Opinion ID: 2544655
Heading Depth: 2
Heading Rank: 2

Heading: HNB was legally entitled to the subtenant rents until Bishop Estate activated its implied assignment.

Text: The majority acknowledged that HNB had an enforceable, legal right to the subtenant rents pursuant to the assignment of rents provisions. 99 Hawai`i at 345, 55 P.3d at 838. However, the majority held that, because HNB did not have possession of the property and because foreclosure is an equitable action, Bishop Estate's right to payment of the ground rent based on the Commissioner's equitable duty to preserve the property was superior to HNB's legal right. In its application for a writ of certiorari, HNB argues that its legal right under the assignment of rents provisions was superior to any claim that Bishop Estate had to the subtenant rents because Bishop Estate consented to the mortgages. In its response to HNB's application, Bishop Estate argues that it had legal priority to the subtenant rents based on the terms of its consent to HNB's mortgages. The consent instruments executed by Bishop Estate provide that should there be any conflict between the terms of said leases and the terms of said Mortgage, the former shall control, and that nothing herein shall be construed as being a waiver of any of the terms, covenants and conditions of said leases. Although Bishop Estate acknowledges that the leases did not purport to assign any rights to subtenant rents, in its view, the covenant to pay the ground rent was in conflict with HNB's assignment of rents and, therefore, the covenant to pay rent should control. It has been recognized that if the prime tenant is insolvent the head landlord may resort to the subrents and has a preference therein ahead of other creditors of the prime tenant-to the extent necessary to satisfy the prime tenant's liability under the head lease. 1 Milton R. Friedman, Friedman on Leases § 7.701 at 410 (4th ed.1997) (citing Central Manhattan Properties, Inc. v. D.A. Schulte, Inc., 91 F.2d 728 (2d Cir.1937); Young v. Wyatt, 130 Ark. 371, 197 S.W. 575 (1917); City Inv. Co. v. Pringle, 69 Cal.App. 416, 231 P. 355 (1924), later decision, 239 P. 302 (Cal. App.1925); S.S. Kresge Co. v. Twelve Seventy-Five Woodward Ave. Corp., 270 Mich. 218, 258 N.W. 252 (1935); Shaw v. Creedon, 133 N.J. Eq. 397, 32 A.2d 721 (1943); 49 Am. Jur.2d Landlord and Tenant § 1184 (1995 rev.) (some citations omitted)). [4] Friedman also states: A lease that contemplates subletting by the prime tenant generally includes a collateral assignment of subrents to the prime landlord, the assignment to become effective on default under the prime lease or its termination for breach. This assignment has been assimilated to the rent pledge included in mortgages in those states that follow the lien theory of mortgages. Following this mortgage rule, it is held that mere nonpayment of rent by the prime tenant is insufficient to activate the assignment. Id. at 412, 32 A.2d 721 (citing Childs Real Estate Co. v. Shelburne Realty Co., 23 Cal.2d 263, 143 P.2d 697 (1943); Lincoln Crest Realty, Inc. v. Standard Apartment Dev. Co., 61 Wis.2d 4, 211 N.W.2d 501 (1973)) (emphasis added). In Childs, the Bank of America National Trust and Savings Association (Bank) was the successor trustee to a trust indenture executed by lessee Shelburne Realty Company (Shelburne). [5] After Shelburne defaulted on the loan, Bank appointed Shelburne its agent to collect the subtenant rents and manage the building. Shelburne and Bank agreed that these monies belonged to Bank. Shelburne subsequently defaulted on its lease and the lessor, Childs Company of Providence (Childs), served a notice of default and, later, a notice of termination of the lease. 143 P.2d at 698-99. The lease provided, inter alia, that the rent shall be a first lien and superior to an incumbrance created by lessee ... upon all rents[ .] Id. at 699. The trust indenture was subject to terms and conditions of the lease. Id. The California Supreme Court stated that a lessor's claim to subtenant rents is akin to that of a mortgagee. The lessor has an equitable lien or security interest but, unless the lease provides otherwise, equitable action is necessary to make the lien operative. Id. (citations omitted). Thus, the court held that Childs' right to the subtenant rents did not accrue until Childs obtained possession of the property; Bank was entitled to keep the subtenant rents it had collected until Childs took possession. Id. at 700. The Wisconsin Supreme Court reached a similar result in Lincoln Crest. Lincoln Crest Realty, Inc. (Lincoln) leased Lincoln Crest Apartments to Standard Apartment Development (Standard). Standard assigned its subtenant rents to Lincoln. [6] As security for a loan from Midland National Bank (Midland), Standard assigned its rights under the lease to Midland. However, the assignment expressly stated that the assignment of subtenant rents was subordinate to Lincoln's rights to those rents. According to Lincoln, it terminated Standard's lease on January 26, 1971. On February 2, 1971, Lincoln filed a complaint for a declaration that the lease had been terminated or a judgment terminating the lease and an order directing Standard to surrender the premises. The next day, Midland was served with the complaint and an order restraining it from expending any subtenant rents. At that time, Standard had $24,002.47 in its operating account at Midland. Midland offset this amount with the balance owed by Standard under its note as of September 28, 1970. 