United States: Federal Receiverships Are Often Overlooked Yet Can Be Attractive To Creditors

• Federal receiverships, allowed under Rule 66 of the Federal Rules of Civil Procedure and governed by 28 U.S.C. § 3103 et seq., are not commonly used by creditors to enforce their rights.
• Federal receiverships offer many of the benefits that state receiverships and assignments and federal bankruptcy cases tend to provide, but also some additional advantages in certain cases.
• In light of current economic conditions and future projections, federal receiverships are an underutilized and efficient means of securing and monetizing collateral and real estate collateral, in particular.

Federal receiverships, allowed under Rule 66 of the Federal Rules of Civil Procedure and governed by 28 U.S.C. § 3103 et seq., are not commonly used by creditors to enforce their rights. Though not a panacea for creditors attempting to enforce their rights in all scenarios, federal receivership can produce more favorable results than other options in certain cases.

In light of current economic conditions and future projections, federal receiverships are an underutilized and efficient means of securing and monetizing collateral and real estate collateral, in particular.

This Holland & Knight alert features significant background and in-depth analysis of considerations that clients should take into account when exploring the use of federal receiverships.

Background

A federal receivership differs from most other insolvency situations, including state receiverships, in several important ways.

• First and foremost, these receiverships proceed in U.S. district courts, often providing significant advantages over state court, bankruptcy court or out-of-court procedures. See28 U.S.C. §?3103(a).
• Second, the reach of federal receivers is broad because federal courts can empower receivers to act across state borders, wherever assets are located. See28 U.S.C. §?3103(b); 28 U.S.C. §?754. As a result, if the debtor owns properties, including real estate, in multiple jurisdictions, the federal court is empowered to appoint a receiver to manage and/or preside over the disposition of secured property located in multiple states.
• Third, federal receivers have the power to sell assets to third parties through private or public sales and provide an attractive alternative, which avoids the creditor having to take possession of the secured collateral as it might have to do through a traditional foreclosure.
• Finally, major creditors often have substantial input in the appointment of federal receivers. A receiver is properly viewed as an arm of the court, S.E.C. v. Hardy, 803 F.2d 1034 (9th Cir. 1986), but particularly in cases in which a borrower does not contest the imposition of a receivership, a creditor can expect the court to support appointing the recommended receiver to allow for efficient disposition of the collateral.

Bankruptcy actions, state court receiverships and assignments for the benefit of creditors each share one or more of these characteristics with federal receiverships. However, no other enforcement option encompasses all of the features of a federal receivership. Choosing a federal receivership over other options, then, should result from an assessment of case-specific goals with these factors in mind.

Appointing a Federal Receiver

Because of inconsistencies in state receivership laws, appointment of a federal receiver, if appropriate, may be beneficial for companies with businesses across state lines. See, e.g., S.E.C. v. American Capital Investments, Inc., 98 F.3d 1133, 1144 (9th Cir. 1996), abrogated on other grounds by Steel Co. v. Citizens for a Better Environment, 523 U.S. 83 (1998) ("we conclude that the power of sale is within the scope of a receiver's 'complete control' of receivership assets under [28 U.S.C. § 754], a conclusion firmly rooted in the common law of equity receiverships."). As a result of their broad equitable powers, federal district courts have the power and authority to appoint receivers. See 28 U.S.C. §?3103(a) ("a court may appoint a receiver for property in which the debtor has a substantial nonexempt interest if the United States shows reasonable cause to believe that there is a substantial danger that the property will be removed from the jurisdiction of the court, lost, concealed, materially injured or damaged, or mismanaged.").

When assessing whether a federal receivership is appropriate, federal courts first determine whether they may exercise jurisdiction and then consider the following factors: "(1) the probability that fraudulent conduct has occurred or will occur; (2) the validity of the claim by the party seeking the appointment; (3) whether there is an imminent danger that property will be concealed, lost, or diminished in value; (4) the inadequacy of [alternative] legal remedies; (5) the lack of a less drastic equitable remedy; and (6) the likelihood that appointing the receiver will do more good than harm." Aviation Supply Corp. v. R.S.B.I. Aerospace, Inc., 999 F.2d 314, 316–17 (8th Cir. 1993) (discussing the factors relevant to the receivership inquiry). Federal courts, however, have appointed receivers even in the absence of fraud when dire financial circumstances justify the appointment.

Because the receiver has a fiduciary duty to the court, the proposed receiver, of course, must be qualified to serve in the role and ideally will have experience in the borrower's area of business or have a demonstrated capability to assume responsibility for the management and related disposition of the business' assets. By way of example, a client of one of the authors recently joined with other creditors to obtain the appointment of a receiver to successfully manage the disposition of $50 million in assets belonging to a precious metals recycling business with assets in multiple countries, and although the receiver had never worked in that industry specifically, the court was persuaded that he was well qualified to monetize the business' assets. 

Key Considerations and Attributes

Although a bankruptcy or an out-of-court assignment sometimes is necessary, if the answer to any of the following questions is "yes," a federal receivership should be seriously considered.

Are Multiple Borrowers or Assets in Multiple States Involved?

