|A recent bankruptcy decision in the United States Bankruptcy Court for the Southern District of New York has provided a useful road map for lenders seeking to perfect their interest in an assignment of a borrower’s rents and, conversely, a cautionary tale for borrowers who may seek to utilize the protections of the Bankruptcy Code to reorganize.|
|In Soho 25 Retail, LLC v. Bank of America, N.A. as trustee for the Registered Holders of GS Mortgage Securities Corporation II (In re Soho 25 Retail, LLC) (Hon. Sean H. Lane presiding),1 the Bankruptcy Court addressed the issue of whether the rents from certain debtor-owned real estate were property of the bankruptcy estate or property of the lender by virtue of an assignment of rents executed by the parties.|
|The debtor in Soho 25 was a single-asset real estate entity that owned condominium units serving as ground floor retail space. The property was leased by the debtor to three commercial tenants. In July 2006, the debtor borrowed $8.5 million from a mortgage lender, secured by an amended and restated promissory note, a mortgage and an assignment of leases and rents (the “Assignment” and together with the note and mortgage, the “Loan Documents”). The language of the Assignment was characterized by the bankruptcy court as “expansive.”2 Among other reasons, the Assignment contained language immediately authorizing the lender or its agents to collect the rents, but provided the debtor with a “revocable license” to enjoy the rights of a lessor under the leases provided there was no event of default. The Assignment also contained other language indicating that the lender’s rights were broader than a mere security interest. For example, the Assignment provided that: As part of the consideration for the Debt, [the debtor] does hereby absolutely and unconditionally assign to [the lender] all right, title and interest of [the debtor] in all present and future Leases and Rents, and this Assignment constitutes a present and absolute assignment and is intended to be unconditional and not an assignment for additional security only. It is further intended that it not be necessary for [the lender] to institute legal proceedings, absent any requirements of law or regulation to the contrary, to enforce the provisions hereof.3|
|The Assignment also provided that upon occurrence of an event of default, the debtor irrevocably appoints the lender as its attorney-in-fact; and that the debtor’s license would be ‘immediately revoked,’ without the necessity of the lender entering upon and taking and maintaining full control of the Property in person, by agent or by court-appointed receiver.|
|In 2009, the debtor defaulted under the Loan Documents by failing to make timely payments and in June 2009, the lender issued a default notice. Thereafter, the lender issued letters to the debtor’s tenants instructing them to pay the lender directly. In a joint letter dated November 2, 2009, the lender and the debtor together instructed one of the tenants to pay the lender directly. On November 13, 2009, the lender commenced a foreclosure action which included a demand for appointment of a receiver of rents. A default judgment was entered against the debtor in May 2010 and a referee was appointed to ascertain and compute the amount due to the lender under the Loan Documents. A public auction to sell the debtor’s property was scheduled for September 29, 2010. On September 28, 2010, the day before the foreclosure sale, the debtor filed a voluntary petition for relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”).|
|The debtor filed a plan of reorganization on December 27, 2010. On January 3, 2011, the lender filed a motion for relief from the automatic stay pursuant to section 362(d) of the Bankruptcy Code to continue its foreclosure action. The Debtor filed a complaint against the lender, arguing that the lender had improperly collected the debtor’s rents after the bankruptcy filing, and opposed the lift stay motion.|
|The debtor vigorously argued that under New York law, an assignment of rents is not self-executing and does not become effective until a lender affirmatively asserts its rights to the rents. In support of its position, the debtor pointed to language in the Assignment, indicating that it was being given as “additional security.” The debtor also pointed to the majority of state law cases holding that an absolute assignment is not permitted under New York law, regardless of the language of the agreement.4|
|The lender argued that the Assignment was, by its terms, self-executing, pointing to a number of cases suggesting that an absolute assignment is permissible where supported by language in the agreement, including language indicating that the assignment is in the present tense; that the rents are held in trust for the lender; or that the lender is entitled to take instant action to collect the rents without the need to appoint a receiver.5 The lender also argued that, in any event, the lender had taken affirmative steps to protect its interest in the rents in this case.|
|The Bankruptcy Court found that New York law was, at best, unclear on the issue of whether an assignment of leases and rents could be self-executing. The Bankruptcy Court determined, however, that it did not need to resolve the “murky legal question” in this case because the lender had evidenced sufficient affirmative steps to make the assignment of rents effective under New York law. Here, the lender’s steps included commencement of a foreclosure proceeding including a request for appointment of a receiver; formal written demands by the lender to turn over rents; and in particular, the joint letter from the debtor and lender demanding that a tenant pay rent directly to the lender. The Bankruptcy Court also found that the lender took “a significant affirmative step to enforce its interests” by seeking relief from the automatic stay once the bankruptcy case was filed. Ultimately, the court determined on the facts of this case, that “the rents are not property of the estate because the Debtor had, at most, a revocable license in the rents at issue – a license that was revoked by the Lender prior to the Petition Date – and because the mortgage and note remained unsatisfied.6|
|One takeaway for debtors from this decision is that one should not wait too long – i.e. until after a lender has already taken affirmative steps to perfect its interest in rents – to file a bankruptcy case, particularly if the rents will be necessary for a reorganization. The Soho 25 case should caution a borrower against the notion that it can buy time by waiting until the eve of a foreclosure sale to file bankruptcy.|
|Mickee M. Hennessy, Esq. is a Partner in the Bankruptcy, Workout and Restructuring Department at Westerman Ball Ederer Miller & Sharfstein, LLP in Uniondale, New York.|
|1. 2011 WL 1333084 (Bankr. S.D.N.Y. March 31, 2011).
2. Soho 25, 2011 WL 1333084 at *2.
3. Id. (emphasis in text).
4. Soho 25, 2011 WL 1333084 at *6, citing Lt. Propco, LLC v. Carousel Ctr., Co., L.P., 68 A.D.3d 1695, 1696 (4th Dept. 2009); Suderov v. Ogle, 149 Misc.2d 906, 909 (N.Y. App. Term 1991); Dream Team Assoc. v. Broadway City, 2003 N.Y. Slip Op. 50894U, 2003 WL 21203342 (N.Y. Civ. Ct. May 7, 2003).
5. Id., citing Credit Lyonnais v. Getty Square Assocs., 876 F. Supp. 517 (S.D.N.Y. 1995); Fed. Home Loan Mortg. Corp. v. Nora Assoc., 1992 WL 125520 (S.D.N.Y. May 26, 1992); Fed. Home Loan Mortg. Corp. v.Dutch Lane Assocs., 775 F. Supp. 133 (S.D.N.Y. 1991).
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