Sixth Circuit Finds Rents Collected Under An Assignment Of Rent That Is Fully Transferred Are Not Part Debtor’s Bankruptcy Estate

In In re Town Ctr. Flats, LLC, 855 F.3d 721 (6th Cir. 2017) the Sixth Circuit held that under Michigan law an assignment of rents agreement transferred the ownership of the rents to the creditor and therefore the rents were not property of the bankruptcy estate.

The debtor in In re Town Ctr. Flats, LLC, owned a 53-unit residential complex. The creditor held a mortgage and an agreement for assignment of rents in the event of default. Pursuant to the agreement, upon default, the assignment of the rents was irrevocable, absolute and unconditional. The debtor defaulted and creditor commence foreclosure leading the debtor to file for Chapter 11 bankruptcy relief. The creditor moved to prohibit the debtor from collecting and utilizing rents under the assignment of rents provision. The debtor opposed the motion, arguing the rents were its sole income and thus required to fund the case. The bankruptcy court agreed with the debtor and found the rents were cash collateral in the bankruptcy estate. It allowed the debtor to use the rents provided the debtor gave adequate protection to the creditor. Creditor appealed to the district court, which reversed, and the case made its way to the Sixth Circuit.

On appeal, the debtor argued that Michigan statutory authority provides that an assignment of rents provision is only a security interest, not an ownership interest, in the rents. Thus, it was impossible to transfer ownership in the rents regardless of what the credit agreement provided. Debtor also argued that it possessed residual rights to the rents because upon cure, it would be able to collect rents again, meaning debtor possessed a contingent future interest in the rents. Debtor argued it possessed a second residual right in the rents because pursuant to Michigan statutes an assignee was restricted regarding how it could apply the rents it collected.

The Court sided with the Creditor and held that the broad language used the assignment of rents, was limited by Michigan law. The Court stated that Michigan courts generally treat an assignment of rents as a transfer of ownership once the agreement has been completed and recorded and a default has occurred. The Court also refused to recognize that debtor had any residual ownership rights. The debtor had no contingent future interest in the rents because the rents were payments that occurred during a specific time during which only the creditor had an ownership interest in them. Regarding the debtor’s second residual right of ownership argument, the Court reasoned that the restrictions imposed upon the assignee by Michigan statute did not create any property right for the assignor.