Corporate Focus - February 2010
Assignment of rent : an effective remedy against Defaulting
Borrowers?
The property market is still volatile despite
rising property prices, and it remains a tricky time for
lenders. For those lenders struggling to keep debts serviced
until property values rise again, the assignment of rental income
by way of security can provide an effective remedy against
defaulting borrowers.
Through such an assignment, lenders can demand
that rent is paid to them directly from tenants which can then be
used to discharge outstanding loan or interest payments as an
alternative to repossession and sale.
For those properties in negative equity, where
the current value is less than the amount secured on it, the
assignment route enables lenders to keep loans serviced until
property values increase again when the land can be sold to repay
the lender in full.
Whilst lenders are commonly entitled under their
standard mortgage terms to appoint Law of Property Act 1925
Receivers to collect rent directly from tenants, the main benefit
of using the assignment by way of security route rather than
relying on the receiver is that with the latter:
- receivers charge a fee or commission by the
receiver for any rent collected;
- receivers have a discretion to exercise wider
powers than simply rent collection, potentially increasing costs
and depleting available funds from the property; and
- receivers may be unwilling to accept the
appointment if they feel it is too minor, such as where only one
low value property is involved.
Using the assignment method, there are no costs
to the lender whose security entitles them to gain direct control
over rental income without the need for a receiver appointment, as
the lender is empowered to take all necessary steps themselves.
Under lenders’ standard legal mortgages, there is
often a provision requiring landlords to hold any rent received
upon trust for the lender. However this provision is ineffective
against a defaulting or insolvent landlord since unlike assignments
it does not confer rights of ‘appropriation’ of the money. An
assignment gives powers for the lender to pursue the money
directly.
To take advantage of this type of security,
lenders should ask the borrower to sign a form of assignment
containing a fixed charge over the rental account held by the
landlord together with an assignment of the borrower’s right to
receive rent from the tenant
Once this document is entered into, the borrower
is prevented from using or releasing the money held in the rental
account because it is charged to the lender, and is additionally
unable to collect rent directly from tenants since this right is
conferred on the lender as a direct assignment. Lenders are
also entitled to sue tenants directly for non-payment of rent.
It would be prudent for lenders to require this
type of security in every case where rental income from the
property is to be the borrower’s main or only source of repayment
of the mortgage loan. Otherwise, if prices have fallen and
the borrower directs the tenant to pay its rent elsewhere, lenders
will be left in the cold with no immediate remedy except the more
expensive receiver route.
The status of the lender’s security over the
rental account will depend on the level of control it exerts over
that money. If the lender does not allow funds to be released
without their express consent, it will usually be a fixed charge.
However if lenders allow the borrower freedom to use and
release money without reverting back to them in every case, it is
more likely to be construed as a floating charge.
If the rental account is held by another lender,
that other lender should be asked to confirm that it will not
exercise any right of set-off or counterclaim against the money
standing to the credit of the rental account.
To be binding on liquidators, the security
assignment must be registered at Companies House. It is not
registrable at the Land Registry.
Also, notice of the assignment must be given to
all affected tenants in order to reserve priority over the rental
money. The notice explains to tenants that they must make
rent payments directly to the lender if they are asked to do so at
any time in the future. It goes on to say that the tenant
need not contact the landlord to enquire as to the justification of
any request it receives from the lender, and will not be penalised
by the landlord at a later dated for following the lender’s
instructions.
The tenant signs a counter-notice confirming its
understanding of those rights and verifies that it has not already
received a similar request from another lender.
If no notice is served, the assignment will still
confer the same rights over the rent but the lender could lose
priority to another lender who took an equivalent assignment and
served notice on the affected tenants. Priority over the rent
between competing lenders is determined by the date notice is
served and not by the date of the assignment.
The main advantage of the assignment is that it
provides lenders with a more direct route to obtaining critical
funds to service debts. This route is quicker and often cheaper
than appointing a receiver, as the lender may carry out the work
itself. The assignment gives lenders powers of appropriation not
normally found in standard legal mortgages, and if the money has
already been paid to the borrower’s rental account it is
effectively frozen in favour of the lender.
If you would like
more information on this topic, please contact David Tabinor,
partner in our Commercial Property Team, on 0151 242 7979
or david.tabinor@weightmans.com