Appointment of Receivers in Debt Collection: A Brief Overview of Pro’s and Con’s

Very often in a debt collection action, whether a breached contract, defaulted secured note or otherwise, there will be a debtor who is trying to deplete corporate assets (frequently real property) before the inevitable judgment can be rendered. Sometimes depletion isn’t intentional, it is just a byproduct of the business judgment issues that created the problem in the first place. In those circumstances where assets are being wasted, and many more, creditors should consider seeking the appointment of a state court receiver. Receivers can serve as watchdogs for the business, ensuring that status quo is maintained so that the creditors are able to recover whatever assets may remain with an orderly liquidation. In the matters we handle for lenders (and other creditors), receivers come in very handy in the active management of the collateral properties. Appointment of receivers is not a remedy for every case, however, as it often has just as many challenges associated as it does benefits. This Blog post seeks to explore those benefits and drawbacks.

Generally, there are two types of receiverships, one of which will be called “passive” and the other “active.” See In re Chira, 343 B.R. 361, 367 (Bankr. S.D. Fla. 2006). Passive receiverships are crafted to simply conserve and monitor the property, while active receiverships employ broader powers, such as the power to sell and to contract. Id. Naturally, passive receiverships are much less costly and require expenditures only necessary to ensure waste is not committed (i.e. insurance, taxes, utilities), whereas active receiverships require employment of consultants and professionals versed in the field of management. As you can imagine, under the right circumstances, active receiverships can have much higher rewards that go along with the higher risks. While any type of receivership is geared toward preventing asset depreciation, active receiverships can actually serve to generate interim revenue for the lender as well as creating value. We have worked on hotel management, private equity fund and home/condominium builder receiverships that have employed active receivers with great success. In each of those matters, the appointed receivers created substantial additional value for distribution to creditors in accordance with their priority.

To have a receiver appointed, even in the face of a stipulated contract provision, there must usually be some showing that the property is susceptible to deterioration or that the receiver is necessary for preservation of the property. See Electro Mech. Prods., Inc. v. Borona, 324 So. 2d 638 (Fla. 3d D.C.A. 1976). Once appointed, the Court will decide the limitations and boundaries on the receiver’s authority. As a creditor, nothing prohibits you from asking for a broad scope of authority in order to preserve the value of the collateral. For an active receivership, this should mean the power to transact property, to conduct operation as necessary, to administer contracts, minimize or expand overhead, employ professional consultants, request or deny additional capitalization, pursue and resolve legal claims, assert contingent rights, manage vendors and performing key accounting auditing. For lenders, liquidation of property via a judicial/receiver sale often means that the pro-rata application to the creditors will only satisfy the senior lienholder. Naturally, the active receiver will be required to render strict reporting to the court and all parties involved.

Receiverships that invoke a great deal of receiver autonomy and authority are not without risk or drawback, as they require a significant capital outlay from the lender on a defaulted loan that may or may not cover its own loss upon ultimate disposition. Operational costs of a receiver require a careful evaluation of the front end costs and the back end gains in order to see if an active receiver is warranted to manage the asset. For ongoing construction or a business that has a going concern, the employment of an active receiver requires a preliminary evaluation of whether the asset is in a position where it can be easily liquidated without the need for substantial internal input and financing to finish pending projects or mitigate potential liabilities. For ongoing construction projects, this requires at least a cursory evaluation of whether the receiver is the right person to finish the project as designed or preserve the existing structures and prepare it for transition to a buyer who can take over the asset once acquired. I’ve seen several circumstances where involving a receiver early on has helped the lender evaluate their exposure in reclaiming the property at sale. Receivers can assist in evaluating environmental, title, regulatory or other contingent or fixed liabilities that a lender does not wish to assume with the property. In having this unique insight, a lender is able to appraise its true interest in the property and bid appropriately at sale without a surprise after acquisition, or effectuate an interim receiver sale with proceeds applying to the defaulted mortgage.

Another thing for the lender to be aware of is the effect of bankruptcy on a receivership. The appointment of a receiver doesn’t do anything to prevent a defaulted debtor from seeking protection of bankruptcy courts. The filing of a bankruptcy will initially displace the receiver and further require the receiver to turn over property of the debtor to the bankruptcy trustee or debtor-in-possession. See 11 U.S.C. §543 (2012); 11 U.S.C. §101(11) (2012). This may not be a bad thing, however, for now there is likely a bankruptcy trustee who will function to generate recoveries and preserve the value of the estate for the creditors. If you are a secured creditor, the filing will likely only delay inevitable collateral recoveries to you that you otherwise would have been afforded by priority.

As a rule, there are four primary solutions to the plight of the distressed commercial loan: 1) The lender and developer work out an extra-judicial solution that changes the terms of the financing so that the loan can continue to be serviced; 2) the developer files for an assignment for the benefit of creditors; 3) the developer files for Ch. 7 or Ch. 11 bankruptcy; or 4) the lender exercises its remedies under the loan documents–namely foreclosure and the appointment of a receiver. See Using Receiverships to Maximize The Value of Distressed Assets, Dervishi & Seward, Fla. Bar. Journal (Dec. 2009). From a lender’s perspective, the advantage that a receiver has over the other three alternatives is the amount of control the lender can exercise over the process. Id. Restructuring a loan is often a continuation of business as usual with modified terms. Id. The other three alternatives all involve court oversight. However, assignments for the benefit of creditors allow for the debtor to choose the assignee of the debtor’s assets, and the assignee may only be removed for good cause. Id. Similarly, a Ch. 7 liquidation will typically be controlled by a randomly selected bankruptcy trustee, and in Ch. 11 the debtor is entitled to remain in possession of the assets. Id. Only in a receivership can a lender nominate who will control the receivership property during the course of the proceedings. Id. This power is meaningful, as a lender will nominate a receiver that it trusts, and courts generally appoint the recommended receiver absent extraordinary circumstances, such as a receiver’s inability to act impartially. Id. Moreover, unlike bankruptcy, where an undersecured lender will only receive a pro rata share of its deficiency under a plan or distribution, and often must make other financial concessions to unsecured creditors in the financing of a Ch. 11 case and sales under §363(b) of the bankruptcy code, receiverships strictly adhere to creditor priorities. Id. This allows the benefits of the active receivership to directly flow to the lender. Id.

In sum, receiverships can be an important tool for a creditor stuck with a delinquent or defaulted debtor who is at risk of depleting the collateral. Valuable oversight at a time of need can aid in providing information required to make tough decisions. It can also be a tool used to displace that debtor who has misplaced all of your trust. Receivers can be an expensive tool to employ, but under the right circumstances, they will create value. Sale of assets during the pendency of the action will reduce obligations and afford interim pro-rata payout to creditors during the pendency of receivership or foreclosure action. For more information on receiverships and how they can be employed to assist in debt recovery, contact an attorney at Jimerson Birr, P.A. who understands creditor’s rights.