Daily Development for
Tuesday, January 26, 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 bank that holds an activated security interest in rents can hold "excess" rents without applying them to principal or interest payments, and is not required to first satisfy claims of other legitimate judgment creditors.

Vector Realty v. 711 Fourteenth Street, 711 A.2d 1265 (D.C. 1998).

The mortgagor defaulted on its $20,000,000 in mortgage loans in 1991. Pursuant to the terms of the mortgages, the lender sent notice to the tenants to start paying rent to the lender, which held the rent proceeds in a "lock box." In 1995, brokers obtained a judgment against the mortgagor for a commission for leasing the property. The leaseing activity and, of course, the judgment lien, postdated the lender's mortgage.

Apparently the rents in the lockbox were used to maintain the property, but for some time, at least, had not been applied to reduce the loan. By the time of this action, the lender had a surplus of $1,400,000 in the lockbox. The court did not indicate whether the mortgage loans had been accelerated, and apparently did not deem this fact to be relevant.

The court found that the mortgage loan documents created a valid security interest in the tenant rents and that the mortgagee could collect those rents directly from the tenants on demand in the event of a default by the mortgagor. Thereafter, the rent fund constituted the lender's security. The judgment lienholder argued that D.C. precedent established that a lender could not collect rents under an assignment without taking possession of the premises, but the court disagreed with this interpretation. Although the court apparently agreed that the lender had not taken possession of the premises, the court concluded that the lender could collect the rents under the assignment.

The judgment lien creditor therefore was unsuccessful in its claim that the mortgagee bank could not hold the assigned rents in excess of principal and interest payments in a reserve account without first satisfying the other creditors.

Comment 1: Although the mortgagee here did use rents to maintain the premises, since it was in the mortgagee's best interest to do so, it apparently treated the balance of the funds as an additional form of security.

Of course, if, from the outset, the lender had identified the rents as a separate form of security for its loan, and required that the rents be segregated into a lockbox and disbersed only with its approval, it is unlikely there would have been any issue about the mortgagee's rights in these funds. The "special fact" here is that the lender intervened to seize the rents upon default.

It would seem that the mortgagor would have a legitimate complaint if the lender did not prepay the indebtedness and segregated the rents in a separate fund. Quite possible, the various forebearance agreements entered into by mortgagor and mortgagee waived this claim on the part of the mortgagor. Again, the court did not mention this fact, so the case appears to stand for the conclusion that the mortgagor's right that the funds either be paid to reduce the loan or released to the mortgagor do not run to the mortgagor's creditors. There are bankruptcy decisions reaching the same conclusion with respect to collected rents segregated into a lockbox.

Comment 2: This case does not address the question of whether the mortgagee has any liability on the leases. But its conclusion that the mortgagee may be deemed to have a valid interest in rents collected under an assignment without the lender having taken possession of the premises appears to be consistent with those cases that hold that the lender has no responsibility on leases, since the conclusion that the lender does have such responsibility generally stems from the fact that the lender was deemed to have taken possession of the property upon seizing the rents.

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