Summer 2010 • Issue 37, page 3

The Elephant in the Courtroom: Ethical Issues and Criteria in Selecting Receivers

By Bressi, Jess*

[Mr. Bressi examines prospective judicial criteria for selecting a receiver, an issue the RN has not treated in the past. I think you will find his piece well-thought-out and provocative. Ed.]

In these economic times, state and federal judges are frequently requested to appoint a receiver to take over a failed or challenged real estate development project, real property in foreclosure, a corporation having governance issues, or an organization that allegedly engaged in fraudulent practices such as fraudulent transfers, securities fraud, or a “Ponzi” scheme.

The equitable power of courts to appoint a receiver is an awesome remedial power often exercised in the beginning of the dispute and before any adjudication of the merits. Courts appoint receivers with the intent that they act as the Court’s independent, neutral, court-supervised fiduciaries authorized to seize and take control of property notwithstanding a defendant’s constitutionally-protected property interests. Many millions of dollars of property are often involved and very substantial amounts of receivers’ and other professionals’ fees are incurred.

An Awesome Remedial Power
Notwithstanding the awesomeness of the court’s power and the huge financial stakes involved, precious little attention has been given to the receiver selection process and corresponding ethical constraints. Protecting the court’s integrity requires that even the appearance of impropriety be avoided. I suggest that much greater care be taken in the level of disclosures and selection process in order to avoid those abuses in the selection and appointment of receivers that have recently been experienced in a number of jurisdictions.¹

More specifically, in light of the receiver’s role as a direct extension of the authority of the appointing court, receivers should be held to similar ethical standards as other adjuncts to judges, including masters, arbitrators, referees, and mediators. This article discusses the present paucity of statutory and rule guidance for California jurists, and provides practical analysis and a checklist for judges to use when evaluating whether to approve a receiver nominated by one of the parties to the litigation (most often, the plaintiff).

Before discussing the substantive law and rules relating to the selection of a receiver, consider the following hypothetical:

Big Bad Broker (“BBB”)² has principals who play golf and attend seminars with representatives of Colossal Ginormous Bank (“CGB”). At present, BBB’s commercial real estate activity is way down and the income received by BBB has suffered. Several years ago, BBB opened a property management division to create a source of counter-cyclical income when more lucrative brokerage activities are down.

The ever-entrepreneurial principals of BBB had a brilliant idea: they would offer cut-rate or even free receivership services to CGB in exchange for CGB nominating officers of BBB to be receivers in lawsuits CGB filed. In turn, these officers of BBB would, of course, employ BBB to not only manage the property of the receivership estate, but also to be the exclusive sales and leasing agents for the projects. BBB, in turn, would deposit all of the funds of the receivership estates in bank accounts maintained at CGB. Also, BBB would use its extensive buyer mailing and email lists to give its customers first shot at all of the pieces of receivership property it would be managing. The person selected by BBB to serve as the named receiver also has little or no experience serving as a court-appointed receiver.

Should courts know about this type of quid pro quo arrangement before approving the selection of a receiver nominated by a plaintiff? Should a court require disclosure of all business relationships between the nominated receiver, the receiver’s choices of management and brokerage companies and other vendors, and the parties to the litigation, before approving the selection of receiver? The short answer to these questions is, “Yes!”

The Receiver Is A Court Officer
It should always be kept in mind that a receiver is an officer or representative of the appointing court, typically directed to take possession of property that is the subject matter of litigation for the duration of the litigation.³ The receiver acts as a fiduciary and often functions as would the owner of property and a representative of the court that is taking possession of the property.

The receiver holds the property for the benefit of all creditors of the receivership estate.⁴ While receivers are often described to be an “agent” of the appointing court, it is not accurate to describe her or him as “the Bank’s receiver.”⁵ In addition to taking possession of property, receivers often are empowered to sell the property, borrow money against the property, complete construction of incomplete developments, and otherwise act and exercise all of the characteristics of ownership, subject to court oversight and approval.

California Law and Rules Impacting Selection of Receivers
California law provides that unless the parties consent in writing, no party or an attorney or a party or person interested in an action, or relative of any judge by consanguinity or affinity within the third degree, can be appointed a receiver.⁶ California Rules of Court, Rule 3.1179 provides:

1. Agent of the court. The receiver is the agent of the court and not of any party, and as such:

   1. Is neutral;

   2. Acts for the benefit of all who may have an interest in the receivership property; and

   3. Holds assets for the court and not for the plaintiff or the defendant.

2. Prohibited contracts, agreements, arrangements, and understandings. The party seeking the appointment of the receiver may not, directly or indirectly, require any 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, arrangement, 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 or pay for services to appropriate or approved third parties hired to provide 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.⁷

In addition to the prohibited types of contracts and agreements described in Rule 3.1179, Code of Civic Procedure 569 requires receivers to not deposit funds where they are not fully guaranteed or insured, with a party to the litigation, i.e. the plaintiff CGB, or with a financial institution which the receiver owns one percent or more in value of the outstanding stock, or where the receiver is an officer, director, or employee of the financial institution, or is related to an owner, officer, employee or director.

