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Assignment of Rents and Profits of California Commercial Properties – How Lenders Can Prevent Defaulting Borrowers from Keeping The Cash

Lenders on commercial properties usually require a Deed of Trust that gives them an assignment of rents and profits. The idea is that, if the borrower defaults, the lender is entitled to all rents and profits which have accrued and are collected after the default. Profit is short for” profit-à-prendre“, middle French for right of taking, meaning a right to go on property and take natural resources, such as timber, crops, or minerals.
This assumes that the borrower has leased the property and has something to collect. The frustration of small and moderate commercial lenders is with the knowledge that, while they are not getting paid, the defaulting borrower is collecting cash from its tenants. Enforcement of the assignment of rents clause can provide some satisfaction.

The enforcement of the rents and profits assignment is governed by California Civil Code section 2938. It requires that the assignment must be perfected by recording. And it provides lenders four ways to enforce assignments of rent, summarized as:
(1) The appointment of a receiver,
(2) Obtaining possession of the rents, issues, or profits,
(3) Delivery to any one or more of the tenants of a written demand for turnover of rents, or
(4) Delivery to the assignor of a written demand for the rents.

The statute also protects the lender enforcing its rights under the statute by providing that such enforcement does not violate the one action rule of Civil Procedure section 726; the lender may still foreclose, and if it does so judicially, may seek a deficiency judgment. However, it provides that rents collected by the lender are to be credited against amounts required to reinstate the loan (Civil Code 2924(c). The unwary lender collecting rents and profits directly may accidentally reinstate the loan, taking the borrower out of default. The lender needs to calculate the risk of this happening; an alternative is to have a receiver appointed, in which case the lender does not usually receive rent until after completion of a foreclosure, thus avoiding risk of triggering a reinstatement.

Another concern for the lender is that, under subdivision g, the borrower or any of its other assignees can demand that the collecting lender use those rents for the “reasonable costs of protecting and preserving the property”, including payment of taxes and insurance and compliance with building and housing codes. The collecting lender then becomes obligated to do so, and that obligation continues until the lender either ceases to collect the rents or has a receiver appointed to do so. Lenders considering collection should consult with an experienced California real estate attorney.

California statutes and legal decisions characterize rents and profits as real property collateral, not personal property, even after the borrower landlord collects them. However, for the creditor to collect, they must take one of the statutory steps, otherwise, the borrower-landlord is free to do what they want with the cash.