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Court Distinguishes Perfection From Enforcement In Assignment-Of-Rent Cases

Banking Law Roundup

Sharp   Thinking

No. 151       Perspectives On Developments In The Law From Sharp-Hundley, P.C.      April 2018

Court Distinguishes Perfection From Enforcement In Assignment-Of-Rent Cases

            By John T. Hundley, John@sharp-hundley.com, 618-242-0200

            Applicants for the bar exam routinely are taught to distinguish between the creation of a security interest and its perfection, and that the resolution of competing claims will depend upon when perfection occurs.

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            But developing case law with respect to one kind of property ‒ rents ‒ is challenging the latter premise.

            That case law ‒ most clearly exemplified by BMO Harris Bank, N.A. v. Joe Contarino, Inc., 2017 IL App (2d) 160371 – says  that with respect to rents, it is not so much when the security interest is perfected that matters, it’s when that interest is first enforced. 

            In BMO, the Appellate Court relied upon § 31.5 of the Conveyances Act, 765 ILCS 5/31.5, added in 1996.  That statute contains the customary provisions that recordation constitutes perfection and that from “the time of recordation, the assignee has a superior claim to the rents that are subject to the assignment, as against all parties whose claims or interests arise or are perfected thereafter” (§ 31.5(b)).  But the statute goes on to state:                                                                               

(d) Unless otherwise agreed to by the parties, the mere recordation of an assignment does not affect who is entitled, as between the assignor and the assignee, to collect or receive rents until the assignee enforces the assignment under applicable law.

  • 31.5(d). At first blush, the reader would assume that that provision only applies “as between the assignor and the assignee.” But in BMO, the appellate panel relied on that provision to hold that it is the date on which enforcement of the security interest begins that is determinative in the case of rents, as between competing claimants.  (In apparent agreement on this point is U.S. Bank N.A. v. Randhurst Crossing LLC, 2018 IL App (1st) 170348, ¶ 66, a case discussed in another context on p. 2 of this newsletter.)

            Thus, in BMO, the holder of a citation lien under 735 ILCS 5/2-1402 (who had not taken action to enforce the lien by way of a turnover motion) lost out to holders of recorded assignments of rents who had enforced their assignments by obtaining turnover provisions in forbearance agreements.

            BMO thus adds to the list of advantages that a well-drafted forbearance agreement can offer when a loan begins to go bad.  Well-recognized previously were the ways that forbearance agreements stripped debtors of potential defenses to foreclosure.  But the idea that a forbearance agreement actually can bring better results than seeking and obtaining possession from a court ‒ this seems new and powerful.

Cash Collateral Order Results In “Constructive Possession”

A creditor’s obtaining a cash collateral order in a bankruptcy court is sufficient to show that it obtained constructive possession over rents so as to make appropriate a turnover of those rents in post-bankruptcy proceedings, a panel of the Appellate Court in Chicago has held.

Ruling in U.S. Bank N.A. v. Randhurst Crossing LLC, 2018 IL App (1st) 170348, the panel dealt with the situation where the creditor’s foreclosure action and motion for a receiver were stayed by the debtor’s Chapter 11 bankruptcy.  However, in the bankruptcy court the creditor sought and received a segregation and accounting order on the ground that rents from the mortgaged property were the creditor’s “cash collateral.”  Some $278,000 in rents accumulated during the bankruptcy.  After the bankruptcy stay was lifted and the creditor sought a turnover order in the foreclosure court, the debtor objected on grounds that the creditor had not received possession, a typical prerequisite for collection of rents. 

The Appellate Court ruled that obtaining the cash collateral order was sufficient.  Likening the situation to a case in which a creditor had obtained an injunction against use of the rents and to a case in which the creditor had obtained an order that the rents be paid into the clerk of court, the panel found there was a doctrine of “constructive possession” which also sustained creditors’ claims to rents.  The cash collateral order in the bankruptcy court granted the creditor “constructive possession,” the court said, and it awarded the accumulated rents to the creditor.

New Guaranty Requires New Consideration

            A guaranty executed after all the other documents in a transaction requires new consideration, a panel of the Appellate Court in Chicago has held.

            Ruling in L.D.S., LLC v. Southern Cross Food, Ltd., 2017 IL App (1st) 163058, the panel dealt with a situation where a lessor demanded the guaranty in exchange for the lessor’s performance of duties he already was obligated to perform under a lease that was fully executed several days before.

            The court recognized that if a guaranty is executed contemporaneously with the original contract, the consideration for the original contract is sufficient consideration for the guaranty.  However, it said, “[i]f a guaranty is executed after the underlying obligation was entered into, new consideration is generally needed.”

            A couple of observations are appropriate.  First, the case dealt with a homemade guaranty which did not recite that it was given for consideration.  The case thus is not dispositive of the more common situation when the guaranty recites it is for consideration, but the guarantor denies any new consideration was given. 

            Second, lessee in L.D.S. was not in default.  The case thus also does not reach the common situation where the lender requires a personal guaranty as a condition of forbearing from exercising its default rights.

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