United States: Using Receiverships To Investigate And Combat Fraud

Abstract

In this article, Joe Wielebinski and Matthias Kleinsasser of Winstead PC provide an overview of U.S. receivership law and discuss how this equitable remedy may be used to combat fraud alone, or in concert with other creditor remedies. The article lays out the basics of what a receivership is and what legal tools are available to a receiver charged with administering a receivership estate when fraudulent conduct is at issue. The article further discusses practical considerations for persons who suspect (but perhaps cannot confirm) they have been the victims of fraud and who wish to seek appointment of a receiver.

1. Introduction

Appointment of a receiver originated centuries ago in English courts of chancery under principles of equity. Broadly speaking, a receivership is an equitable remedy derived from common law under which a court appoints a person (the receiver) as an officer of the court to manage and protect property (the res or receivership estate, which often consists of a corporate entity and its assets), generally because the property is threatened by dissipation or diminution in value.¹ A receiver is usually granted extensive powers by the appointing court to manage assets, file claims, recover transferred property, and take other actions designed to preserve the receivership estate. For this reason, the appointment of a receiver is a flexible remedy that can be tailored to address specific circumstances. Since the appointment of a receiver usually results in displacing an entity's governing persons, however, courts generally require significant proof of fraudulent conduct, or, at a minimum, that an entity's or asset's value is seriously threatened, to grant this relief.

2. Basics of U.S. Federal and State Receiverships

• What is a receivership?

Receiverships are available under U.S. federal and state law, although the availability of the remedy, and the factors required to be satisfied to appoint a receiver, vary between U.S. jurisdictions. ² For example, most U.S. jurisdictions permit a receiver to be appointed for fraudulent conduct on the part of the governing persons, particularly if those persons have fraudulently transferred assets or taken other actions that threaten the rights of creditors or equityholders. ³ Appointment of a receiver is also a remedy commonly sought and obtained by government regulators when fraudulent conduct is suspected and/or the interests of investors are threatened—e.g., in proceedings brought by the U.S. Securities & Exchange Commission.⁴ The existence of fraud is generally not a requirement to appoint a receiver. When the entity is insolvent or in danger of insolvency and the business's assets are threatened by a serious decline in value that would severely prejudice creditors, a court will often appoint a receiver regardless of whether fraud is suspected.⁵ Some U.S. jurisdictions have also enacted statutes allowing a receiver to be appointed over particular types of property, such as commercial real property.⁶ Moreover, the relevant statutes or the common law of many jurisdictions permits a receiver to be appointed for any reason justified by the rules of equity, thereby giving courts broad discretion in applying this equitable remedy. ⁷ In addition, loan documents and other contracts frequently provide one party with the right to obtain the appointment of a receiver in its sole discretion, though courts are split as to whether such a contractual provision is enforceable.⁸

The breadth of a receiver's potential powers is perhaps the most significant aspect of this equitable remedy. The receiver's powers are typically outlined in the court's order appointing the receiver, meaning that courts frequently can tailor the scope of the receiver's authority to the circumstances of the case. In general, most courts appointing a receiver tend to grant the receiver extensive powers unless the receiver's powers are circumscribed by statute (e.g., because the receiver is appointed under a statute authorizing the appointment only for a specific purpose, such as foreclosing a lender's lien on real property). This could include the power to sell assets, commence litigation and/or initiate a bankruptcy proceeding, often without additional approval of the appointing court. ⁹ For most purposes, the receiver stands in the shoes of the entity in receivership and may act to protect the interests of any parties with an interest in the entity, such as creditors and shareholders. ¹⁰ Under the law of most jurisdictions, the receiver generally has authority to sell property or take other actions with respect to a business that could have been taken by the entity's management, so long as those actions are authorized by the court order appointing a receiver. For example, receivers are regularly authorized to marshal assets, collect rents, pursue claims belonging to the entity, and review and pay creditors' claims. Usually, an order appointing a receivership will prohibit creditors of the receivership estate and other third parties from taking action against the receivership estate outside of the court-sanctioned claims submission process.¹¹ In doing so, the court effectively streamlines the process of liquidating or rehabilitating the receivership estate and ensures that similarly situated parties are treated fairly. Of course, the order is limited by the court's jurisdiction, and enforcement of the order against third parties may require the intervention of foreign courts.

