIGNMENTS OF RENTS: Mortgagee collecting rents under an assignment of rents necessarily is deemed to be bound on repair covenants in leases.

Touma v. St. Mary's Bank, 712 A.2d 619 (N.H. 1998).

The mortgagee had declared a default and exercised mortgagee's rights under an assignment of lease form from the mortgagor. The assignment provided that the mortgagor would perform all of mortgagor's obligations under the lease and also provided that the assignment would not impose any obligation of any nature on the mortgagee to take any action. The tenant argued that the mortgagee was obligated to maintain the roof of the premises during the period of time that it was collecting rents as assignee. [The editor presumes that this period was prior to the mortgagee's obtaining title at foreclosure, but the facts of the case are somewhat vague on th point.] The trial court ruled in favor of the mortgagee.

On appeal: held: Reversed. In a broad ranging opinion that may be precedent shattering, the court appears to hold that an assignee of rents that is collecting those rents is liable to maintain the premises, at least to the extent that the mortgagor is so liable under any leases generating those rents.

While the mortgagee was not obliged to make repairs by virtue of the assignment, the court held that when the mortgagee exercised its rights under the assignment, the mortgagee stepped into the landlord's shoes, at least insofar as the landlord's duty to repair the property.

"The rule that a mortgagee cannot collect rents notwithstanding the existence of a security interest in rents as a type of collateral, even though default may have occurred, without taking over possession and management of the rental premises, stems from the common sense observation that rents do not spring from the ground' and that if the mortgagee seeks to collect the rents the mortgagee must likewise undertake the responsibilities of management and operation of the business premises to justify receiving future rent payments. . . . To do otherwise would in effect have the mortgagor act as an indentured servant acting for the mortgagee in operation of the business while allowing the mortgagee to take the fruits of the mortgagor's continuing efforts without any of the liabilities. Neither Massachusetts nor the New Hampshire courts would permit this." Citing In re Rancourt, 123 B.R. 143, 148 (Bankr. D.N.H. 1991).

The court takes pains to make clear that its result is not dictated by any niceties of "lien theory" versus "title theory," and that it views its conclusions as consistent with the general trend.

The court, however, is not nearly as clear as to whether the mortgagee's liability arises solely from its asserting its claim on the rents or because necessarily the mortgagee becomes a possessor of the property when it exercises its claim to the rents. This may make a difference with respect to tort claims of third parties, for instance. Presumably the court is holding, as did the cases it relies upon, that a mortgagee cannot seize rents without being viewed as a mortgagee in possession.

Comment 1: Most lenders rely upon an assignment of rents to get at the rent collateral specifically to avoid becoming a mortgagee in possession. The editor, in a 1980 Kansas Law Review article, raised arguments against this theoretical model, but the case law since that time has generally supported the notion that an assignee can collect rents without becoming a mortgagee in possession. This case is consistent with a few cases that have not followed that reasoning. The new Restatement of Land Security collects the cases and comes down in favor of a "naked assignment" that is not coupled with a possessor's status. Sec. 4.2, comment c. The Restatement takes no formal position on whether mortgagee/assignees are liable on lease covenants, but the authorities the New Hampshire court relies upon, as the quoted text above indicates, rely on the mortgagee's status as "possessor" for the conclusion that the mortgagee is liable on the lease covenants (which run with the land).

Comment 2: The quoted excerpt above from a New Hampshire Bankruptcy opinion relies in turn on In re Prichard Plaza, 84 B.R. 289, 298 (Bankr. D. Mass. 1988). Despite this apparently applicable language, both bankruptcy cases deal with perfection issues, and their language clearly is dicta with respect to the issue of the mortgagee's duty to perform on leases.The Prichard case, which held that a lender must take possession to activate a rents interest, probably does not reflect current thinking in Massachusetts either now or at the time the instant case was decided. See HRPT Advisors, Inc. v. MacDonald, Levine, Jenkins & Co., P.C., 686 N.E.2d 203 (Mass. App. Ct. 1997) the DD for February 12, 1997.

Comment 3: Of course, a mortgagee can get "double protection" by getting a receiver appointed to activate the rents assignment, but in most cases the equitable appointment of the receiver will require that rents be used to maintain the premises and even to fulfill lease obligations, which may be something that the mortgagee would wish to avoid. At least, with a receiver, the liability will be limited to the amount of rents collected. If a mortgagee is a "mortgagee in possession," or otherwise liable on lease covenants, then conceivably it would have to undertake a significant repair (such as a roof replacement) if required by the lease even if the cost of such repair exceeded rents collected.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1 - 6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

Items reported here and in the ABA publications are for general information purposes only and should not be relied upon in the course of representation or in the forming of decisions in legal matters. The same is true of all commentary provided by contributors to the DIRT list. Accuracy of data and opinions expressed are the sole responsibility of the DIRT editor and are in no sense the publication of the ABA.