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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   September 2010

Receiverships 101

Learn why lenders turn to court-appointed third parties to manage assets

In today's market, receivers play an increasingly pivotal role in all aspects of commercial real estate. In fact, many commercial lenders are showing a preference for receivership, which can be crucial to repositioning and marketing distressed assets and, in some cases, selling the property before foreclosure.

A receivership is a proceeding in which a court appoints an impartial third party to take charge of a troubled asset during a pending foreclosure action. Lenders are increasingly turning to receiverships when loan-workout solutions fail or when a borrower simply gives a property back.

If lenders leave a defaulting borrower in place until foreclosure, the borrower may allow the property to deteriorate, diminishing its value. Because receivers often are involved in property disposition -- and the purpose of a receivership is to protect assets while maximizing returns -- this approach ultimately benefits prospective buyers seeking opportunistic investments,  as well.

Any type of property can be placed in receivership, from traditional real estate holdings such as multifamily housing, shopping centers or office buildings, to properties with an enterprise component, such as hotels, gas stations, restaurants and entertainment venues. These properties may involve a host of business and legal issues -- including liquor licenses, franchise agreements, multiple bank accounts and vendor agreements -- and require specific knowledge of the business and its industry.

In all situations, receivers must secure necessary approvals, permits and licenses, in addition to ensuring documents are recoded properly. Other responsibilities may include selecting and overseeing contractors and vendors.

Because many complicated issues are involved in receivership, it is critical that the appointed receiver have significant legal expertise.

As receivership becomes more essential, commercial mortgage brokers should be well aware of the process, especially when helping buyers find financing for their purchases of properties in receivership.

Maximizing value

When a property is headed toward foreclosure, a court-appointed receiver can step in to control operations, protect the value of all assets, monitor and approve expenses, and determine the best action. This could include ceasing or continuing operations, preserving or liquidating collateral, preparing the property for a quick sale, or any combination of these. If construction is not complete, the receiver may work with the lender to decide whether to continue or suspend construction,  as appropriate.

A receiver also can help guard against further losses to the property. This entails striving for optimal returns while preventing physical and financial damage. To do so, the receiver maintains oversight of all aspects of accounting, including receipts and disbursements and other financial records.

To make the receiver's job possible, the lender may, at its discretion, fund operating losses to maintain or enhance the asset until reaching a sale or other outcome.

Defining receivers' roles

There are many forms of receivership. But most commercial lenders and loan servicers deal with general-assets receivers, which are appointed to take over an entire business, or rents-and-profits receivers, which take possession of specific assets that secure the loan and any income those  assets generate.

A limited receivership can be effective for continuing construction on a partially completed job, with minimal interruption, while also reassuring the lender that a third-party fiduciary is in control of the project. This is simply a modified version that allows the receiver to take a more limited role as long as certain requirements are met, such as staying within budget and on schedule and using funding only for specified items.

Under these circumstances, the lender no longer funds the developer directly but provides the funds to the receiver, who in turn reviews and approves all monetary requests and pays all vendors and suppliers directly. This allows the existing contractors, developers or both to continue their work unhindered, while giving the lender a third-party watchdog to safeguard spending. The limited nature can revert to a full receivership without further hearing if, in the receiver's judgment, the agreement's terms are not  being met.

Receiverships Vs. Bankruptcies

Receiverships and bankruptcies often are confused. A receivership occurs when the lender seeks to protect its security by having an independent third party take possession. In contrast, bankruptcy courts and rules are primarily aimed at protecting the borrower, not the lender.

The two can overlap. For instance, business-owners might file for bankruptcy after a receiver has been appointed to regain possession of the property. If this occurs, lenders may seek to remove the assets from the bankruptcy court's jurisdiction via a "relief from stay" motion, allowing foreclosure action to proceed.

To do so, the lender must successfully show why the debtor should not regain possession of the property and why the bankruptcy court should leave the receiver in possession. A common argument for removing a property from the bankruptcy estate is the lack of any equity beyond the lender's security and the absence of value to creditors.

Also, the asset's location usually determines the court jurisdiction in which the action will occur. Receivership actions are typically filed in the state court in the county in which the collateral is found. State receiverships are limited to state boundaries.

When the lender and borrower are in different states or the business is conducted in multiple states, receiverships are conducted in the federal district court. Typically, federal receiverships offer greater flexibility and cost-efficiency.

The nature and scope of the receiver's responsibility and authority is specified in the order that appoints the receiver. The order defines the receiver's power to take possession and assume exclusive control of the asset, as well as to operate the business and continue, terminate or complete construction. There are numerous additional powers over the property. It is critical that the receiver reviews the draft order carefully before it is filed to ensure all necessary points are included, such as the ability to sell the property "as is, where is."

The order also should include permission for the lender to make "protective advances" under the existing loan or for the receiver to borrow money to fund the business's operating losses to maintain or enhance the asset's ultimate sale value. If this is anticipated, the order should also grant the receiver permission to borrow money.

These loans are considered senior to all other debts as evidenced by "receiver's certificates," which the receiver can repay whenever funds are available. A well-drafted order will protect the lender and the receiver from further liability from claims related to construction defects, title issues and  other matters.

Benefits

Receiverships are an increasingly viable option for the time between default and foreclosure. Receivers often can clear up issues of potential liabilities tied to health, safety and environmental concerns, homeowners-association regulations, existing liens, franchise agreements, and possible future warranty issues in a residential-tract developments or condominium conversions.

As an agent of the court, a receiver's liability is limited to the assets of the receivership estate itself as long as the receivership is properly conducted and cannot be held personally liable. 

In addition to limiting liabilities, receiverships also steer the eyes of vendors, franchisors, suppliers and others away from the lender's pocketbook. Unlike the business-owner, a receiver is not required to pay pre-receiver debts and as such, can provide a clean break between borrowers and prospective buyers. Although the borrower remains the property's legal owner, the receiver has sole legal possession.

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In addition to restoring order, a well-managed receivership can help bring value to assets, ultimately making them more attractive to prospective buyers and investors.

In the face of chaos, receivers can bring an objective management perspective to the business. They can instill a higher level of professionalism to project management, operations, accounting and reporting, which may have deteriorated in the period preceding the loan default. These improvements benefit the business and the property well beyond the term of the receivership.


 


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