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?
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.
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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 sales contract.
There’s a take-away from this answer that goes beyond yours truly.
People who are buying bank-owned properties might assume that they’re entitled to any back rents that were due after the foreclosure and were 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 sales contract give them the right to collect it.