A leading treatise on receivership law states: “It is a rule of general application that a receiver should be a person wholly impartial and indifferent toward all parties interested in the fund over which the court has found it necessary to extend its care and protection. Said the Supreme Court of Pennsylvania, ‘It goes without saying, who is the officer of the court and whose actions are under its control, ought to be disinterested, unbiased and impartial as between the parties; and where any breach of propriety in any such respect occurs, it is the duty of the court to remove the receiver and substitute another. But in the exercise of this power the court must be guided by sound discretion under the circumstances of the particular case. No definite rule can be framed, but the power of removal is to be exercised under the broad discretionary jurisdiction of a court of equity.’” Ralph Ewing Clark, The Law and Practice of Receivers, Third Edition, Section 112(b), pages 162-163.

Guidance for Judges in Selecting Receivers in California
There is precious little in California’s Rules of Court or substantive law directly dealing with ethical or similar standards for the appointment of receivers for judges. Under Title X, Judicial Administration Rules, Rule 10.611, judges are instructed that “each court should select attorneys, arbitrators, mediators, referees, masters, receivers, and other persons appointed by the court on the basis of merit. No court may discriminate in such selection on the basis of gender, race, ethnicity, disability, sexual orientation, or age.”

In other contexts, particularly the selection and appointment of arbitrators and mediators, courts are provided substantially greater levels of guidance and specific standards of appointment. But only one canon of the California Code of Judicial Ethics touches on receivers, Canon 3C(4). It provides that “[a] judge shall not make unnecessary court appointments. A judge shall exercise the power of appointment impartially and on the basis of merit. A judge shall avoid nepotism and favoritism. A judge shall not approve compensation of appointees above the reasonable value of services rendered.” The Advisory Committee Commentary to Canon 3C(4) states “appointees of a judge include assigned counsel, officials such as referees, commissioners, special masters, receivers, and guardians, and personnel such as clerks, secretaries, court reporters, court interpreters, and bailiffs. Consent by the parties to an appointment or an award of compensation does not relieve the judge of the obligation prescribed Canon 3C(4).”

With receivers handling literally billions of dollars of litigants’ assets, Canon 2 of the California Code of Judicial Ethics is also implicated: “[A] judge shall respect and comply with the law and shall act at all times in a manner that promotes public confidence in the integrity and impartiality of the judiciary.” Once again, the Advisory Committee Commentary to Canon 2 notes that “public confidence in the judiciary is eroded by irresponsible or improper conduct by judges. A judge must avoid all impropriety and appearance of impropriety. . . The test for the appearance of impropriety is whether a person aware of the facts might reasonably entertain a doubt that the judge would be able to act with integrity, impartiality, and competence.”

It is not a quantum leap of logic to conclude that appointing conflicted or unethical receivers with financial ties to vendors or the litigants would erode public confidence in the judiciary. Yet, there is no systematic or standardized disclosure mechanism in California to assure that judges are advised of some of the relationships highlighted in the earlier hypothetical.

Should Judges Impose on Receivers Ethical Rules Similar To Those Applied to Mediators and Arbitrators?
When you consider that receivers function as agents of the court and are held to a fiduciary standard, it is anomalous that California has much more detailed levels of disclosure and disqualification standards for both mediators and arbitrators than for receivers.

As to mediators, California Rules of Court, Rules 3.850 through 3.860, establish “minimum standards of conduct for mediators in court-connected mediation programs for general civil cases.”⁸ The rules note that “for mediation to be effective there must be broad public confidence in the integrity and fairness of the process.”⁹

Receivers arguably serve much more powerful roles than mediators, however, in that receivers are making decisions regarding the disposition of assets rather than just making recommendations and seeking to facilitate settlement. Receivers often have possession of millions, if not billions, of dollars of litigants’ assets subject to constitutional protections of due process and constitutionally protected property interests. Yet — with the exception of Rule 3.1179, and Code of Civil Procedure Sections 566 and 569 — California has no analogous rules for receivers regulating the impartiality, conflicts of interests, disclosure and withdrawal applicable to mediators.

