Ninth Circuit News Appellate Court Refines Receiver Appointment Powers Generally and in Diversity Actions
By Christianson, Shawn & Jewett-Brewster, Monique*
In a case of first impression, the Ninth Circuit Court of Appeals has held that federal law governs the appointment of a receiver in a diversity action, that federal courts have broad discretion to appoint receivers based solely on their equitable powers, and that appointment orders are reviewed under an abuse of discretion standard.
The Ninth Circuit Court of Appeals has ruled in Canada Life Assurance Co. v. LaPeter, 557 F.3d 1103 (9th Cir., filed March 4, 2009, amended April 8, 2009) that federal law governs the issue of whether to appoint a receiver in a diversity action and has specifically recognized that the federal court may grant the extraordinary remedy of appointing a receiver based solely on its equitable powers without regard for state laws dealing with such appointments.
This far-reaching decision is significant not only because federal courts are using receivers more frequently but also because it expands the contexts in which plaintiffs may seek federal receiverships in diversity cases. The LaPeter opinion illuminates factors federal courts weigh in evaluating whether to appoint a receiver in a given case, and confirms that abuse of discretion is the appropriate standard of review for a district court’s appointing order.
In LaPeter, an appeal was taken from a district court’s order appointing a receiver to manage a shopping mall. The facts are instructive.
In 1996, the Trustees for the LaPeter 1985 Living Trust purchased the ParkCenter Mall in Boise, Idaho, and financed approximately $7.2 million of the $9.6 million purchase price through a promissory note issued by Crown Life Insurance Company. The Crown Life loan was secured by a deed of trust against the Mall, and by an assignment of leases and cash collateral. Crown Life assigned the loan to Canada Life Assurance Company approximately three years after LaPeter’s purchase of the Mall.
LaPeter approached Canada Life with a request that it refinance the loan at a lower interest rate in early 2005. During negotiations LaPeter made representations to Canada Life about the Mall’s current and projected lease income, including that LaPeter expected to receive less income in the near future because some high-paying Mall tenants either planned not to renew their leases, or would renew their leases only at lower rental rates. Canada Life agreed to refinance the loan in June 2005 at a lower interest rate based, in part, on LaPeter’s representations about its current and projected lease income.
Late that year Canada Life learned for the first time that, contrary to LaPeter’s representations, several Mall tenants the parties had discussed as tenuous for renewal had in reality renewed their leases, resulting in a significant – and undisclosed – increase in rental income to LaPeter. Canada Life cancelled its refinancing commitment to LaPeter in November 2005, based upon this newly-discovered information.
After Canada Life cancelled its refinancing commitment, LaPeter could not find alternative financing. It defaulted on the loan by, among other things, failing to make payments and to pay property taxes when due. Canada Life, asserting that LaPeter’s defaults triggered its right to take possession of and manage the Mall, took steps to foreclose on its deed of trust. In March 2007 it also filed an action in the Idaho state court seeking appointment of a receiver to assume possession, management, and control of the Mall. LaPeter removed this action to federal court on diversity jurisdiction grounds.
The United States District Court for the District of Idaho entered an order in June, 2007 appointing a receiver and setting the receiver’s duties and obligations, which included collecting the Mall’s rent and managing its operations. The order specified that the district court found the receiver’s appointment necessary because the Mall and the rents constituting Canada Life’s collateral were “in danger of substantial waste and risk of loss,” and indicated that the Mall’s income might become insufficient to service Canada Life’s note.
The receivership order did not indicate whether the district court applied state or federal law in making the appointment, but its findings tracked the Idaho statute under which the receiver’s appointment had been sought. LaPeter’s appeal from this order challenged, among other things, the district court’s apparent application of state law as the basis for the receiver’s appointment, on the theory that federal law, if applied, would not permit the appointment.
The Ninth Circuit Court of Appeals noted in LaPeter that it had “never squarely addressed” the issue of whether federal or state law governs a district court’s appointment of a receiver where the federal court’s jurisdiction arises solely from diversity. The Court thoroughly examined, and ultimately was persuaded by, the Eleventh Circuit Court of Appeals’ National Partnership Investment Corp. v. National Housing Development Corp. opinion, in which the Eleventh Circuit concluded that federal, rather than state law, properly governs the appointment of a receiver in a diversity case. Id., 153 F.3d 1289 (11th Cir. 1998).
In National Partnership, the defendant appealed the district court’s order appointing a receiver pendente lite in the plaintiff’s diversity action to foreclose on the plaintiff’s security interest in collateral. The defendant-appellant contended that the appointment of a receiver in a diversity case must be governed by state substantive law in accord with the United States’ Supreme Court’s Erie doctrine, which provides that a federal court sitting in diversity must apply state law in determining all substantive claims.
