My Japanese Debtor Leased Out Mortgaged Property. Can I Claim the Rent?

Japanese Attorney at Law - Bengoshi L.L.

• 10 min read

When a debtor defaults on a loan secured by a mortgage over leased real property, the lender (mortgagee) naturally looks to all available sources of recovery. Beyond the eventual sale of the property itself, the rental income stream it generates can be a significant asset. In Japan, mortgagees have established rights to access these rents, but the legal pathways and their effectiveness, especially when other creditors or insolvency proceedings are involved, require careful navigation. This article explores the primary methods through which a mortgagee in Japan can claim rental income from a mortgaged property: the right of subrogation to rent (物上代位 - butsujō daii) and the more structured "Secured Real Property Earnings Execution" (担保不動産収益執行 - tanpo fudōsan shūeki shikkō).

The Mortgagee's Underlying Right to Fruits (Rent)

The foundation for a mortgagee's claim to rent lies in the Japanese Civil Code. Article 371, as amended in 2003, clarifies that a mortgage extends to the "fruits" of the mortgaged real property that accrue after the mortgagor (debtor) has defaulted on the secured obligation. "Legal fruits" (hōtei kajitsu - 法定果実) explicitly include rent. This provision provides the substantive legal basis for a mortgagee to assert a claim over the rental income stream once the borrower is in default.

Claiming Rent via Subrogation and Attachment (Butsujō Daii)

One of the primary traditional methods for a mortgagee to reach rental income is through the exercise of a right of subrogation (butsujō daii), as provided by Article 304 of the Civil Code (which applies to mortgages via Article 372). This article allows a lienholder, including a mortgagee, to exercise their rights over money or other things that the debtor is entitled to receive due to the sale, lease, or loss of the collateral. In the context of leased property, this means the mortgagee can claim the rent owed by the tenant to the mortgagor.

To effectively exercise this right with respect to rent:

  • The mortgagee must attach (差し押さえる - sashiosaeru) the specific rent payment(s) before the tenant pays the mortgagor or before the mortgagor validly transfers the rent claim to a third party who perfects their rights. This attachment is a court procedure.

The development of case law around this right has been crucial:

The "Perfection Standard Theory" (登記基準説 - Tōki Kijun Setsu)

A landmark Supreme Court judgment on January 30, 1998 (Heisei 10), significantly clarified the priority rules when a mortgagee attempts to attach rent via subrogation, and another party (e.g., another creditor of the mortgagor) has taken an assignment of the same future rent from the mortgagor. The Court held that priority between the mortgagee and the assignee of the rent is determined by comparing the date of the mortgage registration against the date of perfection of the rent assignment (typically, notice with a certified date to the tenant, or the tenant's consent with a certified date).

  • If the mortgage was registered before the rent assignment was perfected, the mortgagee's subsequent attachment of the rent (via subrogation) would generally prevail over the assignee's claim to that rent.
  • Conversely, if the rent assignment was perfected before the mortgage was registered (a less common scenario for pre-existing mortgages), the assignee would have priority.

This "perfection standard theory" (or "registration standard theory") effectively means that a registered mortgage puts the world on notice of the mortgagee's potential claim to future fruits like rent, and subsequent dealings with those rent claims by the mortgagor are subordinate. The act of attachment under Article 304, in this context, was re-characterized by the Court not as the act that creates priority over other claimants to the rent, but primarily as a necessary step to specify the claim being exercised and to protect the tenant (the third-party obligor) from the risk of having to pay twice (once to the mortgagor/assignee and again to the mortgagee). This principle was further affirmed in related contexts, such as a conflict between a mortgagee exercising subrogation and another creditor who had merely attached the rent (Supreme Court, March 26, 1998 (Heisei 10)).

Scope and Limitations of Subrogation to Rent

While powerful, the mortgagee's right to subrogate to rent has been further defined and limited by subsequent case law:

