Foreclosure complicates collection of back rent

Rent it Right

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted Apr. 7, 2011

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Rent it Right

Janet Portman
Inman News™

Q: Last month you answered a question by a rental property owner who bought his property from a foreclosing bank. The resident tenants hadn't paid the rent while the bank owned the home; the new owners wanted to collect it. Your answer indicated that the new owners were entitled to that back rent. I don't think that's correct -- would you check it out? --Tim C.

A: Right you are, my answer was a bit too glib. I was treating the purchase of the property, and the leasing contracts that went along with it, as if it were a regular sale -- one that didn't involve a foreclosure. In a regular sale, the new owner would clearly have the right to demand back rent from tenants who had failed to pay while the original owner was on the scene.

The legal rule here is that the purchaser buys subject to any contractual obligations of current tenants. This gives the buyer both the responsibility to follow through with the leases (honor them), and the right to enforce them (demand the rent).

But the answer may be different when the original owner defaults on a loan or mortgage, and a bank gets between the defaulting owner and a subsequent purchaser. Many thanks to you for bringing this to my attention; now let's see if I can set our readers straight.

Most lending documents specify that if the owner-borrower defaults, the lender has the right to the "rents and proceeds." The question is: At what point does that right kick in?

Some loan documents allow the lender to begin collecting the rent as soon as the borrower defaults, by notifying the renter to send the rent directly to the bank. And if the lender ultimately forecloses and becomes the owner, it clearly has the right from that point on to receive the rents.

But if the tenants owed rent before the default and foreclosure, in most states the borrower (the original owner) retains the right to receive that money.

Now, what happens if a foreclosing lender fails to collect rent that falls due after it forecloses, and then sells to a new buyer (this was the original question)? A California court looked at that question, and decided that because the sale contract specifically reserved to the bank the rent due but unpaid during the time it owned the property, the bank (not the buyer) was entitled to that money.

Presumably, if the sale contract did not reserve these rents to the selling bank, the new owner would be entitled to them.

The Illinois case you pointed to (Fidelity Mutual Life Insurance Co. v. Cole Taylor Bank) said something a bit different: The bank is entitled to accrued rents, "especially where the sale ... was made pursuant to the understanding that the receiver or mortgagee did not relinquish its rights to the accrued rents." So, to know for sure in any situation who can collect unpaid rent, one would have to study state law and the sale contract.

There's a takeaway from this answer that goes beyond yours truly. People who are buying REO (bank-owned) properties might assume that they're entitled to any back rents due after the foreclosure and not collected by the bank. That assumption would be risky. Buyers in this position who are counting on getting that rent should make sure that state law and/or the sale contract gives them the right to collect it.

Q: I've been in my apartment for a couple of years, and recently began seeing green-black mold in the closet, bedroom and hallway. It won't go away, even when I clean with a bleach solution and ventilate. I think it's the cause of my persistent cough. I've asked management to move me to another unit, but they won't, citing my poor payment history.

It's true that I was late with the rent three times, but I always paid before the end of the notice period, including the late-rent fee. Is this a valid reason to deny me a change of apartments? --Dana W.

A: In some situations, tenants cannot exercise their rights unless they are paid up in the rent. For example, in many states, if a tenant withholds rent due to a rental's substandard condition (a violation of the implied warranty of habitability), and asserts this failure to repair as a defense to an eviction for nonpayment, the tenant must deposit the rent into an account maintained by the court.

This prevents tenants from falsely claiming substandard conditions as a way to avoid (or delay) paying rent. But no statute that I'm aware of conditions a tenant's right to use this remedy on never having been late in the past.

Similarly, some states give tenants a break when they are repeatedly late with the rent, but not forever. For example, a tenant who is late once may be entitled to a pay-or-quit notice; but if she is late again within a six-month period the landlord may deliver an unconditional quit notice.

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