In re Madison Heights Group, LLC, 506 B.R. 728 (Bankr. E.D. Mich. 2013) -
A mortgagee exercised its assignment of rents prior to bankruptcy. After a Chapter 11 case was filed, the debtor sought court authority to use rents from the property as cash collateral. The mortgagee objected, arguing that the rents were not part of the bankruptcy estate.
Under Section 363 of the Bankruptcy Code "cash collateral" is defined to mean cash and other cash equivalents - specifically including rents of property - in which both the bankruptcy estate and another entity (such as a mortgagee) have an interest. A debtor-in-possession may not use cash collateral unless either the other entity consents or the court authorizes the use. If requested by the other entity, the court must prohibit or condition use of cash collateral as necessary to provide adequate protection of its interests.
The question of whether the debtor and a mortgagee both have interests in rents has been the subject of extensive litigation. Historically, debtors argued that a mortgagee did not have an interest in post-petition rents unless it had exercised its assignment of rents prior to bankruptcy. However, Section 552 of the Bankruptcy Code (dealing with the post-petition effect of liens) was amended to specifically provide that if a lender had a security interest in rents prior to bankruptcy, the security interest generally extends to post-petition rents (although there is an exception to the extent that a court orders otherwise based on "the equities of the case").
This largely resolved the dispute regarding a mortgagee's interests in post-petition rents. However, there has been continuing litigation over whether a debtor has any interest in post-petition rents, particularly in cases where there is what purports to be an absolute assignment of rents to the mortgagee.
In Madison Heights, prior to bankruptcy an assignment of rents was executed and recorded, there was a default under the mortgage, and the lender recorded a notice of default and served the notice and the assignment of rents on tenants (which was the statutory procedure for exercising an assignment of rents under applicable state law).
Thus, the lender argued that as of the petition date the debtor had no ownership interest in the right to receive rent or the actual rent payments. Only the lender owned the rights and payments. Consequently, the rental income was not property of the bankruptcy estate and was not cash...