• A borrower or borrower group located across several states presents an additional rights enforcement challenge for creditors. Most state law-based remedies, such as state court receiverships and assignments, are applicable only to assets located in that particular state. Creditors that rely on those remedies and need to take control of assets in multiple states typically must commence actions in each of those states and work to coordinate those actions.
• Federal receiverships can be useful in managing these risks because federal receivers have the authority to deal with all of the assets and creditors of the borrower or borrower group in multiple states. To convince a federal court to take jurisdiction of the matter in the first place, a creditor almost always must establish that it and the borrowers are from different states and, therefore, that there is diversity of jurisdiction. Born from this issue of multistate jurisdiction, the power of federal receivers extends beyond the state in which the appointing court is located. Given that many creditors are national banks and therefore deemed a citizen only of the single state designated as its main office in its articles of association, establishing diversity jurisdiction is usually not difficult. But assuming jurisdiction is established, a federal receivership provides for "one-stop shopping" and avoids having to seek relief from multiple state courts (and having to retain counsel in multiple states).
• However, "[u]nless expressly authorized by order of the court, a receiver shall have no power to employ attorneys, accountants, appraisers, auctioneers, or other professional persons." See28 U.S.C. §?3103(b)(2). As a result, the receivership order often provides the receiver with the authority to retain professionals.

Does the Creditor Need to Dispose of Collateral But Cannot Take Possession or Title?

• Creditors often look to receivers to help with collateral disposition. For any number of reasons, existing management may not be the right choice for the job. Creditors themselves are often wary of taking possession or title to assets of a borrower, even for short periods of time pending disposition, because they view the associated responsibilities and known or potential liabilities as being too great. When such factors are a concern, a federal receivership should be considered.
• A federal court can authorize a federal receiver to sell assets. For a creditor that does not want to foreclose on real or personal property because of possession or title risks, having a receiver sell the collateral can be outcome determinative.

Will the Debtor Agree not to Oppose a Request for a Third Party to Take Control of Its Assets?

• If a borrower or debtor will consent to (or at least not oppose) a creditor's request for appointment of a receiver, then, as a general matter, a federal receivership may be preferable to other remedies because it will avoid the multilayered costs involved in a traditional bankruptcy proceeding.
• In cases that clearly call for a receiver (such as fraud, mismanagement and waste), opposition to the appointment by the company is not likely to deter a creditor or materially delay the appointment process. When the basis for appointment is less apparent, however, or whether a creditor simply wants to remove management for less than clear misconduct, a court is far more likely to give an objecting company its day in court.

Is the Creditor Seeking a Quick Disposition of Real Property?

• A receiver may sell real property via public or private sale. The sale of real property by public sale, governed by 28 U.S.C. § 2001(a) and § 2002, only requires that the sale be conducted at the courthouse of such locale, where the greater part of the property is located; that the sale be upon such terms and conditions as the court directs; and that notice of the sale be published once a week for at least four weeks prior to the sale in at least one newspaper of general circulation in that locale.
• The sale of real property by private sale, governed by 28 U.S.C. § 2001(a), only requires that the court must appoint three disinterested persons to appraise the property. So long as the price is two-thirds of the appraised value and the terms are published in a newspaper of general circulation at least 10 days before confirmation of the sale, the court will promptly approve the sale if uncontested.
• By way of example, one of the authors represented a national bank, serving as the agent for a consortium of banks, in the Eastern District of Pennsylvania, where a federal receiver was appointed, and the receiver successfully sold via private sale 17 different real estate developments that were in various stages of construction and located in three states. Each sale was efficiently accomplished with few or no objections and sold "free and clear" except for "liens for real estate taxes, municipal liens and assessments, liens for water and sewer charges, liens for special assessments and liens for any condominium assessments."
• In addition, having a matter heard in federal court as opposed to state court likely will save time and expense. Federal courts are often better equipped to deal with complicated commercial matters and emergency situations. Further, federal courts have well-established procedural rules for federal receiverships, which, unlike many state receiverships and bankruptcy procedures, are not governed by detailed statutory language. Therefore, federal judges have a high degree of flexibility in granting power to federal receivers and can shape their authority to fit the facts and circumstances of a particular case. This flexibility can also allow creditors and the court to craft uncomplicated and efficient proceedings.

How Does a Receivership Sale Compare to a Section 363 Bankruptcy Court Sale?

• A receivership also may be more advantageous to a Chapter 11 restructuring because it is not subject to the same procedural requirements as a bankruptcy proceeding, typically involves fewer constituencies, and the receiver's fees and expenses likely will be less than the expenses incurred by professionals retained by creditors and/or the debtor. For example, the borrower is not required to file schedules of assets and liabilities and regular operating reports, although the receivership order typically does contain some reporting requirements. There also is no restriction against replicating the automatic stay afforded by debtors through Section 362 by including in the order appointing the receiver an injunction against additional creditors suits involving the property subject to the receivership.
• There are, however, certain situations where a bankruptcy proceeding may be preferable. Most notably, a bankruptcy proceeding avoids the need to persuade a court, through an evidentiary hearing, to appoint a receiver in situations where the borrower opposes the appointment and the loan documents do not expressly provide for appointment in the event of default. In addition, the borrower may prefer bankruptcy because it allows for resolution of all creditor claims as opposed to clams related to assets secured by the loan. Furthermore, a Section 363 sale under the Bankruptcy Code unambiguously is a sale free and clear of all encumbrances and likely avoids consideration of state law arguments, which vary by state, that could support a successor liability or similar argument. Moreover, the Bankruptcy Code contains provisions that expressly allow for "cherry picking" of leases and other contracts for inclusion or elimination in the context of a Section 363 sale. Ultimately, however, the court has wide latitude with respect to the terms of the receivership order and a well-drafted order can replicate many of the attributes of a bankruptcy proceeding.

Consideration of Federal Receivership is Warranted

Federal receiverships offer many of the benefits that state receiverships and assignments and federal bankruptcy cases tend to provide, but also some additional advantages in certain cases. Particularly if a creditor is trying to enforce its rights across multiple states or against assets that it does not want to risk possessing or owning, or in cases in which a debtor is somewhat cooperative or poses little threat to the request for a receiver, creditors should seriously consider the potential benefits of federal receiverships.

Originally published 17 June 2020

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.