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.
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.
15. What does title insurance do?
Just as in the context of residential real estate, title insurance protects the insured, who can be the property owner and/or the mortgage lender, from loss due to undisclosed defects in title to real property and, for creditors, from loss due to the invalidity or unenforceability of its mortgage lien. Title insurance will defend against a lawsuit attacking the title as it is insured, or reimburse the insured for the actual monetary loss incurred, up to the dollar amount of insurance provided by the policy. Most policies contain a number of exceptions to the insurance policy, either specific exceptions for recorded liens, or general exceptions for issues the policy does not cover, including defects known to the insured, arising out of governmental documents not otherwise recorded, or arising out of creditors’ rights. Most title policies insure the title against both recorded and unrecorded claims, subject to stated exceptions. Coverage for unrecorded risks is beneficial because of the difficulty or impossibility of ascertaining all such risks. Many states have rating bureaus that regulate the types of policies, policy endorsements, and rates that apply to title insurance in a given jurisdiction. A creditor usually will require title insurance to insure the lien of its mortgage. Depending on the type and characteristics of the property and the loan, the creditor may also seek certain endorsements to the title policy covering a particular risk of concern to the creditor, such as insolvency. Those endorsements will affect the pricing for the policy. Endorsements may insure a whole variety of risks, including but not limited to zoning, usury, environmental liens, mineral rights, and other matters too numerous to list here. Certain endorsements are also only available in certain states or for certain types of properties or loans.