In the period immediately following a default by a borrower, a mortgage lender is often faced with a number of strategic issues to consider. The lender must quickly determine, among other things, the underlying cause(s) of the default, whether the borrower is in a position and prepared to deal with the problem, the rights and remedies available to the lender, and how quickly and aggressively the lender should proceed with the exercise of one or more of its remedies.

In addition to the other remedies which a mortgage lender has in its arsenal, such as power of sale, foreclosure, receivership, taking possession and suing the borrower on its promise to pay the debt (which remedies will be discussed in future articles), a lender holding an assignment of rents as additional security to the mortgage may consider "scooping" the rents by diverting the rental payments generated by the borrower's tenants to the lender in order to exercise control over the borrower's revenue and reduce the lender's exposure. This remedy, often an interim step, has significant advantages to the lender.

First, cutting off the borrower's revenue stream can be accomplished relatively quickly with minimal expense and will surely get the borrower's immediate attention, if the lender has otherwise been unsuccessful in its attempts to so do. If the borrower did not appreciate the serious nature of its failure to perform its mortgage obligations, the diversion of its revenue will provide a powerful message.

Secondly, exercising the rights under the assignment of rents can usually be accomplished within a short time period and without initiating any legal proceedings. The tenants can be redirected to pay rents to the lender 10 days following delivery to the borrower of notice of the lender's intention to enforce security pursuant to section 244(1) of the Bankruptcy and Insolvency Act, in the likely situation that the borrower is insolvent.

Thirdly, merely capturing the rents will not itself result in the lender having the burden of being considered a "mortgagee in possession" with all of the obligations which come with such status. In other words, the lender will not, by exercising this remedy alone, become responsible for "management" and "landlord" obligations or risk potential environmental liability or the cost of retaining a property manager or receiver.

However, the blunt instrument of "scooping" rents does also have some inherent risks which must be considered:

  • Was the mortgage default triggered by the fact that the tenants defaulted in payment of rent to the borrower or have the tenants prepaid rents to the landlord at a discount so that there is little or no rent to be collected, rendering this action impractical?
  • Will sending the tenants a notice requiring them to pay rents to a mortgage lender be met with resistance because of poor landlord/tenant relations or other reasons?
  • Will the use of this remedy destroy the likelihood of any future potential co-operation between the borrower and the lender which may prove mutually beneficial in dealing with challenges they both face in respect of the distressed real estate asset?

As is the case with respect to the choice of any remedy, the particular situation in which the lender and the borrower find themselves must be carefully assessed. Of course, if the lender has a security package which affords a wide range of choices, it will be in an advantageous position vis-a-vis its debtor. In particular, a security package which includes an "assignment of rents" provides the lender with the opportunity to take some degree of control of the most important benefit of ownership and management of a property without necessarily being burdened with the obligations attached thereto.

From the borrower's perspective, its early recognition that its real estate asset has become "distressed" and keeping the lender continuously informed of the situation will, in many cases, be instrumental in establishing a dialogue and result in work out solutions which may avoid the lender's temptation to enforce its legal remedies.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.