Fall 2009 • Issue 34, page 3

Resolving Recent Issues Affecting Receivers & Receiverships

By Rense, Kirk*

(Issues arise from time-to-time that affect significant portions of the receivership community and receivership law. Here is a round-up of a few that have recently become of interest – Ed.)

Illegal Agreements Between Receivers and Foreclosing Lenders
The dramatic increase in the use of receivers and receiverships coupled with the decline of work in the real estate industry has prompted many new persons and entities to enter the receivership field or to refocus business operations on receiverships.

At the same time, many financial institutions have been thrust into using receivers and receiverships for the first time to protect their collateral assets as real property values plummet and loan defaults hit record highs.

This combination of new receivers / purported receivership companies and financial institutions inexperienced in receivership procedures has resulted in abuses of receivership law to accommodate business interests of these troubled financial institutions.

RN is advised that members of at least one major real property broker/manage-ment firm have offered in seminars aimed at the financial community to perform receiverships for free provided that the company is retained to market and sell affected properties after non-judicial foreclosures. Further, some financial institutions are demanding complete control over actions of potential receivers as a precondition to nominating them to the court for appointment.

Such maneuverings are illegal, though expedient (and seemingly cost-effective) practices from a business perspective. Not a tiny bit illegal. Not somewhat illegal. Rather, quite blatantly and unqualifiedly illegal.

California Rule of Court 3.1179 provides that a receiver is an agent of the court, is neutral, and holds assets for the court, not for either the plaintiff or the defendant:

“The party seeking the appointment of a receiver may not, directly or indirectly, require and contract, agreement, arrangement, or understanding with any receiver whom it intends to nominate or recommend to the court, and the receiver may not enter into any such contract, agreement, or understanding concerning (1) the role of the receiver with respect to the property following a trustee’s sale or termination of a receivership, without specific court permission; (2) How the receiver will administer the receivership or how much the receiver will charge for services …(3) who the receiver will hire or seek approval to hire, to perform necessary services; or (4) what capital expenditures will be made on the property.”

Businesses may react: “What spoilsports!” But receivers are quite literally a part of the court, a remote personification of the judge, and may never have two masters (regardless of receivers’ or litigants’ emphasis on enhancing profitability).

Every MBA holder knows game theory demonstrates that those who ignore the rules of the game are rarely caught, and regularly prevail over those who follow the rules. Hence the pertinent business question is not what is right or wrong, but will I be caught breaking the rules, and, if caught, what are the potential consequences.

What are the Consequences?
As for being caught breaking the rules, the chances seem slim. Enforcement of the rules lies wholly with the appointing judges, and it may fairly be said many judges are not sufficiently versed in receivership law or have insufficient time in run-of-the-mill foreclosure actions to smoke out illegal relationships. Defendants in such cases are typically without either the funds or the means to investigate and call inappropriate conduct to the court’s attention.

If a business is caught, the court’s punitive remedy seems limited to civil sanctions. A quick review of case law does not disclose any instance where an appointing court has attempted to invalidate a security interest upon discovering such an inappropriate receiver-litigant relationship.

The consequences of impropriety may be more severe for the receivers or attorneys involved. Certainly the court may bar such persons from that courtroom in the future, and may report counsel who enter into or are aware of such sub-rosa arrangements to the State Bar for discipline. Names of the transgressors may circulate in the judicial community, making it more difficult to obtain that next appointment, or retention.

The fact that such proscribed arrangements are banned by statute ought to be sufficient to prevent their occurrence. But it demonstrably is not. This leaves it to members of the receivership community to monitor and report such improprieties in order to preserve the general respect with which receivers and receiverships are held by the judicial community and the public.

To Turn Over or Not To Turn Over—That is the Question
The issue of whether a real property rents, issues and profits receiver should turn over possession of the property immediately upon completion of the non-judicial foreclosure sale without benefit of a court order to do so has recently arisen. The California Judicial Council rents, issues and profits receiver form order includes a paragraph addressing this issue. Form RC 200 states:

“20. Duty to Turn Over Possession. Upon receipt of a copy of a recorded trustee’s deed upon foreclosure or written notice from plaintiff that defendant has cured the defaults existing under plaintiff’s loan documents of that plaintiff has accepted a deed in lieu of foreclosure, the receiver shall, without further order of the court, turn over possession of the property to the successful purchaser, or defendant, or plaintiff, respectively.”

Where a custom form of appointing order has been used which does not include this language, must a receiver go back to court and obtain specific authorization to turn over the property? Assume the appointing order contains the standard language that the receiver is to possess / operate the receivership property until further order of the court. Can this instruction be safely ignored where title to the property has changed hands?

At least one treatise, from the Rutter Group, has been mentioned to the RN for the proposition that such turnover by a rents, issues and profits receiver should be automatic without further court order. There has been no response to an RN letter to that organization requesting comment.

The question was generally posed to several long-time receivers. Some took the position that no additional order is necessary, that the property should be turned over promptly upon the completion of the sale (and, presumably, the recording of the trustee’s deed upon foreclosure). Another recalled the issue arising only once, and there the successful deed holder obtained a stipulation to turnover and corresponding court order. A few took the position that a receiver must follow the explicit language of the appointing order and not relinquish the property until the court orders her/him to do so. Those receivers suggest obtaining the required order by stipulation if possible.