The Eleventh Circuit rejected defendant’s argument. The Court reasoned that because the equitable appointment of a receiver is an ancillary remedy not affecting the final outcome of an action, a determination that federal law governs the appointment of a receiver in a diversity case does not conflict with the Erie doctrine that state law must be applied to determine substantive matters.
In reaching this conclusion the Eleventh Circuit also observed that where a situation is covered by a Federal Rule in a diversity case, the federal court generally must comply with the Rule despite contrary state law. The Eleventh Circuit noted that Rule 66 of the Federal Rules of Civil Procedure1 “assert[s] the primacy of federal law in the practice of federal receiverships,” and consequently held that federal law must govern the appointment of a receiver by a federal court exercising diversity jurisdiction.
After first observing that it disagreed with LaPeter’s contention that Idaho and federal law governing receivers’ appointment were substantially different, the Ninth Circuit adopted the reasoning in National Partnership.
The Ninth Circuit acknowledged that even if federal law “differed greatly” from state law regarding appointment of receivers, any disharmony between the two bodies of law would not implicate the Erie doctrine, specifically because the appointment of a receiver does not “directly affect” the ultimate outcome of the litigation. The Court pointed out that the district court’s order below appointing the receiver simply had allowed Canada Life to manage the Mall pending a final resolution of the litigation of the parties’ rights and obligations regarding the refinancing agreement and Canada Life’s ability to proceed with foreclosing its security interest in the Mall.
The Ninth Circuit concluded that the receivership action was only “tangential” to the central disputes at issue, and as such, did not conflict with the Erie doctrine.
The opinion contains additional useful language and observations on the breadth of federal courts’ power in granting the “extraordinary remedy” of appointing a receiver. The Ninth Circuit Court of Appeals identified the federal courts’ broad discretion to exercise their equitable powers independent of state law as an additional basis for its LaPeter ruling — federal courts sitting in diversity may exercise equitable powers independent of state law. The Ninth Circuit opinion concludes that “regardless of whether state law provides a vehicle by which to appoint a receiver, the federal courts are free to provide that remedy solely by virtue of their equitable powers.” LaPeter, supra, 557 F.3d 1103, at 1109.
The LaPeter opinion also identifies a number of factors which federal courts may consider in making such a determination, although the Court acknowledged that no factor alone is dispositive, and that there is no “precise formula” to use. It articulated factors which may be considered when deciding whether to appoint a receiver:
The Court also reaffirmed its View Crest Garden Apartments, Inc. v. United States, 281 F.2d 844 (9th Cir. 1960) decision, wherein the Court discussed the showings which must be made by a litigant: (1) prior to appointing a receiver to collect rents during the pendency of a foreclosure action; and (2) to bestow upon a receiver the additional authority to manage the property at issue.
The Ninth Circuit Court of Appeals explained that in order for the Court to authorize the receiver to manage property (as opposed to simply collecting rents), the plaintiff should establish the doubtful financial standing of the defendant, the insufficient value of the property, and “something more” – which, as discussed by the Court, may include a showing that the property serving as the plaintiff’s collateral is in danger of waste.
In LaPeter, the Court of Appeals pointed out that the district court specifically had found that the rents constituting Canada Life’s collateral were “in danger of substantial waste and risk of loss,” and that due to this fact, the Mall “is or may become insufficient to discharge the debt which it secures.” The Ninth Circuit emphasized that the district court properly exercised its broad discretion to grant the remedy of appointing a receiver to both collect rents and manage the Mall.
In summary, the LaPeter decision confirms that federal courts sitting in diversity are not constrained by state statutes which provide for the appointment of a receiver. Rather, as the Ninth Circuit explains, federal courts may exercise their equitable powers to consider a number of illustrative, but not dispositive, factors in making a determination as to whether the appointment of a receiver is justified on a case-by-case basis. Considering the present state of the economy, secured creditors in growing numbers will continue to seek the federal courts’ appointment of receivers as a method to preserve and protect their collateral.
The LaPeter decision gives both plaintiffs and defendants a window into the federal courts’ decision-making process, and timely affirms the fact that, regardless of state laws, federal courts overseeing diversity jurisdiction cases have broad discretion to appoint receivers.
*Shawn M. Christianson, Esq. is a shareholder in Buchalter Nemer’s San
Francisco office, where she specializes in the practice of commercial
litigation, bankruptcy and receivership law.
1 Federal Rule of Civil Procedure 66 provides, in pertinent part: “These [Federal] Rules [of Civil Procedure] govern an action in which the appointment of a receiver is sought …. [T]he practice in administering an estate by a receiver … must accord with the historical practice in federal courts or with a local rule.”