It is an all too common scenario these days with mortgage foreclosures still commonplace in Chicago: someone leases a single family home or condominium unit (used for residential purposes) from the then owner of the property. Subsequent to this lease being executed and the tenant taking possession, the owner goes into default on his or her mortgage, the owner’s lender, i.e., a bank, files a judicial foreclosure action and, as is often the case, the bank becomes the owner of the property. Typically in these scenarios the bank will have a court appointed receiver manage the property during the foreclosure process and/or hire a manager subsequent to the foreclosure process to manage the property and address any tenant issues.
As the lease nears expiration, the tenant, who is likely aware of the foreclosure, inquires of the former owner and the bank, as to the status of his or her security deposit (which, for higher-end properties in Chicago, can easily exceed $5,000.00). The former owner, if they respond at all, tells the tenant about the foreclosure and that the former owner has no assets in any event, and that the tenant should contact the bank to get their security deposit. Upon contacting the bank, the bank responds that the former owner’s security deposit was never transferred to it during the course of the foreclosure or at any other time, and that the tenant should seek the return of their security deposit from the former owner. A conundrum is afoot. Is the tenant simply out of luck? The answer to this question has not been specifically addressed by the Illinois courts; however, the Chicago Residential Landlord and Tenant Ordinance (RLTO) likely gives us the answer, and it is not good for the bank.
The RLTO has long been the bane of many landlords’ existence in the City of Chicago, but it could quick become a thorn in the side of foreclosing lenders as well.
According to the City, the purpose of the RLTO is “to protect and promote the public health, safety and welfare of [the City of Chicago’s] citizens, to establish the rights and obligations of the landlord and the tenant in the rental of dwelling units, and to encourage the landlord and the tenant to maintain and improve the quality of housing.” (RLTO, Section 5-12-010).
In our situation above (which is, by the way, a real life situation), the tenant realizes that his former landlord is still liable under the RLTO for the security deposit. At the same time, however, the tenant understands that the former landlord is unlikely to have the security deposit and unlikely to have the assets to satisfy a judgment if the tenant were to sue the former landlord under the RLTO. Therefore, the tenant looks to the bank for the return of his or her security deposit.
Unfortunately for the bank, the RLTO does appear to cover this set of facts and subject the bank to liability for the return of the security deposit. In fact, not only can the bank be liable to the tenant for the return of his or her security deposit but, like any landlord, the bank can be subject to severe penalties should it fail to comply with the relevant terms of the RLTO with respect to the security deposit. The liability stems from the RLTO defining “landlord” as including the original landlord’s successor in interest, i.e., the bank in this instance.
Based on the provisions of the RLTO, whether or not the bank received the security deposit from the original landlord, it would be liable to the tenant for the maintenance and return of the security deposit.
Section 5-12-80(e) of the RLTO further provides that:
[t]he successor landlord shall, within 14 days from the date of such transfer, notify the tenant who made such security deposit by delivering or mailing to the tenant’s last known address that such security deposit was transferred to the successor landlord and that the successor landlord is holding said security deposit. Such notice shall also contain the successor landlord’s name, business address, and business telephone number of the successor landlord’s agent, if any. The notice shall be in writing.
If the bank fails to follow these precise requirements, it would further violate the RLTO. In terms of penalties for violation of the RLTO, the bank is subject to strict liability damages in an amount equal to two times the security deposit plus interest and attorneys’ fees and costs.
The bank is now left with the option to defend a lawsuit initiated by the tenant, which the tenant has a likelihood of winning and to then being awarded his or her attorneys’ fees and costs, or coming out of pocket for the security deposit, thereby hopefully being able to negotiate with the tenant to avoid the severe penalties imposed by the RLTO.
Any lender foreclosing on a property covered by the City of Chicago RLTO would be well-advised to become familiar with the ordinance and do everything possible to comply with its terms.
For more information, please contact:
Jonathan Weis at: firstname.lastname@example.org or 312-368-0100.
In the purchase and sale of real property which is leased to tenants, sellers and purchasers must pay particular attention to the allocation of rent collected both before and after the closing. A typical purchase and sale agreement will include, among other things, language addressing the allocation of rent by the parties for the current period as well as the collection of delinquent rent after closing which is attributable to the seller’s period of ownership prior to closing. In negotiating a contract, the parties will need to determine whether the purchaser is responsible for attempting to collect pre-closing delinquent rents and the rights of the seller to pursue tenants after closing for any such pre-closing delinquent rents.
Collection of pre-closing delinquent rent can be a complicated issue for purchasers and sellers to resolve. On the one hand, the purchaser may be reluctant to allow the seller to undermine the financial condition of a tenant by pursuing lawsuits against a tenant that may be paying current rent to the new landlord. On the other hand, a former owner does not have a full range of typical landlord remedies at its disposal to effectively induce tenants to pay delinquent rent as the former owner cannot assert an eviction action against a tenant and terminate the tenant’s right of occupancy.
The tension between purchasers and sellers with respect to pre-closing, delinquent rent is further complicated by a recently decided opinion issued by the Illinois Appellate Court in 1002 E. 87th Street LLC v. Midway Broadcasting Corporation (2018 IL.) App. 1st 171691, June 5, 2018). In that case, the Court upheld a lower court ruling that Illinois law does not permit the purchaser of real estate to pursue claims against a tenant for pre-closing, unpaid rent under a lease assigned to the purchaser at closing. The purchase and sale agreement between the purchaser and seller in that case contained standard provisions confirming that the “landlord” under the lease included any successors and assigns. It also provided that all obligations and liabilities of the original landlord were binding on the purchaser, as successor landlord. That would include any pre-closing landlord defaults that remained uncured. Notwithstanding the successor landlord’s assumption of the lease, including, potential liability for pre-closing defaults of its predecessor, the Court ruled that the successor landlord did not have the right to recover pre-closing rent. The Court specifically stated that the rule in Illinois is that rent in arrears is not assignable.
The lesson to be learned from the 1002 E. 87th Street case is that it is important to negotiate and set the expectations of the parties with respect to pre-closing delinquent rents at the time of contract. Since a predecessor landlord may have little power other than initiating litigation (which is not desired by the successor landlord) against a tenant for delinquent rent and the successor landlord is unable to maintain an action for that delinquent rent, parties must give careful thought to the method of addressing the collection of pre-closing delinquent rent. Fortunately, there are a number of different approaches that the parties may employ to coordinate and enhance the collection of pre-closing, delinquent rent.
For further information regarding the purchase and sale of commercial real estate as well as matters involving the rights of sellers, purchasers and tenants, please contact:
email@example.com or 312-368-0100.