Equitable Receivership as an Alternative to Bankruptcy, Part II: How a Receivership Operates, How Claims are Paid, and How the Receivership is Resolved
By: John M. Tanner
Part II—How a receivership operates, how claims are paid, and how the receivership is resolved.
This is the second in a two-part series. In the first part, the author discussed situations where a creditor might find it advantageous to get a receiver appointed over a debtor and how to obtain the appointment of a receiver. The article begins on page 16 of the attached Colorado Banker Magazine. Click here to read part I.
Immediate Effect of Appointment
When a company is put into receivership, the receiver immediately supplants company management. For this reason alone, creditors may prefer a receivership over bankruptcy when a debtor company has a sound business plan and its money problems are just a symptom of bad management. A bankruptcy, on the other hand, tends to entrench that bad management.
The appointment of a receiver puts all property subject to the suit into the custody of the court, which acts through its receiver. Although the receiver taking physical possession of property is helpful, it is not required. Any interference with the receiver’s functions is punishable by contempt of court.
Nationwide notice (federal receiverships). A federal receiver has jurisdiction only over property in judicial districts where it was appointed or where it files certain paperwork. Filing the papers is often a federal receiver’s first task.
Equitable stay. The appointing court should enter an order prohibiting any other court from entering orders that purport to order the receiver to do (or not do) anything. This includes execution on a money judgment or orders compelling discovery.
Order to present and file claims/bar date. An Order to Present and File Claims with a quick bar date that requires a claimant to dismiss any other claims (such as pending litigation) before filing a claim is helpful in consolidating all actions into the receivership. Such an order should be sent to all potential claimants.
Order protecting agents. Receivers have about the same judicial immunity as a judge. The receiver should obtain an order stating that all its agents have that same immunity.
Discovery. The court should enter an order that allows discovery against the receiver but interferes as little as possible with the receiver’s primary duties.
The receiver should file regular reports. The reports inform the court and the estate what has happened, may protect the actions of the receiver from later attack, and can suggest the direction a receiver is considering (this can flush out objections early in the proceedings and thereby save time and money).
As a general rule, receiver’s reports should be ministerial and non-adversarial. They must be signed under oath by the receiver and be sent to all parties, and should be sent to all claimants. A receiver may distribute via posting on the Internet.
Gathering and Protecting Assets
The receiver’s charge is to gather and protect assets. If the assets are tangible, it may require leg work and the help of law enforcement. If the assets are intangible, protecting them becomes more complicated. In the Indian Motorcycle receivership, protecting the primary asset—the Indian Motorcycle trademark—involved buying companies, filing litigation, hiring a licensing agent, entering into licenses, and otherwise expanding the business beyond its original parameters.
If cash flow does not allow the receiver to pay itself, its counsel, and other post-appointment creditors, the receiver may sell receiver’s certificates to raise funds. These certificates are secured by a lien on the assets of the estate.
A contract should be approved before the receiver acts pursuant to it. This can be done in the appointing order, monthly receiver’s reports, or by separate motion. Once approved, the receiver need not get approval for each subsequent act further to the contract. Unlike a bankruptcy trustee, receivers seldom have to put the full detailed bills of themselves and their counsel on the public record, which can be another advantage.
Winding Up a Receivership
Determination of claims. Receivers should set up the most expedited process reasonable to determine claims. Due process is satisfied as long as the claimant has notice and an opportunity to be heard. Generally, a receiver should not spend efforts litigating with the estate if it can be reasonably avoided.
Payment of claims. Once the sale is completed, the receiver distributes the assets pursuant to a formula, which is usually proposed by the receiver and approved by the court after considering any objections. Typically, the receiver and its counsel are paid first (to the extent they have not already been paid), receivership certificate holders second, the receiver’s other administrative creditors third, and pre-appointment creditors after that. As in bankruptcy, pre-appointment creditors tend to fall into classes, but the classes are neither rigid nor statutorily imposed. Typically, distribution is based on the “absolute priority” rule: secured, unsecured (priority), unsecured (general), and then equity.
In some instances, receiver will be able to successfully reorganize the company. As a receivership cannot discharge debt, which means all bills are either paid in full or new arrangements are reached with enough creditors that the company can succeed. At that time, the receiver is discharged.
If the company cannot be reorganized, its must be liquidated or distributed in kind. The sale can be on any terms and conditions the court sets, and is reviewable only for the grossest abuse of discretion. A receiver generally does not give representations and warranties, but provides a court order saying that the sale is free and clear from all claims, liens, and encumbrances of parties with notice of the receivership.
Discharge of the Receiver
Once the company is reorganized or the claimants are paid, the receiver is discharged. This ends the estate and creditors with actual or constructive knowledge of the receivership generally cannot pursue the receiver, the estate, or the buyer for debts that existed before the closure of the estate.
Receiverships offer greater flexibility for creditors than do bankruptcies. A receivership immediately eliminates bad management and puts the company under the supervision of the court. The receiver can be chosen for his or her knowledge of the industry of the troubled company. In the proper case, a receivership can be an effective process for creditors or investors of a troubled company.
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