United States: Receivership: The Right Tool For Some Jobs

Every lender is looking for a good way to improve the return on non-performing assets in its loan portfolio. One frequently overlooked tool is use of a receivership as a method for controlling and liquidating the assets of a delinquent borrower’s assets. A courtappointed receiver frequently represents the most direct and cost-effective method for maximizing the potential for recovery. Thus, especially where there is substantial collateral to control and dispose of, the broad powers and authority accorded court-appointed receivers makes a receivership the right tool for the job.

Receiverships also address a vexing but unavoidable fact. Some delinquent borrowers do not negotiate to arrive at an equitable resolution of their financial problem, but instead look for the lender to make a mistake or miss an opportunity, thereby allowing the borrower to avoid liability or spirit valuable collateral away from the lender’s enforcement efforts. Some borrowers may tempt a lender to use questionable enforcement methods in hopes of creating defenses or claims they would not otherwise have. Use of a court-appointed receiver can be a forceful collection tool without exposing the lender to new claims or defenses. In these cases, a receivership is the right tool for the job.

Receivers are appointed by courts on the application of interested parties, typically creditors. Anyone can be a receiver although most are professional fiduciaries or business managers selected for their knowledge of the business or assets involved. Receivers are usually compensated on an hourly basis and reimbursed for their expenses. The petitioning party nominates the receiver but the appointment is up to the supervising court. The receiver begins to act after filing an oath of office and fidelity bond. Receivers are usually appointed in court-filed lawsuits; however, many states authorize the appointment of a receiver by a court as an ancillary remedy in arbitration matters. See, e.g., California Code of Civil Procedure § 1281.8.

Initially the receiver makes certain that he/she has secure control of the business or assets of the receivership estate and then manages or liquidates the assets using good business judgment, reporting monthly to the court and creditors. Like a bankruptcy trustee, the receiver is not responsible for unpaid expenses incurred by the debtor prior to the receiver’s appointment. See, e.g., 39 Pa. Statutes § 95-96. The receiver also is not responsible for executory contracts of the borrower. See, e.g., Real Estate Marketers, Inc. v. Wheeler, 298 So. 2d 481 (Fla. Ct. App. 1974). The receiver does, however, take estate property subject to properly perfected security interests. See, e.g., Key Bank Nat. Ass’n v. Michael, 737 N.E. 2d 834 (Ind. Ct. App. 2000). As a practical matter, however, secured lenders and some critical suppliers may be unwilling to continue doing business with the receiver unless some pay-down of the pre-appointment debt is made. If that is the financially prudent course for the estate, the receiver is empowered to do so.

If authorized by the appointment order or a supplement to it, a receiver is entitled to borrow by issuing receivership borrowing certificates. Such borrowing can even be on a secured basis, and in the real estate mortgage context it is normal for the mortgage holder to advance funds for major repairs, tenant improvement construction costs, brokerage fees and the like in order to improve the overall economics of the property. See, e.g., Amick v. Hotz, 101 F. 2d 311 (8th Cir. 1939)

The receivership comes to an end when its purpose has been fulfilled, the sale of the property has occurred, settlement has been reached, environmental problems have been remediated, or all funds have been disbursed to the creditors. The receiver then prepares and files a final accounting and report for the court. If approved, the court ratifies the receiver’s actions, discharges him/her from all obligations with respect to the receivership estate, and approves his/ her fees and expenses. See, e.g., Royall v. Peters, 180 Va. 178, 21 S.E.2d 782 (1942).

The most common use of receivership is to assist a lender in enforcing its rights under a mortgage or deed of trust on real property by collecting rent and managing and maintaining the real property pending a foreclosure. In many jurisdictions a lender is entitled, as a matter of right, to have a receiver appointed following default on a mortgage so long as the mortgage specifically allows for that remedy. No waste, fraud or other danger to the property is required. See, e.g., Turner v. Superior Court, 72 Cal. App. 3d 804, 811 (1977). A receiver appointed to collect rents and manage and maintain real property can maximize the value of the real estate collateral. Financially troubled borrowers often do not reinvest their rents in maintenance, leasing and other value-enhancing expenditures, and many troubled properties are merely evidencing the borrower’s lack of sufficient management acumen or resources.