  • Against Tenant's Set-Off Rights: A tenant generally cannot set off claims against the mortgagor (landlord) that the tenant acquired after the mortgage was registered, against rent payments that also accrued post-registration and are being claimed by the mortgagee via subrogation (Supreme Court, March 13, 2001 (Heisei 13)). This strengthens the mortgagee's access to the gross rental stream, unimpeded by later-arising cross-claims between the landlord and tenant.
  • Sub-Lease Rents: A mortgagee's right to claim rent from the original tenant (the mortgagor's lessee) does not automatically extend to rents payable by a sub-tenant to that original tenant. Direct subrogation to sub-rents is generally not possible unless the original tenant's position is such that they can be legally equated with the owner/mortgagor for these purposes (Supreme Court Decision, April 14, 2000 (Heisei 12)).
  • Need for Separate Attachment: If multiple mortgagees wish to exercise subrogation rights over the same rental stream, or if another creditor has already attached the rent, a mortgagee cannot simply join the existing attachment by way of a demand for distribution. They must initiate their own separate attachment procedure under Article 304 to establish their claim to the rent (Supreme Court, October 25, 2001 (Heisei 13)).
  • Priority versus Assignment Order (Tenpu Meirei): If an unsecured creditor not only attaches the rent but also obtains an "assignment order" (tenpu meirei - 転付命令, a court order effectively transferring the specific rent claim to them in satisfaction of their debt) which becomes final and conclusive before the mortgagee has effected their own attachment of that rent via subrogation, the creditor with the finalized assignment order will generally prevail for that specific rent. The prior registration of the mortgage alone does not automatically defeat a perfected assignment order for specific, accrued rent payments if the mortgagee has not yet taken the step to attach those particular rental payments (Supreme Court, March 12, 2002 (Heisei 14)).
  • Tenant Security Deposits (Shikikin - 敷金): The mortgagee's right to rents collected via subrogation is subject to the tenant's rights concerning their security deposit. Upon termination of a lease, a tenant is entitled to have their security deposit applied against any unpaid rent or damages. The mortgagee's claim to rent is effectively on the net amount after accounting for the tenant's legitimate claims against the security deposit (Supreme Court, March 28, 2002 (Heisei 14)).

Criticisms of Broad Subrogation to Rent

Despite its utility for mortgagees, the broad application of butsujō daii to rents has faced criticism, including:

  • It can significantly deplete the assets (rental income) that would otherwise be available to the mortgagor's general unsecured creditors.
  • If all rental income is diverted to the mortgagee without adequate provision for property upkeep, it can lead to the deterioration of the mortgaged property, harming its long-term value.
  • Priority among multiple mortgagees can become complicated. The "first to attach the rent" often gains priority for that specific rental payment, which may not align with the seniority of their mortgage on the property itself unless all senior mortgagees also diligently attach the rents.

The Secured Real Property Earnings Execution (Tanpo Fudōsan Shūeki Shikkō) – A Dedicated Procedure

Recognizing some of the limitations and potential inequities of relying solely on the general subrogation and attachment mechanism, the 2003 amendments to the Civil Execution Act introduced a specialized procedure: the "Secured Real Property Earnings Execution" (Articles 180-188).

Purpose and Mechanism:
This procedure provides a court-supervised method for mortgagees (and other specified secured creditors) to obtain satisfaction of their secured debt from the income generated by the mortgaged real property, primarily rents. It can be used as an alternative to, or sometimes in conjunction with, a foreclosure sale of the property itself.

  1. Petition: The mortgagee files a petition with the execution court.
  2. Administrator Appointment: If the requirements are met, the court appoints an administrator (kanrinin - 管理人).
  3. Management and Collection: The administrator takes over the management of the property, collects rents and other income, pays necessary property management expenses (including taxes, insurance, and urgent repairs).
  4. Distribution: The net income collected by the administrator is then distributed to the petitioning mortgagee and any other secured creditors entitled to participate according to their priorities.

Relationship with Foreclosure Sale:
An earnings execution can be initiated even if a foreclosure sale is not immediately contemplated. If a foreclosure sale is initiated or concluded while an earnings execution is ongoing, the earnings execution is typically terminated once the property is sold and the purchaser pays the price.

Relationship with Butsujō Daii (Art. 304 Attachment):
The earnings execution procedure is designed to be a more comprehensive and orderly way to manage and distribute rental income compared to individual Art. 304 attachments.

  • If an earnings execution proceeding is commenced by one mortgagee, it generally takes precedence over individual Art. 304 rent attachments by other mortgagees concerning rents covered by the administration.
  • A mortgagee who had already attached rents under Art. 304 before an earnings execution commenced may see their attachment suspended, but they would typically be entitled to receive distributions from the earnings execution proceeding based on their priority (Civil Execution Act Art. 93-4).
  • If an earnings execution is already in place, another mortgagee generally cannot use Art. 304 to individually attach rents falling under the administrator's purview; they would need to participate in the existing earnings execution or, if grounds exist, initiate their own (which would likely be consolidated or coordinated).

Effect on Leases and Prior Dispositions of Rent:
The administrator generally manages the property subject to existing valid leases. The administrator also has certain powers to enter into new leases (e.g., for vacant units) to maximize income for the benefit of creditors, within statutory limits (Civil Execution Act Art. 95).
Regarding prior dispositions of rent by the mortgagor (such as an assignment of future rents to a third party or a tenant's prepayment of rent), the priority against the earnings execution would likely be determined by principles similar to those established for butsujō daii. The Supreme Court, in a decision on July 3, 2009 (Heisei 21), affirmed that a tenant could not assert a set-off against the administrator based on a claim against the mortgagor that the tenant acquired after the mortgage registration, mirroring the rule for butsujō daii. This indicates that the date of mortgage registration remains a key determinant of priority.

