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.
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.