As a special assets manager, receivership is a key equitable remedy that can mitigate a lender’s potential losses and facilitate a timely settlement. Over the years, I have seen receivership as an important and effective way to perfect the lender’s interest in the cash collateral, prevent waste, and mitigate environmental contamination liability.

What is a receiver? And what legal basis does the lender have in suing for receivership?

Receivership is an equitable remedy. The rules of equity and this remedy goes back to English chancery courts who were appointing receivers to take charge of and preserve assets at least as early as the reign of Queen Elizabeth I (1588-1603). American colonies based their law and legal procedures on those of England; the idea of chancery courts was preserved in the Constitution, by language that extended the judicial power of the federal government to all cases at law and in equity, found in Article 3, Section 2.

Receiver as defined by Black’s Law Dictionary:

“A disinterested person appointed by a court, or by a corporation or other person, for the protection or collection of property that is the subject of diverse claims (for example, because it belongs to a bankrupt or is other being litigated).”

Statutory Basis for Appointment (i.e. California)

A key California statute addressing the appointment of receivers is Code of Civil Procedures Section 564, which authorizes appointment of receivers upon an adequate showing to the court:

(a) To preserve a common fund or property in dispute and danger of injury or dissipation [Section 564(B)(1)];

(b) To preserve liened real property during judicial or non-judicial foreclosure under a right of action in a note and deed of trust [Sections 564(b)(2) and (b)(10);

(c) To enforce judgments [Section 564(b)(3)];

(d) To preserve property pending appeal [Section 564(b)(4)];

(e) To take charge of corporate assets when a corporation is insolvent (or in imminent danger of becoming insolvent) on behalf of a judgment creditor [Section 564(b)(5)];

(f) At the request of one of several identified state regulatory commissions [Sections 564(b)(7) and (9)];

(g) To collect rents, issues or profits [Section 564(b)(11)];

(h) To allow lender to inspect liened real property for hazardous materials or conditions [Sections 564(c)]; and

(i) “In all other cases where receivers have heretofore been appointed by the usages of courts of equity.” [Sections 564(b)(8)].

The above is only a partial listing of the California Code of Civil Procedure Section 564 that authorizes appointment of receivers.

It is important that the lender and the receiver also understand California Rules of Court beginning at Section 3.1175, which contains “Civil Rules” governing the operations of receivers and receivership estates.

Rule 3.1179

(a) Agent of the court

The receiver is the agent of the court and not of any party, and as such: (1) Is neutral; (2) Acts for the benefit of all who may have an interest in the receivership property; and (3) Holds assets for the court and not for the plaintiff or the defendant.

(b) Prohibited contracts, agreements, arrangements, and understandings

The party seeking the appointment of the receiver may not, directly or indirectly, require any contract, agreement, arrangement, or understanding with any receiver whom it intends to nominate or recommend to the court, and the receiver may not enter into any such contract, arrangement, agreement, or understanding concerning: (1) The role of the receiver with respect to the property following a trustee’s sale or termination of receivership, without specific court permission; (2) how the receiver will administer the receivership or how much the receiver will charge for services or pay for services to appropriate or approved third parties hired to provide services; (3) Who the receiver will hire, or seek approval to hire, to perform necessary services; or (4) What capital expenditures will be made on the property.

Federal Law

Rule 66 of the Federal Rules of Civil Procedure authorizes the appointment of receivers by federal court judges. Title 28 of the United States Code, governs the judiciary and judicial procedure, and conduct of receivers and rules governing receivers.

Receivership Qualifications

The receiver appointed may not be a party, an attorney of a party, or be a person interested in an action without the written consent of the parties. CCP§ 566.

It is important for the lender to understand that the receiver is an agent of the court. The receiver’s neutral role requires that the lender be judicious in whom it recommends as a receiver. The receiver’s understanding of commercial real estate and its operations is critical for it to be successful in its role. Background and experience can vary tremendously. For example, I sued for receivership ex parte on a major, luxury resort that required a very unique set of skills associated with hospitality: hotel operations, hard and soft goods, franchise agreements, PIP Reports, liquor license, and restaurant operations. Hotels are more analogous to an operating business than real estate.