Advantages over Butsujō Daii:

  • Ensures professional property management and payment of necessary expenses, preventing deterioration.
  • Provides a more orderly process for collecting rents from multiple tenants.
  • Can offer a clearer framework for determining priorities among multiple mortgagees participating in the earnings distribution.
  • Can be used to address problematic tenancies or improve the property's income generation.

The commencement of formal insolvency proceedings against the mortgagor significantly impacts a mortgagee's ability to claim rental income.

In Mortgagor's Bankruptcy (Hasan):

  • Pre-Bankruptcy Butsujō Daii Attachments: An attachment of rent properly effected by a mortgagee via subrogation before the commencement of bankruptcy proceedings generally remains effective. The mortgagee can continue to receive those attached rents.
  • Post-Bankruptcy Butsujō Daii: Based on the principle established by the Supreme Court on February 2, 1984 (Showa 59) (though that case involved a statutory lien, its reasoning has been considered applicable to mortgagees), a mortgagee may still be able to exercise their subrogation right by attaching rents even after bankruptcy proceedings have commenced against the mortgagor. This can sometimes lead to the bankruptcy trustee choosing to abandon (disclaim) an over-encumbered, rent-producing property if the rental income is entirely captured by mortgagees.
  • Impact of Former Bankruptcy Act Article 63 Abolition: Previously, Article 63 of the old Bankruptcy Act placed certain restrictions on the effectiveness of pre-paid rent or assignments of rent against the bankruptcy trustee. The abolition of this article in the new Bankruptcy Act (effective 2005) means that the general priority rules (i.e., mortgage registration date vs. perfection date of the rent assignment/prepayment) now largely govern the enforceability of such dispositions against the trustee.
  • Tenant's Security Deposit: A tenant's right to have their security deposit applied against unpaid rent or to claim its return is generally protected. Article 70 of the Bankruptcy Act allows a tenant who is paying rent to the estate to request the trustee to set aside (or provide security for) an equivalent amount to cover their eventual claim for the return of their security deposit.
  • Ongoing Secured Real Property Earnings Execution: Such a proceeding generally continues despite the mortgagor's bankruptcy. The court-appointed administrator and the bankruptcy trustee would need to coordinate. The trustee retains the power to seek the sale of the underlying real property or to redeem it from the mortgage.

In Mortgagor's Rehabilitation/Reorganization Proceedings (Minji Saisei / Kaisha Kōsei):

  • Automatic Stay: Upon commencement of these proceedings, there is an automatic stay that prohibits creditors, including mortgagees, from initiating or continuing individual enforcement actions, which includes both butsujō daii attachments and Secured Real Property Earnings Executions.
  • Rent Becomes Part of the Estate: Rental income from mortgaged property becomes part of the debtor's estate and is administered by the debtor-in-possession or the reorganization trustee under the court's supervision.
  • Mortgagee's Claim as Secured: The mortgagee's claim (including any claim to rental income as part of their security) is treated as a secured claim within the rehabilitation or reorganization plan. The plan will dictate how the secured claim is to be treated (e.g., rescheduled payments, potential modification of terms).
  • Limitation on Post-Commencement Rent Claims via Subrogation: There's a view that if the value of the mortgaged property (as a going concern, potentially including its income-generating capacity) is already fully accounted for in the treatment of the mortgagee's secured claim under the plan, the mortgagee might be restricted from separately claiming post-commencement rents via subrogation, as this could lead to a form of double recovery.

Choosing Your Strategy: Subrogation vs. Earnings Execution

When a mortgagor defaults, the mortgagee with rights to rental income must decide on the best enforcement strategy:

  • Subrogation via Attachment (Butsujō Daii): This can be quicker for specific, identifiable rent payments, especially if there are few tenants and the legal situation is straightforward. However, it can be piecemeal, may not cover property management, and can lead to priority races among mortgagees.
  • Secured Real Property Earnings Execution: This is a more comprehensive, albeit potentially more complex and time-consuming, procedure. It is better suited for properties with multiple tenants, ongoing management needs, or where a more orderly collection and distribution of income is desired. It also provides a formal mechanism for addressing operating expenses.

The ongoing academic and practical debate in Japan includes whether the availability of the more structured Earnings Execution procedure should lead to a restriction or even abolition of the older butsujō daii mechanism for rents, to streamline and rationalize the process.

Conclusion

Japanese law provides mortgagees with definite, though evolving, rights to claim rental income from mortgaged properties once the debtor defaults. The traditional method of subrogation via attachment (butsujō daii), governed by the "perfection standard theory," allows mortgagees to assert priority based on their prior mortgage registration. The more recent Secured Real Property Earnings Execution procedure offers a comprehensive, court-supervised alternative for managing the property and distributing its income. The choice of method depends on the specific circumstances, including the complexity of the tenancy situation, the need for active property management, and the presence of competing creditors or insolvency proceedings. Understanding the nuances of these mechanisms, their priority rules, and their interaction with broader insolvency principles is crucial for mortgagees seeking to maximize their recovery from leased, mortgaged assets in Japan.