Bankruptcy

Judge Isgur Takes on the "Absolute" Assignment of Rents

By Stephen Sather

Section 541(a)(6) Spells It Out

The Code provisions dealing with post-petition rents maintain a balance. Section 541(a)(6) brings the rents into the estate; Sec. 552(b) extends the lender's lien to post-petition rents and Sec. 363 requires adequate protection in order to use rents. This structure "incentivizes debtors and creditors to behave efficiently."

C1 Trust seeks to seprate the rental income from the assets and individuals that produce the rental income. Permitting such separation creates inefficient incentives that could greatly impede any debtor's ability to successfully reorganize. It is a fundamental principal of a capitalist society that when the owners of productive assets cannot benefit from the income produced by the assets , the incentive to produce income is eliminated. Without any prospect to generate rental income, the business's prospects for success are minimal at best.

In concluding his statutory reading, he said:

The Court therefore follows the unambiguous text of Sec. 541(a)(6) and declines C1 Trust's request to choke the Debtors out of bankruptcy.

You Can Call It Mickey Mouse But It's Still a Lien

Having decided the issue, he went on to offer several additional rationales. First, he argued that the term "absolute" assignment of rents is a misnomer. Regardless of what you call it, it is still a security device. He quoted In re Foundry of Barrington Partnership, 129 B.R. 550, 557 (Bankr. N.D. Ill. 1991) for the proposition that:

The lender can call this arrangement an "absolute" assignment or, more appropriately "Mickey Mouse." It's still a lien.

The Court noted that the Fifth Circuit used the term "contingent present assignment" to describe the so-called absolute assignment of rents.

Why It's Different Outside Bankruptcy

Synthesizing Whiting Pools with International Property leads to the conclusion that the post-petition rents at issue in this case are property of the estate. This conclusion is unmistakable despite the fact that the International Property lender was was permitted to retain the "absolutely" assigned rents. They key difference between the ostensibly inconsistent outcomes in this case and International Property is the bankruptcy framework. Outside of bankruptcy, International Properties stands for the proposition that once default occurs, the lender immediately has rights to the "absolutely" assigned rents. The debtor cannot keep rents received post-default. Upon receiving the rents, the lender must then take the cash from those rents and apply it to the mortgage debt. In doing so, the lender becomes both the equitable and the legal title holder of the cash from the rents. It is not until the cash is applied to the debt that the equitable title transfers from the debtor to the lender.

This case would follow the outcome of International Property if the Debtors had not filed bankruptcy. Upon the Debtors' bankruptcy filing, however, Sec. 541(a)(1) brings all property in which the Debtors hold an equitable interest into the estate. At the time of the filing of the bankruptcy petition, the Debtors held equitable title to all future rents, despite the lender's right to the rents under the "absolute" assignment.

Id. at 633.

This is a thoughtful opinion and well worth the time to read it. Judge Isgur has done an admirable job of reconciling the labels, the state court doctrine and the Bankruptcy Code's effect on these rights. Not only that, his opinion is based on basic capitalist principles.

Full post as published by A Texas Bankruptcy Lawyer's Blog on August 11, 2010 (boomark / email).