Equitable Receivership as an Alternative to Bankruptcy, Part I
By: John M. Tanner
Part I—When a receivership may be a good idea for a creditor, and how to get a receiver appointed over a debtor. The article begins on page 12 of the attached Colorado Banker Magazine. Click here to read part II.
If the only tool you have is a hammer, you treat every problem like a nail.”
When a company gets into financial trouble, many creditors’ reaction is to seek to put the debtor into bankruptcy. An equitable receivership may be the better course of action for creditors, however. For purposes of this article, an “equitable receivership” is a receivership that is neither a simple care-taking pending foreclosure nor initiated by a governmental regulator.
There are two primary advantages of a receivership. First, it immediately replaces management with the receiver, whereas a bankruptcy entrenches management. If money is really the problem, bankruptcy may a good course of action; but if money is just a symptom and the actual problem is management, then a receivership may be better for creditors.
Second, a receivership has greater flexibility than a bankruptcy. The individual or company best suited to serve as receiver may be appointed. A receivership judge can set out virtually any procedures that are appropriate.
Bases for Appointment of a Receiver
While most commercial Deeds of Trust provide for appointment of a receiver upon default, few asset-based loan documents do. As such, a creditor is left to seek appointment under Colorado law, which provides a receiver may be appointed whenever in fairness one should be appointed. Appointment is, however, considered an “extraordinary remedy” and done only when there is no other adequate remedy available. A receiver can be appointed for the company itself, for some or all its assets, or both. The appointment of a receiver creates an estate, similar to a bankruptcy estate.
The circumstances in which a receiver might be a good idea are limitless. There are, however, some recurring situations where an equity receiver is appointed:
Impotent Management of a Business
When management is not being effective and the usual methods of replacement do not work. For example:
Deadlocked shareholders or partners. In many privately owned companies, the equity is owned equally by a small number of people, and if this number is even a deadlock may occur. A deadlock that is causing the company injury cries out for a receivership.
Bad management. At times a controlling shareholder may not be doing what is best for the company, but is not susceptible to a shareholder derivative suit. He or she may be judgment proof, may have abandoned his or her role, or such a suit may just take too long to be effective.
Mistrusted management/limited receivership. A receiver may be appointed for a limited function when there is concern about who really is management. In the Yellow Cab receivership, there was concern about voter fraud in the election of management, so a receiver was appointed to supervise the election.
A trust may also give rise the appointment of a receiver. For example:
Intra-beneficiary dispute. Where there is a dispute among actual or potential beneficiaries of a trust, appointment of a receiver may allow the trustee to satisfy the duty to distribute or otherwise maintain the status quo until the dispute is resolved.
Beneficiary/trustee dispute. Where there is a dispute between the beneficiaries and the trustee, the appointment of a receiver may be in the interest of the beneficiaries so that the trustee cannot use the trust corpus to fund the litigation against the beneficiaries.
During a divorce, issues may arise regarding ownership or management of a family business. A receiver may be advisable in such a situation.
A receiver may be appointed after judgment to dispose of the property of the judgment debtor by way of a more orderly (and more profitable) procedure than a mere Sheriff’s sale, such as a sale as a going concern.
Mechanics of Appointment of Equity Receiver
A receivership action is commenced by the filing of a complaint seeking the appointment of a receiver. A verified motion is usually filed at the same time—this immediately brings the issue to the court’s attention.
Proposing a Receiver
The plaintiff must propose a specific receiver—there is no panel as there is for bankruptcy trustees. The receiver must be neutral and, once the receiver is appointed, the plaintiff has no legal control over the receiver’s actions. The receiver is an officer of the court and has fiduciary-like duties to the court and whoever the court ultimately determines are the proper beneficiaries (usually creditors and equity). The receiver does not and cannot owe the plaintiff any more duties than it owes others.
Even if the case is a proper one for a receiver, the plaintiff’s proposed receiver may be rejected by the court. The defendant may propose its own receiver, who also may be rejected by the court. The court can even select its own receiver.
One way the plaintiff may exert influence over a receiver is in funding. Often a receivership estate lacks sufficient cash-flow, so the receiver sells receiver’s certificates (liens against the estate—discussed in Part II in the next issue of Colorado Banker) to fund operations. As a practical matter, the plaintiff is the most likely the buyer of such certificates, and may decide to buy them only under certain conditions.
The Appointing Order
Unlike a bankruptcy, which is given substance and structure by the Bankruptcy Code, statutes regarding receiverships are scant. This flexibility, which is one of the greatest advantages of a receivership, comes with a price: the powers of a receiver are limited to those set out in the court orders. As such, the Order Appointing Receiver needs careful thought and consideration, and should be as broad and detailed as possible.
END PART I. In the next issue of Colorado Banker, the author discusses how a receivership proceeds, how assets are distributed to creditors and other claimants, and how the receivership is concluded.
This Article is published for general information, not to provide specific legal advice. The application of any matter discussed in this article to anyone's particular situation requires knowledge and analysis of the specific facts involved.
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Comments or inquiries may be directed to:
John M. Tanner