Under a typical loan agreement, the lender provides cash to the borrower in exchange for a promise to pay the funds back with interest. The lender will typically also require some form of collateral as security for the promise to pay (i.e. if the borrower defaults on their obligation to pay, the lender gets to keep the collateral).
Most of the time the collateral is real estate encumbered by a lien of mortgage. It is also possible to pledge payments the borrower receives from a third party as collateral for their own loan. This becomes more clear in an example.
Collateral Assignment Example
John owns Lot 1. After purchasing the property, John borrows money from WP Investment Company and gives them a mortgage (lien on the real property) on Lot 1. This leaves WP Investment Co. with a security/asset/stream of payments coming in from John via the “Promissory Note” and lien of “Mortgage”. Let’s call John the “Original Borrower” and WP Investment Co. the “Original Lender”.
WP Investment Company owns Lot 72 – a risky commercial property. WP Investment Company is looking to borrow money from Bank of New York. The Bank is willing to loan WP money, but requires some additional security to compensate for the riskiness of the property. WP discloses that they have payments coming in from John (via the mortgage on Lot 1), and they’d be willing to pledge this to the Bank as additional security/collateral for the loan. Among other titles, WP would be known as the “Collateral Assignor” and Bank of New York would be both the “Collateral Assignee” and the “Collateral Lender”.
Keys to a Collateral Assignment
It is important to note that the Mortgage is not assigned to the Collateral Lender (it’s not an Assignment of Mortgage). Rather, the promissory note is what is assigned to the Collateral Lender (and should be physically delivered/possessed by them). This means that the loan is basically split in two, with the interest in the real property (Mortgage) remaining with the Original Lender and the personal property interest (Promissory Note) transferred to the Collateral Lender. Despite this (and as detailed below), satisfying and foreclosing the mortgage should be handled by both parties – as they both have interests in the underlying loan.
How to Satisfy a Collaterally Assigned Mortgage
There are two options when seeking to release a mortgage that has been subsequently collaterally assigned:
- Get a satisfaction of mortgage from both the Collateral Assignor and the Collateral Assignee. Both have an interest in the mortgage being satisfied, therefore, both are required to release it.
- Get a Collateral Assignment from the Collateral Assignee back to the Collateral Assignor (from Bank of New York back to WP Investment Co., in the above example). Then get the Satisfaction of Mortgage only from the original lender/Collateral Assignor (WP Investment Co, in the above example).
There are two foreclose scenarios to consider: 1) A default of the Original Borrower, or 2) A default of the Collateral Assignor.
A default of the Original Borrower will require both the Original Lender and the Collateral Lender/Assignee as co-plaintiffs to the foreclose proceedings. The property would then be either co-owned or divided pursuant to their interests in the real/personal property. Alternatively, the Collateral Lender could assign their interest back to the Original Lender – with the Original Lender then foreclosing out the property.
A default of the Collateral Assignor will not substantively affect the Mortgage. The Collateral Lender would be able to pursue its rights under the promissory note (under the Uniform Commercial Code, as the UCC governs personal property), possibly taking over the Original Lender’s interest in the Mortgage. This would leave the Mortgage still intact.
Insuring a Collateral Assignment of Mortgage
While the Collateral Lender/Collateral Assignee was not assigned the Mortgage, they do have an interest in it (as they hold the promissory note/obligation secured by the Mortgage). Therefore, the loan policy insuring the Mortgage may be endorsed or a new loan policy may be issued altogether. Most underwriters will allow either of the following:
- The Collateral Assignee to be listed as the only party insured. This would also require an exception for any rights the Collateral Assignor may have in the underlying mortgage.
- Both the Collateral Assignee and Collateral Assignor to be listed as the insured parties.
Collateral Assignment of Mortgage Form
Download a copy here.
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When Lenders consider their real property security options, their analysis should go beyond simply taking a mortgage from a debtor who owns real estate. A debtor’s interest in real property leases (whether as landlord or tenant) means a Lender should obtain either an Assignment of Lease or a Mortgage of Lease as additional security. Like any other specific security agreement, these agreements facilitate the orderly and more effective enforcement of the Lender’s security in the underlying debtor asset.
Assignment of Lease
In cases where the debtor owns real property but does not occupy it, the revenue stream from third party leases is a significant asset that should be secured. Although most mortgage standard charge terms include at least a brief paragraph related to assignment of leases, they do not provide the benefit of the more fulsome provisions typically contained in a stand alone specific Assignment of Lease (in cases where there may be a significant tenant) or a general Assignment of Lease (securing all present and future leases without reference to a specific tenant).
The debtor’s interest as landlord is secured by registration against title to the debtor’s real property, typically immediately following the registration of the mortgage of land. It should be noted that in order to register a specific Assignment of Lease, there first requires the registration of a Notice of Lease in respect of the lease that is being specifically assigned. The Assignment of Lease also has a personal property component that cannot be overlooked. The rents and leases that are secured by the Assignment of Lease fall within the definition of personal property under the personal property security legislation; and as such require the registration of a financing statement against the debtor.
An Assignment of Lease document includes certain generally accepted provisions.
The debtor assigns to the Lender (as collateral security for the payment of principal and interest under the mortgage of land) all rents and other monies due to it by tenants and the benefit of all tenant covenants under all current and future leases.
The debtor covenants to not collect rent more than one month in advance (to ensure that the normal revenue stream is available to the Lender on enforcement) and to not amend any material terms of the leases without the Lender’s approval. In the case of a specific Assignment of Lease, it is prudent to also obtain similar covenants from the tenant itself and an acknowledgement that the tenant will attorn to the Lender in the event of default by the debtor.
The debtor is permitted to continue to collect rent according to the terms of the leases until an event of default occurs pursuant to the mortgage of land, after which the Lender may give notice to the tenants to pay all future rents to the Lender directly.
Mortgage of Lease
In cases where the debtor does not own real estate but rents space instead, the right to occupy the premises may be a key asset of the debtor that should be secured. Although it is typical that a general security agreement includes a reference to leasehold interests in the description of the charged collateral, the general security agreement does not provide the benefit of the more complete language in a stand alone specific Mortgage of Lease document.
The debtor’s interest as tenant is secured by registration against title to the debtor’s leasehold interest in the real property. This requires the prior registration of a Notice of Lease in respect of the lease that is being secured.
It should be noted that if there is a real property mortgage on title granted by the owner/landlord to another lender prior to the lease, and if the tenant/debtor or tenant’s lender has not obtained a non-disturbance agreement from the owner/landlord, the Mortgage of Lease will be no better security than the lease itself (i.e., subject to being terminated at the option of the prior mortgagee in the event of default under the real property mortgage). Most leases will contain a prohibition against mortgaging the lease, so it will be necessary to obtain the landlord’s consent to a Mortgage of Lease in those cases.
A Mortgage of Lease document typically contains some basic provisions.
As in a mortgage of land, the Mortgage of Lease specifies a principal amount, interest rate, payment dates, and contains charging language whereby the debtor’s leasehold interest is security for payment of the principal and interest.
Similarly, in the event of default, the Lender has the ability to exercise a power of sale and sublease or assign the leasehold interest to a third party.
The debtor covenants to not pay rent more than one month in advance, to not amend any material terms of the leases without the Lender’s approval, to not terminate or surrender the term of the lease and to hold possession of the premises in trust for the Lender.
Most Lender mortgage standard charge terms contain flexible language that contemplates the use of the terms for both cases where the chargor owns a freehold interest in the property or a leasehold interest in the property.
So please consider an Assignment of Lease or Mortgage of Lease as part of your security package. We would be pleased to assist you with these documents.