Amounts deposited with Debtor/Landlord for reimbursement for build out are not lender’s cash collateral even where the lender holds an assignment of rents

The Chapter 13 Trustee in re Callas, No. 13 B 43900 (Bankr. N.D. Ill. Apr. 23, 2015) brought a motion against the estate to turn over alleged cash collateral proceeds to the secured lender. The proceeds came from the tenant, Veteran’s Administration (VA), who paid them to Debtor pre-petition. The lease required the VA to reimburse the Debtor for the cost of a build out for the leased property; a portion being paid in a lump sum of $2000. The Debtor received the lump sum payment from the VA and subsequently deposited it into a debtor-in-possession account. The lender asserted an interest in the funds pursuant to an assignment of rents. Specifically, the lender contended it held an interest in the funds as proceeds of pre-petition rents by virtue of the assignment of rents, which it had perfected by recordation under Illinois law. The issue before the court was whether the lender acquiring an interest in the proceeds. Illinois law holds that although an assignment of rents creates a lien upon rents of the land that may be enforced upon default by taking affirmative steps to acquire possession of the land, it does not automatically grant the mortgagee an interest in specific rents paid after default. Instead, an assignment of rents allows the mortgagee to take certain steps after default to obtain possession and start collecting the rents; but until he takes such steps the mortgagor is entitled to keep the rents. A security interest in rents arising under an assignment of rents, while perfected against third parties upon recordation, does not automatically grant an interest in particular amounts, paid after default and constituting rents from the property. Here, the Debtor filed bankruptcy before the lender foreclosed. Since the rents were paid to the Debtor before the commencement of this case, and while he retained control of the property, the lender could assert no interest in the proceeds of the funds. The funds were not the lender’s cash collateral, but the property of the Debtor’s estate available for general estate distribution free and clear of any claims by the lender.

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