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Default Law Requires Commercial Tenants to Pay Bank, Not Landlord

By March 4, 2011Blog, Real Estate Law

It’s no secret that, these days, many commercial property owners are having trouble meeting their mortgage payments.  If you are a tenant of such an owner in California, you should know about section 2938 of the California Civil Code (“Section 2938”).
Section 2938 requires, under certain circumstances, a commercial tenant to pay rent to its landlord’s creditor rather than its landlord.  This requirement may arise when the landlord has conditionally assigned the right to receive such rent to the creditor – normally a bank, with repayment of its loan secured by a deed of trust against the leased property.  When the landlord defaults under its obligation to the creditor – normally nonpayment on the loan – then, provided the creditor has followed the proper Section 2938 procedures, the creditor may compel the tenant to make rental payments directly to the bank.

The triggering procedures are spelled out in Section 2938.  While the statute covers a variety of remedies to enforce an assignment of rent, the focus of this discussion is the direct demand remedy – compelling a commercial tenants, upon the receipt of a simple notice from a creditor with whom it has likely never dealt before, to pay the rent to that creditor, rather than the landlord.

Direct demand notices must be in a statutorily-prescribed form. Upon receipt, the tenant is required by law to begin making rental payments to the creditor, and this obligation typically continues until receipt by the tenant of another written notice from a court or the creditor.  To provide a measure of protection to the tenant, the statute makes exceptions, such as where the tenant has previously received a Section 2938 notice from another creditor or the tenant has made a legitimate, good faith payment to the landlord within 10 days following receipt of the notice.  The statute also makes it clear that the tenant’s rental obligations are satisfied to the extent paid to a creditor in accordance with Section 2938.

Bottom line:  it is critical that any commercial tenant receiving a notice to pay rent to a 3rd-party take that notice seriously, and consult with legal counsel if there is any uncertainty about what to do next.

Scott M. Toussaint, Real Estate Group