Properly Perfected Assignment of Rents:  Rents Not Part of Bankruptcy Estate

The United States Court of Appeals for the Sixth Circuit (which includes Michigan) has held that, if a creditor has properly perfected an assignment of rents prior to the filing of a bankruptcy case, the rents are not property of the estate.

In Town Center Flats, LLC v ECP Commercial II LLC (In re Town Center Flats), the debtor owned a 53-unit residential apartment complex, which construction had been financed through a mortgage and assignment of rents.  Rents from the tenants were the debtor’s only source of income.

The debtor defaulted on its obligation under the loan and the creditor properly perfected the assignment of rents by notifying the tenants and recording a notice with the register of deeds.  The debtor then filed a Chapter 11 bankruptcy.

The creditor filed a motion to prohibit use of the rents collected after the filing.  The debtor opposed the motion, claiming that the rents were cash collateral and pointing out that, without the rents, it had no income to fund a plan of reorganization.  The bankrupcty court agreed and entered an order allowing use of the rents.  The creditor appealed, arguing that, due to the perfection of the assignment of rents, the rents no longer belonged to the debtor and were not part of the bankruptcy estate.

The district court agreed and vacated the bankruptcy court’s decision.  The debtor appealed to the Sixth Circuit Court of Appeals, which affirmed.

Applying Michigan law, the court held that once the assignment of rents had been perfected, the debtor “no longer had an interest in the rents,” citing Otis Elevator v Mid-America Realty Investors, 522 NW2d 732 (Mich. Ct. App 1994).

The court noted that excluding assigned rents from the bankruptcy estate in a single-asset real estate case such as this one would effectively foreclose Chapter 11 relief from these kinds of debtors, but held that Michigan law is clear on the matter.

© Steve Sowell 2018