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Footnotes

1. The potential scope of the res is very broad. When a business entity is in receivership, the res will often include accounts receivable, real and personal property, causes of action, and intellectual property—in short, the entirety of the business's assets.

2. See, e.g., Fed. R. Civ. P. 66 (stating that an action in federal court in which the appointm ent of a receiver is sought is governed by the Federal Rules of Civil Procedure); Brill v. Harrington Invs. V. Vernon Savs. & Loan Ass'n, 787 F. Supp. 250, 253 (D.D.C. 1992) (listing several factors to be considered in appointing a receiver, such as fraudulent conduct on the defendant's part and imminent danger of property being lost, concealed, or diminished in value).

3. See, e.g., Tex. Civ. Prac. & Rem. Code §64.001(a)(1) (permitting appointment of a receiver in an action by a vendor to vacate a fraudulent purchase of property); Brill, 787 F. Supp. at 253 (listing fraudulent conduct on the defendant's part as a factor to be considered in appointing a receiver).

4. See, e.g., Securities and Exchange Commission v. Stanford International Bank, Ltd., et al., 3-09CV0298-N, in the U.S. District Court for the Northern District of Texas, Dallas Division ("Stanford Receivership"), filings available at http://stanfordfinancialreceivership.com/.

5. See, e.g., Tex. Civ. Prac. & Rem. Code § 64.001(a) (permitting a Texas court to appoint a receiver in multiple situations, including over an insolvent corporation or over a corporation facing imminent danger of insolvency).

6. See, e.g., Maryland Commercial Receivership Act, codified at Title 24, 2019 Maryland Code, available at https://law.justia.com/codes/maryland/2019/commercial-law/title-24/ .

7. See, e.g., Tex. Civ. Prac. & Rem. Code § 64.001(a)(6) (allowing a receiver to be appointed for any reason justified by rules of equity).

8. See, e.g., LNV Corp. v. Harrison Fam. Bus., LLC, 132 F. Supp. 3d 683, 690-91 (D. Md. 2015) (reviewing split of authority over whether a receiver may be appointed under a contract).

9. See, e.g., Tex. Civ. Prac. & Rem. Code §§ 64.031-64.034 (listing receiver's power to bring lawsuits, take possession of property, and take similar actions).

10. See, e.g., Reid v. United States, 148 Fed. Cl. 503, 523 (2020) (receiver "steps into the shoes" of the entity in receivership and owes fiduciary duties to creditors). Although the receiver will act to benefit all stakeholders, most receiverships pay creditors before providing a return to equity, consistent with good corporate practice and U.S. bankruptcy law. In large receiverships with assets having value above the secured creditors' debt, creditors are generally provided with notice of a bar date by which they must submit their claims. Claims that are timely filed and allowed are then paid pro rata from the receivership estate under an established priority scheme. If assets have been fraudulently transferred (such as in a Ponzi scheme) or otherwise need to be recovered, the claims administration process may take years to complete while fraudulent transfer litigation is ongoing.

11. See, e.g., Amended Receivership Order, Securities and Exchange Commission v. Stanford International Bank, Ltd., et al., 3-09CV0298-N, in the U.S. District Court for the Northern District of Texas, Dallas Division ("Stanford Receivership"), available at Amended_Order_Appointing_Receiver.pdf (stanfordfinancialreceivership.com) (prohibiting parties from enforcing liens, seizing assets, pursuing claims, and taking other actions against the Stanford International Bank receivership estate). (Accessed October 11, 2021).

Originally published by iccfraudnet.org

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.