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Receivership

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The Un-Bankruptcy: A Texas Receivership as an Alternative to Bankruptcy (and fourteen ways to appoint a receiver in The Lone Star State)

Creditors seeking to exercise control over a borrower or collateral may utilize a number of remedies. They may seek a foreclosure or UCC sale, assignment for the benefit of creditors, file an involuntary bankruptcy petition under Section 303 of the Bankruptcy Code (if they hold unsecured claims),[1] or, seek the appointment of a receiver.

Bankruptcy and receivership provide a particular advantage because they allow creditors to take control of the debtor or collateral without the risk of taking possession.  (See the prior post by my colleagues Jay Krystinik and Keith Aurzada on ways lenders may minimize risk in wresting control of a property away from a obligor, here.)  Receiverships provide the additional benefit of flexibility and, often, are more easily obtained and less costly than an involuntary bankruptcy.[2]  Both federal[3] and state laws provide for the appointment of receivers.

Receivership laws vary from state to state and, indeed, most states provide a veritable cornucopia of receivership statutes.  Here, we will look at the receivership laws in the State of Texas to demonstrate the breadth and scope of state receivership laws.

Availability of Receivership

Texas law provides for the appointment of a receiver in many ways:

  • by a vendor to vacate a fraudulent purchase of property (Texas Business Organizations Code section 11.403(1));
  • by a creditor to subject property or funds to the creditor’s claim (Texas Business Organizations Code section 11.403(2));
  • between partners or others jointly owning or interested in property or funds (Texas Business Organizations Code section 11.403(3));
  • by a mortgagee of the property for the foreclosure of the mortgage and sale of the property (Texas Business Organizations Code section 11.403(4)):
  • for a corporation that is insolvent, is in imminent danger of insolvency, has been dissolved, or has forfeited its corporate rights (Texas Civil Practices and Remedies Code 64.001(5));
  • “in any other case in which a receiver may be appointed under the rules of equity” (Texas Civil Practices and Remedies Code 64.001(6));
  • to rehabilitate a domestic or foreign entity (Texas Business Organizations Code section 11.404, 11.409);
  • to liquidate a domestic or foreign entity (Texas Business Organizations Code section 11.405, 11.409);
  • to preservation and protection marital property during a divorce proceeding (Texas Family Code 6.502);
  • over the assets of a missing person (Texas Civil Practices and Remedies Code 64.001(d));
  • to preserve mineral interest or leasehold interest under a mineral lease owned by a nonresident or absent defendant (Texas Civil Practices and Remedies Code 64.091);
  • to sell property incapable of division (Texas Rule of Civil Procedure 770);
  • over property in a municipality that is not in compliance with certain life, health, and safety ordinances (Texas Local Government Code 214.0031); and
  • over property of a nonprofit housing organization that presents a life, health, or safety risk (Texas Local Government Code 214.0031).

Flexibility of Remedy

In addition to their widespread availability, state law receiverships are also valued for their flexibility and adaptability.  Under the Texas general receivership statute, a receiver is authorized to take charge and keep possession of property, receive rents, collect and compromise demands, make transfers, and perform other acts as authorized by the court.  Texas Civil Practices and Remedies Code 64.031.  Indeed, Texas courts are authorized to broadly define a receiver’s powers to accomplish the objectives of the receivership and to modify the scope of the receiver’s powers.  Texas Business Organizations Code 11.406(5) (“[The Receiver] has the powers and duties that are stated in the order appointing the receiver or that the appointing court: considers appropriate to accomplish the objectives for which the receiver was appointed and may increase or diminish at any time during the proceedings.”).  A receiver’s authority and duties are governed by the receivership order and, thus, can be tailored to each particular circumstance and the needs of the creditor. It is this flexibility that makes receivership uniquely useful to creditors.

Conclusion

Receivership is one of several remedies creditors may utilize in seeking to exercise control over a borrower or collateral.  Receiverships may be particularly attractive to creditors because they avoid the need to take possession of the property, are available in a number of circumstances, and offer flexibility that is not available under bankruptcy or other remedies.

 

 

[1] 11 USC § 303.

[2] An involuntary bankruptcy requires a trial to determine whether the debtor is paying its debts as they come due, and mandates an award of attorneys’ fees against the petitioning creditors if the court does not grant relief.  See 11 USC § 303(h).

[3] Under federal common law, a district court may use its equitable powers to appoint a receiver.  Appointment of a receiver by a federal district court is akin to the entry of an injunction and is not a statutory remedy.  Although no federal statute authorizes the appointment of a receiver, federal equity receivers are subject to a number of statutes governing their behavior.  See, e.g., 28 U.S.C. §§ 754, 2001, 2002, 2004.

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Managing Property Managers — A Guide for Lenders

Lenders are frequently confronted with questionable lender-liability claims not only from borrowers (usually in connection with collection or foreclosure procedures) but also from property managers unable to recover from borrowers. Claims property managers assert directly against lenders include those for breach of oral or written contract, fraud, and unjust enrichment (particularly if the lender has foreclosed its interest in the borrower’s property). Lenders can hedge against the risk of claims by property managers through a variety of methods, both pre- and post-borrower default.

 

As part of origination (or any subsequent review of the borrower’s property management agreement), the lender should ensure that the property management agreement clearly defines that the property manager can turn solely to the borrower for satisfaction of the property manager’s fees and expenses. Thorough property management agreements will also cap expenses the property manager is allowed to incur absent approval, which can help avoid successful assertion of contractor liens.

 

The lender can also obtain a three-party subordination agreement among the lender, borrower and property manager that subordinates the property manager’s rights to those of the lender and allows the lender to, among other things, (i) seize rents immediately upon default, and (ii) terminate the property management agreement and appoint its own property manager. Termination of the property manager and appointment of the lender’s desired property manager is preferred to the lender directing the actions of the borrower’s property manager, as a lender should take care to avoid a direct relationship with the borrower’s property manager.

 

Post-default, the lender should send a reservation of rights letter that defines the parties’ relationships and limits a property manager’s authority. This is particularly true where a property manager has exceeded the scope of mere management and may have undertaken an ownership role at a property or asserted liens against the property, potentially relying on credit support from a lender for repayment of expenses.

 

Lenders should also consider seeking a court-appointed receiver to operate the property and act as a buffer. The court can grant a receiver the authority to terminate the existing property manager and appoint a new property manager, often of the lender’s choosing. Because a receiver is cloaked with a certain level of immunity (although acts of gross negligence or wilful misconduct are often excepted), a receivership offers a prudent method through which a lender can eliminate a troublesome property manager. A receivership also offers a lender a trial period during which the lender can examine the performance of a property manager of the lender’s choosing that it may decide to retain following foreclosure or a receivership sale. For example, Bryan Cave has extensive experience in obtaining receivers, as well as drafting and revising property management agreements, all of which can protect a lender before meritless claims are asserted.

 

In the event that a property manager asserts claims directly against a lender, such claims are commonly derivative of claims properly held by the borrower (the property manager’s principal) and, if based in contract, are often not properly memorialized. For example, among other successfully asserted defenses, Bryan Cave has obtained summary dismissal of property manager’s claims against lenders due to (i) failure to comply with the statute of frauds (which requires certain contracts to be in writing); (ii) lack of privity between the lender and the property manager; and (iii) the property manager’s lack of standing to assert the principal’s claims. Although unpaid property managers will always try to look to a deep pocket for recompense, judicious planning can reduce the risk and merit of any such claims.

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