A real property receiver can also add substantial value to real estate collateral wholly apart from good management. Property with a potential environmental problem can be investigated and remediated without the secured lender becoming a potentially responsible person and liable for the cleanup costs. As a fiduciary of the court, a receiver who undertakes these activities has no personal liability, and because the receiver is not the lender’s agent, the receivership creates no surrogate liability for the lender. See, e.g., U.S. v. Sugarhouse Realty Inc., 162 B.R. 113 (E.D. Pa. 1993). The expenses of investigation and remediation can be treated as necessary advances under lender’s mortgage, with repayment secured. Similarly, if a borrower defaults on an uncompleted construction project and there is no bonding company to step in, a court-appointed receiver can complete the construction for the lender’s benefit. The costs of the construction can be paid with advances under the construction mortgage credit facility. See, e.g., Friday v. Smith, 195 F. 742 (3rd Cir. 1912).

Receivers can also effectively be used as an alternative to a bankruptcy or the litigated dissolution of a corporation or other business. See, e.g., Delaware Corp. Code § 291. Both bankruptcy and state court litigation over liquidation carry with them substantial overhead in the form of a litigationstyle environment where needed decisions are formally presented to a judge for resolution. Of course, that entails substantial lawyer time and costs, together with the delay inherent in court proceedings. The laws of many states authorize court-appointment of a receiver as an alternative to bankruptcy or state court litigation over dissolution of a business. A receiver can even continue to operate a business as the wind-down and liquidation begins. Receiver sales of most assets do not require prior court approval, and almost all business decisions are simply taken by the receiver using good fiduciary and business judgment. When the liquidation is complete, the receiver seeks a single court-order authorizing distribution of the proceeds of the liquidation to the creditors after payment of the fees and costs of his receivership. Any disputes, including priority of secured interests or rights, can be resolved summarily by the supervising court at that time. See, e.g., Alexander v. Hillman, 296 U.S. 222 (1935).

As an independent fiduciary, a receiver enjoys the confidence of the court that appointed him/her and that of the creditor constituency he/she serves. Because of that, a receiver can be an effective tool to investigate the financial history of a business or asset, and credibly report any wrongdoing. Financial failure almost always carries with it the taint of possible improper dealings by owners or management. Traditionally lawyers have investigated those matters through lawsuits, elaborate discovery and motions. Business owners and management usually resist the effort to invade their financial privacy, and large sums can be spent to obtain basic facts. A courtappointed receiver charged with the task of reviewing the financial data and providing an objective report on what happened can dramatically reduce the costs to the benefit of all concerned. If the problem is complex or large enough, a receiver can be authorized to hire appropriate assistance, such as accountants. See, e.g., Glisson Coker, Inc. v. Coker, 260 Ga. App. Ct. 270, 581 S.E. 2d 303 (2003).

Although a receivership is the right tool for many jobs, it is not the right tool for all jobs. For example, where a delinquent mortgage encumbers a building that is leased up, reasonably well-managed, and has a net cash flow that is being paid over to the lender, a receiver is not a particularly useful adjunct to the process. Likewise, receiverships work better where there are physical assets and documentable intellectual property that can be managed for the benefit of creditors. Businesses that rely significantly on the personal efforts of owners, e.g., a small accounting firm or an architect’s office, would not be amenable to a receivership. The receiver cannot compel an owner-debtor to continue to work. Similarly, real property occupied by an owner-borrower-tenant is not usually appropriate for receivership management.

Where a lender believes that a fiduciary should be in charge of the assets of a debtor, receivership is frequently a better choice than bankruptcy. Chapter 11 reorganizations, especially for modest-sized businesses, impose a tremendous administrative cost. The cost of formal legal proceedings, the slow pace of action, and the lack of easy creditor input all suggest bankruptcy is a less desirable alternative than receivership in many cases. Similarly, the lack of resources and more limited powers of a Chapter 7 bankruptcy trustee mean a liquidating bankruptcy is less suitable than a receivership, except in cases where a quick sale is the primary objective.

Nonetheless, in some cases, other creditors or the debtor itself will believe a bankruptcy is a better alternative and will file a bankruptcy petition. The usual result is that the Bankruptcy Court dismisses or abstains from the bankruptcy case in favor of the receivership, or appoints the receiver as the bankruptcy trustee. After all, there is little reason for multiple fiduciaries to manage the subject assets. See, e.g., In re Iowa Trust, 135 B.R. 615 (N.D. Iowa 1992).

This article is presented for informational purposes only and is not intended to constitute legal advice.