Legal Talk – Cession of rental income, the danger of giving up too much too soon

Widespread consternation in the residential rental property market has been sparked by a September 2008 judgment of the Supreme Court of Appeal, Picardi Hotels Ltd v Thekweni Properties.

Thekweni Properties had obtained a loan from a bank to purchase immovable property.  The property was subsequently leased to Picardi Hotels.  As is usual in mortgage bond arrangements, the bond over the immovable property contained a clause in terms of which all rental income from the immovable property was ceded to the bank as additional security for the loan to Thekweni.

When Thekweni Properties sued Picardi Hotels for arrear rental, Picardi contended that as Thekweni had ceded its rights to the bank, it was only the bank which had the right to take action against it.  The Supreme Court of Appeal upheld Picardi’s argument and found that Thekweni Properties had indeed forfeited its right to sue Picardi Hotels for arrear rental. This somewhat surprising result came about because of the wording of the cession clause in the mortgage bond agreement.

The clause provided that “the Mortgagor cedes, transfers and assigns to the Bank all the Mortgagor’s rights, title and interest in and to all rentals and other revenues of whatsoever nature, which may accrue from the mortgaged property as additional security for the due repayment by the Mortgagor of all amounts owing to or claimable by the Bank at any time in terms of this bond…”

An ordinary and plain construction of this clause, the Court held, especially the use of the present tense and the inclusion of all the constituent elements of a cession, clearly and strongly indicated that the parties intended an unconditional and immediate cession of the right to the rental. The bond agreement also contained a proviso in terms of which the bank could not “act upon” the cession without the mortgagor’s consent, unless the mortgagor had breached the terms of the agreement.  This proviso, however, did not change the interpretation of the cession.  In fact, it reinforced the interpretation that the cession was immediate, as one can only “act” on a right if one is already in possession of the right concerned. The proviso therefore served only to prohibit the bank from itself suing for rental until the event of a breach by the mortgagor. Providing for an immediate cession of rental, as the bond agreement did, creates a few practical problems, some of which the Court discussed.

The first involves collection of the rental.  Thekweni argued that on the Court’s interpretation it would be barred from collecting rent; only the bank would be permitted to do so.  The Court disagreed, holding that this was a question of mandate and that there was no practical bar to the bank permitting the debtor to collect the ceded rentals on its behalf.

While this may be so, it is not apparent from the judgment whether the bond agreement contained a clause mandating Thekweni to collect the rent, although this may be implied from the proviso preventing the bank from “acting upon” the cession.  What the Court did not consider, however, is a different possible situation where Picardi, learning of the cession, chose to pay the rental directly to the bank, as it would be entitled to do, thus bypassing Thekweni.  Because the rental income had been ceded, Thekweni would not have a claim against Picardi and, because the cession is immediate, Thekweni would also not be in a position to claim the rental from the bank.

A second problem the Court considered was that of instituting action for unpaid rental.  In order for Thekweni to institute a claim it would have to obtain a recession of the claim from the bank.  In order for the bank not to lose its security, however, the recession would itself have to be subject to a clause ceding the recovered amount and any future amounts paid in rent back to the bank.  The arrangement becomes quite unwieldy.

 In addition, unless the bond agreement itself provides for the recession to the mortgagor in the event of non-payment of rent, there would be a delay before summons could be issued as the recession documents would first have to be completed.  This delay would be to the advantage of the defaulting tenant. The judgment therefore presents a somewhat technical defence, which shrewd tenants seeking to delay proceedings may be able to raise to claims for arrear rental from landlords.  It must be said, however, that the practical problems which this judgment gives rise to are not the fault of the Court, but arise rather from the wording of the mortgage bond agreement in question.

Mortgagors who have rented out bonded property should therefore examine their bond agreements carefully to establish whether any cession of rental contained provided for in the agreement is an immediate and unconditional cession or not.  If it is, that landlord would do well to obtain a written mandate from the bank authorising it to collect the rentals, in so far as the authorisation is not clearly provided for in the bond agreement. In addition, the landlord should conclude the necessary recession agreement before the tenant defaults on rent or, alternatively, should obtain a written mandate from the bank authorising the landlord to sue the tenant for arrear rental until such time as the mandate is cancelled. 

For those who are yet to enter into bond arrangements on property which is to be rented out, or who are in a position to renegotiate bond agreements on rented property containing the offending clause, the following steps may be worth considering:

Where the bank wishes to have an immediate and unconditional cession of rental income, it may be worth including a clause in the bond agreement in terms of which the bank mandates and, if necessary, compels, the landlord to sue for arrear rental in its own name on the bank’s behalf.  The mortgagor may also wish to protect itself by including a clause in terms of which any rental paid directly by the tenant to the bank will reduce the mortgagor’s ordinary and usual liability to the bank for that period.

 

Where a mortgagor’s ability to service a bond has been assessed without taking the rental income into account, it may be wise to provide for a cession of rental income which only takes effect upon breach of the bond agreement by the mortgagor.

 

Courtesy: Kevin Iles from Bowman Gilfillan

Search By Reference


NEWSLETTER SUBSCRIBE

Stay updated on the latest Property News

Contractor Find - The Smart Way to Find Your Contractor