The Texas Legislature had an unusually busy session in 2011, passing a number of new laws affecting commercial real estate. Among the new laws is the Texas Assignment of Rents Act (TARA).

Commercial loan documents generally include an assignment of leases and rents, which give the lender interests in proceeds the borrower/landlord receives from leases covering the lender’s real estate collateral. Rather than being structured as a security agreement, the documents customarily have contained a present assignment of leases and rents by the borrower to the lender, with a license from the lender back to the borrower to collect rents unless the borrower defaults on the loan.

Attorneys dealing with the new law will need to know a little bit of background on the statute, as well as how to work with the new provisions.

First, some background. Previously, the nature of the interests granted with an assignment of rents was unsettled. Therefore, TARA constitutes a significant change, by definitively characterizing assignments of rents as conveying a security interests in the rents, rather than a presently effective assignment. This is the case regardless of any language in the assignment documents purporting to create a present assignment with a license back to the borrower.

The law is retroactive and creates a perfected security interest with the recordation of a deed of trust, regardless of whether the deed of trust contains any express assignment of rents and regardless of the wording in any separate assignment of rents.

Part of TARA’s intent, as expressed by its drafters and advocates, is to eliminate the need for a separate assignment of rents agreement. However, counsel should know that, as a practical matter, some lenders still require separate assignment of rents agreements in commercial loan document packages — typically with no modifications to their pre-TARA forms.

This is likely because the assignment of rents instrument includes a number of terms in addition to the assignment itself. For example, lenders may require borrowers to agree not to collect more than one month’s rent in advance or materially modify or terminate leases without the lender’s consent. These types of terms protect the value of the leases to the lender, and TARA doesn’t address them. Thus, many lenders still use this additional document.

At least in the short term, they may be using their standard pre-TARA forms. This puts the onus on borrowers’ lawyers to make revisions to comport with TARA. It also creates some new drafting considerations for lenders’ lawyers.

As a housekeeping matter, counsel should note that the enacted TARA legislation amends the Texas Property Code to add TARA as Chapter 64. However, Senate Bill 1368, which is unrelated, also adds Chapter 64.

It remains to be seen which new law actually will remain “Chapter 64″ and which will be renumbered. Until the permanent resident is chosen, lawyers can refer to “Chapter 64 of the Texas Property Code, commonly referred to as the Texas Assignment of Rents Act (as may be amended, renumbered or replaced, ‘TARA’).”

Forms after TARA

Lawyers might think they don’t need to substantively change the old assignment of rents forms, because TARA, in effect, steps in and modifies those existing forms to create a security interest. However, a borrower no longer can make many of the representations and covenants that are included in pre-TARA loan document forms. Following are some practical considerations related to four key elements of customary pre-TARA forms.

Present assignment . Lawyers should modify the actual assignment clause to state that the borrower grants the lender a security interest, rather than a present assignment. The assignment clause, or perhaps the meaning of the defined term referring to the collateral, likely covers the underlying leases, in addition to rents. TARA only expressly refers to rents and does not actually address the leases themselves.

However, a present assignment of leases coupled with only a security interest in rents does not make practical sense for the lender or the borrower (or the borrower’s tenants). Accordingly, if a document includes a separate reference to an assignment of leases, counsel should modify it to confer a security interest.

Limited license . This section creates the revocable license-back arrangement, letting the borrower continue collecting rents until it defaults. Lawyers should remove the granting clause, because this concept no longer applies. If this paragraph also defines the lender’s rights to collect and apply rents following “revocation” of the license, lawyers can modify this language to apply after the lender “commences enforcement of its security interests under TARA.”

Application of rents . This section also may define how the lender is to apply collected rents. TARA provides that lenders are to apply rents first to costs of enforcing the assignment of rents and then toward costs of operating the property only if the lender elects to do so or has otherwise agreed to do so.

Depending on the borrower/landlord’s common-area and maintenance obligations, this is potentially a disastrous issue for tenants and the survival of a shopping center or any office building — basically, any piece of real estate with multiple tenants for which the landlord provides a lot of services. Borrowers’ counsel should consider bargaining for application of rents (after application toward enforcement costs) to operation of the subject property as required under applicable leases. Counsel also should consider this issue when representing tenants.

Notices to tenants .TARA provides a specific procedure for lenders to follow if they want to begin collecting rents directly from tenants. Lenders must send tenants a notice substantially complying with a proscribed form setting forth the tenant’s rights. Lenders’ counsel should agree to modify references to “a notice after receipt ofwhich tenants must pay rent directly to the lender” to refer instead to “notice given in accordance with TARA.”

This list of drafting considerations is not exhaustive. Considerations for real estate lawyers will evolve as litigants test and refine TARA’s parameters. In the meantime, lenders’ counsel should revise their clients’ pre-TARA assignment of rents forms to prevent a borrower from making agreements that the borrower cannot perform under TARA.