This bank asset experienced significant operational cyclicality given its location and use. Suffice to say that only by appointing competent receivers can asset value be preserved and in many cases enhanced as it was in the aforementioned case.

It is important that the receiver be strategic and understands both the legal and economic context in which it operates. There is a significant amount of reporting that must be done and for this reason the receiver must have the infrastructure to address these ministerial requirements (which could include hiring, with court approval, a third-party property management company). I would only recommend receivers who have experience or specialization with a particular commercial real estate product type. For example, a receiver who has only managed apartments may not be qualified to manage a major retail, industrial or hospitality projects. Finally, the receiver must take an oath that he will faithfully discharge his duties and obey orders of the court and execute an undertaking to the state in a sum fixed by the court. CCP 567; Rule 3.1177, California Rules of Court.

Bankruptcy

The lender should monitor factors that may indicate that a commercial real estate loan and its sponsorship are heading for trouble. If it is clear that there is waste and dissipation of the property, the lender may want to move to appoint a receiver. Notwithstanding, once the receiver is in place, a chapter 11 bankruptcy (BK) filing may be next. In that regard, it is my experience that to the extent that a lender has perfected its interest in the cash collateral vis-à-vis receivership prior to BK, it is easier to obtain relief from stay.

Turnover Pursuant to Section 543

The bankruptcy court’s exclusive jurisdiction over the property of the estate is protected by the provisions in § 543 of the Bankruptcy Code. The Bankruptcy Code clearly contemplates that in the usual course events, any custodian (term “custodian” is defined in § 101(11) of the Bankruptcy Code as “a receiver or trustee of any property of debtor, appointed in a case or proceeding not under this title…for the benefit of the debtor’s creditors”) will not remain in possession of the property. This provision provides that once the custodian has knowledge of the commencement of the Bankruptcy case, the custodian may not make any disbursements from, or take any action in the administration of, the property of the debtor, the proceeds, the product, offsprings, rents, or profits of such property, or property of the estate, that is in the possession, custody or control of the custodian, except such action as is necessary to preserve that property. Section 543(B)(1) and (2) require the custodian to deliver all such property to the bankruptcy trustee, and to file an accounting of any property of the debtor.

However, a custodian may be excused by the Bankruptcy court from complying with certain provisions of § 543. Section 543(d)(1) provides that a court, after notice and a hearing, may excuse a custodian from compliance with § 543(a), (b), and (c) if the interests of the creditors and, if the debtor is not insolvent, of equity security holders would be better served by permitting a custodian to continue in possession, custody, or control of the debtor’s property.

The following are some factors that have been considered by the courts in whether a custodian should continue in possession:

• Whether there will be sufficient income to fund a successful reorganization;

• Whether the debtor will use the turnover property for the benefit of the creditors;

• Whether there has been mismanagement by the debtor;

• Whether or not there are avoidance issues raised with respect to property retained by a receiver, because a receiver does not possess avoiding powers for the benefit of the estate; and

• The fact that the bankruptcy automatic stay has deactivated the state court receivership action.

Conclusion

The lender should consult with a qualified lawyer to make sure that its special assets group understands key statutory issues associated with the appointment of a receiver. A key factor in the receiver’s ability to protect and enhance a property’s value is a well-drafted receivership order (a topic for another discussion).

References:

https://leginfo.legislature.ca.gov/faces/codes_displayText.xhtml?lawCode=CCP&division=&title=7.&part=2.&chapter=5.&article=

https://www.federalrulesofcivilprocedure.org/frcp/title-viii-provisional-and-final-remedies/rule-66-receivers/

https://www.law.cornell.edu/uscode/text/11/543

https://www.gpo.gov/fdsys/granule/USCODE-2011-title11/USCODE-2011-title11-chap5-subchapIII-sec543

https://www.luc.edu/media/lucedu/law/students/publications/llj/pdfs/reyes.pdf

Disclaimer: The information discussed herein and in this website is merely for informational purpose only; it is not to be relied upon nor does it constitute legal advise. Legal counsel should be consulted concerning any of the information discussed in this article.

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