In at least one recent instance the foreclosing lender and its counsel brought pressure to bear on the receiver for immediate turnover even though the order did not so provide (and contained the standard retention pending further court order language). The receiver requested that an order directing turnover be obtained, and ultimately learned that the propriety of the foreclosure was being challenged by the borrower/debtor. Would the receiver have incurred personal liability if she/he had turned over the property without benefit of court order under such a circumstance? What if the property were lost to fire after turnover without benefit of court order and the receiver’s insurance policy had terminated upon relinquishment?
Comments on this issue are welcome.


When Must a Receiver Relinquish Bankruptcy Debtors’ Assets?
Section 543(b) generally directs that a custodian of property of a bankruptcy debtor must deliver to the trustee [interpreted to include a debtor-in-possession] any property of the bankruptcy debtor “on the date that such custodian acquires knowledge of the commencement of the case;…” The statute goes on to set additional reporting duties for such custodian.

Subsection (d) of this same statute provides that “[A]fter notice and hearing” the bankruptcy court may excuse compliance with some of the reporting/turnover requirements “…if the interests of creditors…would be better served by permitting a custodian to continue in possession, custody, or control of such property….”

It was recognized some years ago by members of both the Southern California bankruptcy and receivership communities that the timing issue raised by this statute – what happens between the mandated time of turnover and the eventual hearing on a motion to excuse compliance – should be reconciled. Defendants in state and federal court actions were filing petitions under the Bankruptcy Code to dislodge court-ordered receivers in order to collect a month or two of rents (the plaintiff below’s collateral) before a motion could be brought and the receiver reinstated.

An informal conference between leading receivers and Bankruptcy Court judges some years ago led to much of the language now found in California Judicial Council receiver appointment Form RC-310 (the same language appears in many custom appointment orders as well):

“24. Bankruptcy – Plaintiff’s duty to give notice. If a defendant files a bankruptcy case during the receivership, plaintiff shall give notice of the bankruptcy case to the court, to all parties, and to the receiver by the closing of the next business day after the day on which plaintiff receives notice of the bankruptcy filing.

“25. Bankruptcy Receiver’s duties. If the receiver receives notice that a bankruptcy has been filed and part of the bankruptcy estate includes property that is the subject of this order, the receiver shall have the following duties:

  1. Turn over property if no relief from stay will be sought. The receiver shall immediately contact the party who obtained the appointment of the receiver and determine whether that party intends to move in the bankruptcy court for an order for (1) relief from the automatic stay, and (2) relief from the receiver’s obligation to turn over the property (11 U.S.C. Section 543). If the party has no intention to make such a motion, the receiver shall immediately turn over the property to the appropriate entity either to the trustee in bankruptcy if one has been appointed or, if not, to the debtor in possession and otherwise comply with 11 United States Code section 543.

  2. Remain in possession pending resolution. If the party who obtained the receivership intends to seek relief immediately from both the automatic stay and the receiver’s obligation to turn over the property, the receiver may remain in possession and preserve the property pending the ruling on those motions (11 U.S.C. Section 543(a)). The receiver’s authority to preserve the property shall be limited as follows:

    1. The receiver may continue to collect rents and other income;

    2. The receiver may make only those disbursements necessary to preserve and protect the property;

    3. The receiver shall not execute any new leases or other long-term contracts; and

    4. The receiver shall do nothing that would effect a material change in the …circumstances of the property.

  3. Turn over property if no motion for relief is filed within 10 days after notice of the bankruptcy. If the party who obtained the receivership fails to file a motion within 10 court days after his or her receipt of notice of the bankruptcy filing, the receiver shall immediately turn over the property to the appropriate entity – either the trustee in bankruptcy if one has been appointed or, if not, to the debtor in possession – and otherwise comply with 11 United States Code section 543.

  4. Retain bankruptcy counsel. The receiver may petition the court to obtain legal counsel to assist the receiver with issues arising out of the bankruptcy proceedings that affect the receivership.

“26. Failure to turn over property. A receiver who fails to turn over the property in accordance with this order shall not be paid for time and expenses after the date the receiver should have turned the property over.”

RN knows of no corresponding rule formally adopted by the Bankruptcy Court Bench, but the general informal agreement seems to have worked well to avoid the abusing of bankruptcy laws by opportunistic debtors.

Long-time Receiver David Pasternak reports that during the last year he has twice been in a bankruptcy court where the judge did not endorse or follow this procedure, and insisted that the receiver had no latitude in complying with the turnover requirements of 11 U.S.C. Section 543. Under such circumstances, a receiver who retains possession of the property could be subjected to Bankruptcy Court sanctions for violating its turnover requirements. Clearly, the Bankruptcy laws predominate over the state court receivership order.

Mr. Pasternak states that he thinks it is important the California Receivers Forum attempt to establish a dialogue with the Bankruptcy Court judges as soon as possible to reestablish this protocol, and the RN agrees in light of the apparent fact that commercial real properties are now starting to come into receiverships, and this may prove to be a much more common dilemma in future months. Moreover, if there is no “grace period” during which the status quo is maintained pending the filing and hearing of the emergency Bankruptcy Court motion excusing the receiver from turnover, disgruntled receivership parties are all the more likely to file bankruptcy petitions in order to dislodge receivers.

In the interim a receiver may wish to discuss in advance with all counsel whether plaintiff’s counsel would seek an order excusing turnover in the event of a bankruptcy filing by the defendant/debtor, and a projected timetable for doing so. The proclivities of area bankruptcy judges on this issue might be researched in advance. If it appears that the issue may arise, secured creditor plaintiff’s counsel may be able to move quickly enough in Bankruptcy Court on an emergency first-day basis to ameliorate the problem, or at least seek an explicit temporary stay of enforcement of 11 U.S.C. Section 543 to allow a motion to be timely brought.

Comments are most welcome. Ed.