The Appellate Court of Illinois, Second District, recently held that a mortgagee with a foreclosure judgment could not collect on the deficiency against rents from other properties owned by the mortgagor, because the mortgagee's foreclosure judgment was not superior to the prior recorded mortgages for the other properties which contained assignment-of-rent clauses, and the other mortgagees had executed forbearance agreements to enforce those assignment-of-rents clauses.
A copy of the opinion is available at: Link to Opinion
In 2013, a bank, acting as the assignee of the FDIC ("Foreclosing Bank"), foreclosed on four mortgages on several lots owned by a home builder ("Builder") and, on August 24, 2014, obtained a $1.5 million judgment ("Judgment"). In 2014, in post-judgment proceedings, the Bank sought to obtain information from the Builder to enforce the deficiency judgment.
Over one year later, in 2015, the Foreclosing Bank caused a third-party enforcement proceeding to be issued to a property management company owned by the Builder's wife ("Property Management Company") that managed properties owned by the Builder. Once such a third-party enforcement proceeding is issued, it becomes a lien on the judgment debtor's assets held by the recipient of the proceeding.
The Property Management Company responded that it did not hold any assets belonging to the Builder as it was merely an agent that managed properties and that any rents it collected belonged to the mortgagees for the properties it managed (the "Managed Properties"). Then, three of those mortgagees intervened in the post-judgment proceedings ("Other Mortgagees") and claimed that their interests in the rents for the Managed Properties were superior to the Foreclosing Bank's interest due to the assignment-of-rent provisions in their recorded mortgages and because of the forbearance agreements they had entered into that transmitted rents on those properties directly to the Secured Lenders.
A flurry of motion practice ensued. The Foreclosing Bank argued that the Other Mortgagees first had to obtain actual possession of the properties or constructive possession through a receiver. The trial court rejected that argument and held that the forbearance agreements were enforceable contract modifications that predated the Foreclosure Judgment and the third-party citations and were voluntarily entered into in lieu of foreclosure and/or receivership. Thus, the Builder had contracted away its right to receive rents on those properties and the transmittal of rents to the Other Mortgagees did not violate the restraining component of the third-party citations to discover assets.
The trial court further held that this did not violate the common law rents-and-profit doctrine, which requires actual or constructive possession by a lender by court authorization to prevent a mortgagor or its tenants without resources for maintenance or repair, because the property repair and maintenance and management expenses were deducted from the rents before they were transmitted to the Other Mortgagees. The parties filed motions for reconsideration and clarification and, after the trial court issued its ruling that affirmed its previous holding, the Foreclosing Bank filed this appeal.
On appeal, the Foreclosing Bank, relying on case law, argued that the Other Mortgagees had no lien on the collected rents while it had the only perfected judgment lien (via its citation to discovery assets), and that the Other Mortgagees' mortgages and rent-assignment agreements were irrelevant until the Other Mortgagees were granted constructive or actual possession through appointment of a receiver or as mortgagees in possession.
The Appellate Court rejected those arguments in a complex 20-page analysis, including an analysis of the effect of the Illinois Conveyances Act on the Foreclosing Bank's cited case law, the highlights of which appear below.
The Appellate Court found that Section 31.5 of the Illinois Conveyances Act, 765 ILCS 5/31.5(b), provided that "an assignment of rents is perfected upon recording and provides that the assignee has a superior claim to the rents" against anyone whose claim or interest arises or is perfected after that. Thus, the Other Mortgagees' recorded mortgages that contained assignment-of-rents provisions had a superior interest in the rents over the Foreclosing Bank.
The Foreclosing Bank argued that the mere recording of the mortgages containing the assignment of rents provisions did not entitle the Other Mortgagees to the rents. Rather, the Foreclosing Bank argued, the Other Mortgagees had to enforce their liens by obtaining court authorization to collect the rents as required by §31.5(d) of the Illinois Conveyances Act.
However, the Appellate Court pointed out that, under §31.5(d), the Other Mortgagees could enforce the assignments "through applicable law, unless the parties agreed otherwise." 765 ILCS 5/31.5(b). Thus, the Court held, once the Other Mortgagees had perfected their liens on the rents, they also had to take action to enforce those liens either "through applicable law", such as by foreclosing on the liens, or as "the parties agreed otherwise", which they did by electing to skip foreclosure and entering into the forbearance agreements that transmitted the rents directly to the Other Mortgagees. It is important to note here that in Illinois there is no legal requirement that forbearance agreements be recorded.
The Appellate Court observed that "a judgment creditor can establish an entitlement to collect rents by obtaining possession of a mortgagor's property before the mortgagee holding a previously recorded rent assignment takes steps to enforce its rights through foreclosure," including by gaining possessor status or by "the appointment of a receiver."
The Court noted that the Foreclosing Bank could have taken steps to supplant the Other Mortgagees' priority positions for the rents by seeking a turnover of the rents or an appointment of a receiver. But the Foreclosing Bank did not and, instead, had "an unenforced citation lien that cannot not trump an assignment of rents."
A citation lien can only reach assets in the possession or control of a judgment debtor or belonging to the judgment debtor but in the possession or control of a third-party citation respondent. 735 ILCS 5/2-1402(a); 735 ILCS 5/2-1402(m). Here, the rents belonged to the Other Mortgagees because of the forbearance agreements entered into to enforce their perfected liens. Thus, the Court held, no citation lien could attach to the rents collected by the Property Management Company.
The Appellate Court rejected the Foreclosing Bank's other arguments as well. It held that the Illinois Mortgage Foreclosure Law would not be superfluous if trial court's interpretation of the Illinois Conveyances Act was upheld because the foreclosure law applied to mortgagees seeking to foreclose. The Other Mortgagees had not sought to foreclose but to perfect and enforce liens for rent.
The Court also rejected the Foreclosing Bank's argument that the Illinois Conveyances Act was ambiguous and a mere clarification of common law such that the court should reach the opposite outcome. Instead, the Court held that the Illinois Conveyances Act was not ambiguous, but, even if it was, the common law rents-and-profits doctrine, which requires actual or constructive possession of the property through court action before collecting rent, would protect mortgagees' interests in the rents and ensure proper property maintenance because the forbearance agreements required the Other Mortgagees to apply the rents to maintenance and repairs.
The Appellate Court rejected the Foreclosing Bank's co-mingling argument, that the Property Management Company collected the rents and co-mingled them with the Builder's assets thereby negating the liens, pointing out that the Property Management Company was acting as an agent for the Other Mortgagees under the forbearance agreements, not the Builder's agent.
The Foreclosing Bank's prove-up argument also failed. The Foreclosing Bank asserted that by not requiring the Other Mortgagees to prove up the existence or amount of the liens, the one of the Other Mortgagees got a double recovery because it took title to the property through a foreclosure and maintained the right to collect future rents. The Appellate Court pointed out that this mortgagee's purchase of the property after foreclosure extinguished only the mortgage, not the lien on the rents. In re Randall Plaza Center Associates, L.P., 326 B.R. 133, 141 (Bankr. N.D. Ill. 2005).
Accordingly, pursuant to § 31.5 of Illinois' Conveyances Act, the Appellate Court held that the Other Mortgagees' claims to the rents from the Builder's other properties took lien priority over the foreclosure judgment, and any lien created by the citation to discover assets because the Other Mortgagees recorded their mortgages, which contained assignment-of-rent clauses, and enforced them through forbearance agreements that resulted in rents being directly transmitted to the Other Mortgagees, and the Foreclosing Bank failed to seek appointment of a receiver or a turnover order.
Ralph T. Wutscher
Maurice Wutscher LLP
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