Effective June 17, 2011, a new Chapter 64 was added to the Texas Property Code, governing assignments of rents in Texas.  Generally known as the Texas Assignment of Rents Act (“TARA”), the primary purpose of TARA was apparently to clarify the “collateral” nature of rent assignments, which typically appear within or in connection with deeds of trust securing financing on income-producing property.

TARA generally applies not only to future real estate transactions, but also to existing transactions to the extent that they were not the subject of “an action or other proceeding commenced before the effective date” of TARA (i.e., June 17, 2011).

TARA in the Bankruptcy Courts

Two Texas based bankruptcy courts have since addressed this statute:  In re MRI Beltline Industrial, L.P., 2012 Bankr. LEXIS 3712 (Bankr. N.D. Tex. 2012)(Houser, J.); In re Lack’s Stores, Inc., 2012 Bankr. LEXIS 3439 (Bankr. S.D. Tex. 2012)(Bohm, J.).

Effective Date of TARA (June 17, 2011) Matters in Bankruptcy Court

In the more recent case (MRI Beltline Industrial), Judge Houser of the Northern District actually applied TARA in the context of a cash collateral motion.  The debtor was the owner of the income-producing property, and it sought permission to use the rents, which constituted cash collateral.

The lender moved for relief from the automatic stay, apparently asserting, among other things, that the assignment of rents securing its claim was “absolute,” presumably entitling it to immediate possession of the rents.  The court addressed the state of Texas law before TARA, noting that although Texas courts have been reluctant to construe assignments of rents as “absolute,” some courts had indeed held that an absolute assignment of rents could transfer the right to rents to the mortgagee (secured lender) when a specified condition, typically a default, occurs.  (Historically this issue has developed from Taylor v. Brennan, 621 S.W.2d 592 (Tex. 1981) and its progeny, including, for example, FDIC v. Int’l Prop. Mgt., Inc., 929 F.2d 1033 (5th Cir. 1991)).

The court found that it did not have to address that issue, because of the enactment of TARA.  The assignment of rents in this case was signed and delivered prior to June 17, 2011, but the bankruptcy case was filed after that date.  Therefore, the court concluded that subsection (b) of Section 64.051 of TARA applied, the result being that the assignment of rents effectively created a security interest in, and did not pass title to, the rents in favor of the mortgagee (secured lender).

Then, the court simply addressed whether the lender was adequately protected in the context of cash collateral usage, and found that for these purposes, the lender held a small equity cushion and was otherwise adequately protected.  (The court did not, however, allow a “carve out” for attorneys fees, given the limited nature of the adequate protection and other issues expressed in the opinion).

Southern District Discusses TARA

Shortly before the MRI Beltline opinion was issued, Judge Bohm of the Southern District addressed TARA in the Lack’s Stores, Inc. case.  Lack’s presented a more unusual fact pattern, and the Court did not directly apply TARA.  The opinion, however, is instructive because:  (i) it provides an in depth analysis of pre-TARA law in Texas governing assignment of rents, (ii) it analyzed the outcome had TARA applied; and (iii) the court’s acknowledgment that, although the secured lender was not successful in proving the “absolute” nature of its rent assignment, any rents in the hands of the borrower would remain as collateral for the secured debt.

Lack’s involved three parties:  (i) lender, (ii) landlord / borrower, and (iii) tenant / debtor.  In other words, the debtor in this case was not the building owner, but rather the tenant.  The debtor had rejected the lease under Section 365 of the Bankruptcy Code, which gave rise to the landlord / borrower’s claim for lease rejection damages.  Based on an “absolute” assignment, the lender asserted that it had an immediate right to all of the landlord / borrower’s lease rejection damages.

This court reviewed the development of Texas law regarding absolute assignments and collateral assignments of rents, including a variety of Fifth Circuit authority that had addressed this issue in a bankruptcy context.  The court found that although TARA did not apply to this case (based on the effective date of TARA), the result was the same.  The landlord / borrower was not in default in its obligations to the lender, thus the landlord / borrower maintained its superior right to the rents.  Even if the debtor (tenant) paid the lease rejection damages to the landlord / borrower, there was no requirement to remit those funds to the lender.

This result obtained even though the parties had executed an attornment agreement acknowledging the lender’s right to collect rents directly from the tenant / debtor (“adding a third party, Lacks, to the equation does not suddenly vest [lender] with title to the rents.”).  The court also noted that under Section 365 in the context of a lease rejection, a breach of the lease has been deemed to occur, “but the underlying contract or lease has not actually been terminated.”  See, e.g., In re Austin Dev. Co., 19 F.3d 1077, 1082 (5th Cir. 1994).

Again, the landlord / borrower’s right to deploy any rents or rejection damages recovered from the debtor was not unlimited.  The lender “has a lien on these funds.”  Thus, the landlord / borrower could only use the proceeds as allowed by its loan documents, such as making payments on its note or other expenditures authorized under the applicable deed of trust.

Conclusion:  TARA Applies to post – June 17, 2011 Bankruptcy Cases

The bottom line from both of these cases seems to be that the Texas Assignment of Rents Act will apply in bankruptcy cases filed after June 17, 2011.  Typically, this should result in a construction of any assignment of rents as being “collateral” in nature.  Thus, rental proceeds would presumably be “cash collateral” subject to any applicable adequate protection analysis.

Conclusion:  TARA Provides Perfection of Rent Assignments

Additionally, because TARA effectively deems assignments to be perfected upon recording the applicable security document, the fiction of taking some sort of post-petition action or filing a “notice of perfection of rents” appears to be obviated going forward.

*Roger Cox, a shareholder with the Underwood Law Firm, is Board Certified in Business Bankruptcy Law (and formerly Board Certified in Commercial/Real Estate Law) by the Texas Board of Legal Specialization and a member of the American Bankruptcy Institute.  Mr. Cox is a co-author of Bankruptcy Road Map, published by the State Bar of Texas, and he most recently served on the faculty of the SBOT’s 2011 Advanced Business Bankruptcy Course.  This article is for general information only and is not intended as legal advice or as a specific position asserted on behalf of any existing or future client of the firm.

This column is published for informational purposes only. It should not be construed as legal advice and is not intended to create an attorney client relationship. The views expressed are those of the author and do not necessarily reflect the views of the author’s law firm or its individual partners.