211 N.W.2d at 503-04. The court held that the lessor could only gain the right to the rents and profits of the real estate by the appointment of a receiver for that purpose, by taking actual possession of the property, by a declaration of constructive possession by a court order, or by the court's declaration of the lease termination date. Id. at 504-05. Although Lincoln had a contractual right to the subtenant rents, the right did not take effect until it gained actual or constructive possession of the property or secured the appointment of a receiver. Id. at 505. Therefore, the funds deposited in Standard's account prior to the lease termination date belonged to Standard and were subject to Midland's offset. Only rents and profits derived after the termination were subject to Lincoln's assignment. Id. at 506. In the present case, Bishop Estate's lease did not have an assignment of rents provisions. However, Bishop Estate's interest in the subtenant rents is implied pursuant to the general principle that a lessor has a preference in the subtenant rents over the lessee's creditors. See supra. We agree with the court in Childs that, absent express language to the contrary in the lease, a lessor's interest in the subtenant rents is akin to that of a mortgagee's interest. Thus, when Bishop Estate became able to enforce its rights to the subtenant rents depends upon whether its implied assignment of rents is viewed as an absolute assignment or the assignment of a security interest. As noted by the ICA, an absolute assignment of rental proceeds is self-executing; it gives the assignee immediate title to the rental proceeds but postpones their collection until a certain event occurs, such as the assignor's default. 99 Hawai`i at 343, 55 P.3d at 836. In contrast, an assignment of a security interest does not pass title to the rental proceeds and is not self-executing. The assignee has a lien on the rental proceeds that can be enforced once the assignee takes certain actions. The assignee obtains the right to collect the rents by obtaining possession of the premises, securing the appointment of a receiver, or by taking some other equivalent action, such as giving notice to the assignor or the subtenants that it is enforcing its right to the rents or by sequestering the rents. Id. at 343-344, 55 P.3d at 836, 837. States vary as to whether and when they recognize each type of assignment. Id. at 344-345, 55 P.3d at 837, 838. This state has never addressed what is necessary to create either an absolute assignment or an assignment of a security interest. However, Hawai`i mortgage law is based on the lien theory, FHLMC v. Transamerica Ins. Co., 89 Hawai`i 157, 164, 969 P.2d 1275, 1282 (1998), and absolute assignments are generally disfavored in lien theory jurisdictions. (See 12 Thompson on Real Property § 101.02(c)(3) at 365 (David A. Thomas ed., 1994) ([t]he usual view in lien theory jurisdictions seems to be that the clauses, even if worded as absolute assignments, create a type of security interest which is not self-executing)). The Texas Supreme Court has stated: Courts have been reluctant to construe assignment of rentals clauses to operate as absolute assignments. The public policy embracing the rule was articulated by Justice Augustus Hand in Prudential Insurance Company of America v. Liberdar Holding Corp., 74 F.2d 50 (2d Cir.1934): It seems unlikely that mere words of assignment of future rents can entitle a mortgagee to claim rentals which have been collected by a mortgagor and mingled with its other property. Sound policy as well as every probable intention should prevent a mortgagee from interfering with the mortgagor's possession until the mortgagee takes steps to get the rentals within his control. To hold otherwise would be to impose unworkable restrictions upon industry in cases where mortgagors have been led to suppose that they might rightfully apply the rentals to their own business. It has also been felt that to construe the clause as an absolute assignment of rents would impose no duty upon the mortgagee to collect rents, and gives the mortgagor no assurance that the mortgagee would collect them and apply them to the debt. Osborne, G., Mortgages (2d ed.1970) § 150 at 252. Taylor v. Brennan, 621 S.W.2d 592, 594 (Tex. 1981). The United States Court of Appeals for the Fifth Circuit has also recognized that absolute assignments are inconsistent with the expectations of the assignor, who may hope to have a chance to negotiate informally after experiencing financial difficulties. FDIC v. International Property Management, Inc., 929 F.2d 1033, 1036 (5th Cir. 1991). Thus, the United States Court of Appeals for the Fifth Circuit noted that [b]ecause an absolute assignment generally is not intended by the parties, Texas, for public policy reasons, requires especially clear evidence that the parties intended to create such an assignment. Id. We agree that public policy weighs against construing assignment of rents clauses as absolute assignment absent a clear indication that the parties intended to create one. Therefore, we hold that, where a lessor has an implied assignment of subtenant rents, it shall be construed as an assignment of a security interest. Because the lessor's right to the subtenant rents is not self-executing, some action is necessary before the right is perfected. [7] For example, the lessor may obtain either actual or constructive possession of the property or secure the appointment of a receiver. See Lincoln Crest, 211 N.W.2d at 504-05. Until the lessor takes action to activate the assignment, an intervening creditor with a perfected assignment of rents will be entitled to collect the rents, even though the rents were subject to the lessor's assignment at the time the creditor obtained its assignment. However, once the lessor perfects its assignment, the lessor has priority over the intervening creditor from the date of perfection. Cherkis & King, supra note 7, at ¶ 2.03[1][c][iv] at 2-106.5 (citations omitted). In the present case, because the leases did not have an assignment of rents clause, Bishop Estate had only an implied security interest assignment in the subtenant rents. HNB's mortgages had assignment of rents clauses and, as noted by the ICA, whether they were absolute assignments or assignments of a security interest, HNB had a present right to collect the subtenant rents. 99 Hawai`i at 344-345, 55 P.3d at 837, 838. Therefore, HNB had an enforceable right to the subtenant rents until Bishop Estate took the necessary action to perfect its interest. Accord Childs, supra, and Lincoln Crest, supra . Bishop Estate filed a motion for the appointment of a receiver and, had the motion been granted, Bishop Estate's interest would have been perfected. However, the circuit court denied the motion and the record on appeal does not indicate the basis for the court's decision. In its memorandum in opposition to Bishop Estate's motion, HNB argued that Bishop Estate was not entitled to the appointment of a receiver because: Bishop Estate did not have a legal right to the subtenant rents; the requirements of Oyama v. Stuart, supra , were not met; and Bishop Estate's only remedy was to petition the circuit court for the establishment of a rent trust. Thus, until Bishop Estate perfected its interest in the subtenant rents, HNB was entitled to collect the rents and apply them to the amounts owed on the notes. Contrary to HNB's argument, however, Bishop Estate was entitled to the appointment of a receiver to collect the subtenant rents and the circuit court erred in denying the motion. As previously discussed, Bishop Estate's only remedy was to petition the circuit court for the establishment of a rent trust, but it was not entitled to receive the monies until it perfected its interest. The appointment of a receiver would have perfected Bishop Estate's interest in the subtenant rents and given it priority over HNB's interest. The circuit court entered an order erroneously denying Bishop Estate's motion on November 3, 1997. Oyama states that: As a basis for the appointment of a receiver, the plaintiff must show, not only that he has an interest in or right to the fund or property, but that the possession of the property by the defendant was obtained by fraud; or that the property itself, or the income arising from it, is in danger of loss from the neglect, waste, misconduct or insolvency of the defendant. 22 Haw. at 698 (citation and internal quotation marks omitted). Finally, HNB argued that the appointment of a receiver was improper because Bishop Estate had a specific remedy available to it under HRS § 521-78 (1993). [8] However, HRS Chapter 521 is the Residential Landlord-Tenant Code, see HRS § 521-1 (1993) (emphasis added), and, therefore, does not apply in the present case involving commercial properties. Contrary to HNB's argument, the circuit court erred in denying Bishop Estate the appointment of a receiver. Oyama points out that one of the bases of appointing a receiver is an interest in the property and that the income arising from it[] is in danger of loss from ... insolvency of the defendant[.] Id. at 698. Because the prime lessee became insolvent, Bishop Estate was entitled to the appointment of a receiver to collect the subtenant rents. The appointment of a receiver would have perfected Bishop Estate's interest in the subtenant rents and given it priority over HNB's interest. The circuit court entered an order erroneously denying Bishop Estate's motion on November 3, 1997. Therefore, we deem Bishop Estate's interest in the subtenant rents to have been perfected on that date. HNB was entitled to the subtenant rents accrued and collected prior to November 3, 1997 and Bishop Estate was entitled to the rents from November 3, 1997 until the termination of the leases.