For example, Rule 3.855 imposes on mediators an affirmative duty to disclose potential conflicts from the inception of a mediation process through its completion. It is a continuing obligation.¹⁰ This rule imposes a duty on mediators to disclose to all parties “past, present, and current expected interests, relationships, and affiliations of a personal, professional, or financial nature.”¹¹

Just as with mediators and arbitrators, receivers are frequently repeatedly appointed by the same parties. Surely, if past “affiliations” are relevant to the selection of a mediator, it is equally or more relevant to the nomination and selection of a receiver.

California has also enacted ethics standards for arbitrators as Division VI of the Appendix to the California Rules of Court.¹² The standards adopted by the Judicial Council for Contractual Arbitrators create both general duties and specific disclosure obligations. Standard 5 imposes a general duty that “an arbitrator must act in a manner that upholds the integrity and fairness of the arbitration process. He or she must maintain impartiality toward all participants in the arbitration as all times.”

Standard 7 creates a series of subjects that must be disclosed, in addition to any that are also addressed by statute.¹³ Standard 7 also imposes an affirmative obligation to disclose various relationships the arbitrator might have with the lawyers in the arbitration, as well as the parties, as well as an affirmative obligation to disclose whether the arbitrator is serving or, within the preceding five years, has served: (a) as a neutral arbitrator in another arbitration. . ..” The Standard further states “ if the combined total of the cases disclosed . . . is greater than five, the arbitrator must provide a summary that states the total number of cases in which the arbitrator served in each capacity and the number of cases in which the party to the current arbitration or the party represented by the lawyer for a party in the current arbitration was the prevailing party.”¹⁴

It does not take much Internet research of court records to confirm that certain litigants have favored receivers that they routinely nominate to serve as receiver in cases they initiate. While it is a reasonable assumption that the reason that these receivers are repeatedly nominated by the same parties is that they are doing a good job, is there a point where a litigant’s frequency of nomination of a particular receiver could cause the public to question the impartiality of the receiver because he or she is “beholden” to a particular litigant for a large portion of her or his income?

Can (or should) CGB “always” use the same receiver who in turn always uses the same agents, brokers, and property managers, regardless of property type or locale?

Suggested Basic Ethical Rules for Receivers
To fill this void of ethical guidance for courts and parties to receiverships, the author searched for potentially analogous and well-established rules that could be modified and adopted. One such universe of ethical rules is found when dealing with special masters. The following collection of proposed ethical rules regarding receivers is derived from the Basic Ethical Rules for Judicial Adjuncts promulgated by the Academy of Court-Appointed Masters.¹⁵

Rule 1: Dignity and Integrity of the Court
Receivers should observe high standards of conduct so as to preserve the integrity, dignity, and independence of the
appointing court and judicial system.
Sources: CCUSJ, Canon 1; CCJE, Canon I..

Rule 2: Competence and Diligence

1. A receiver should accept only assignments: (1) for which the receiver is suited by education, training, and experience; (2) that the receiver is able to undertake and complete in a competent, professional, and timely fashion: and (3) as to which the receiver is physically and mentally able to meet the reasonable expectations of the parties and the appointing court.

2. A receiver must maintain professional competence and diligently discharge assigned responsibilities in a prompt, fair, nondiscriminatory, and professional manner.

3. A receiver must be patient, dignified, respectful, and courteous; apply an even-handed and unbiased process; and treat all parties with respect.

4. A receiver must maintain order and decorum in judicial proceedings.

Sources: Fed. R. Civ. P. 53(b)(2); CCUSJ, Canon 3.A(1)-(5): CCJE, Canons 3.B and C: JAMS Guidelines, 11; ABAIAAA Code, Canons 1.13 and IV.

Rule 3: Propriety

1. A receiver should respect and comply with the law and should at all times act in a manner that promotes public confidence in the integrity and impartiality of the receiver and the judiciary.

2. A receiver should not engage in any activities that would call into question the propriety of the receiver’s conduct in carrying out the responsibilities assigned by the appointing court.

3. A receiver should not allow family, social, or other relationships to influence official conduct or judgment, nor should a receiver use the prestige of the office for private gain or to advance or appear to advance the private interests of others.

4. A receiver should not hold membership in any organization that practices invidious discrimination on the basis of race, sex, religion, or national origin.

Sources: CCUSJ, Canon 2; CCJE, Canons 2, 3 and 4; ABAIAAA Code, Canon 1.A.

Rule 4: Neutrality/Absence of Conflict or Appearance of Conflict

1. A receiver should avoid conflicts of interest in the performance of official duties. A conflict of interest arises when a receiver knows that he or she (or a close relative) might be so personally or financially affected by a matter that a reasonable person with knowledge of the relevant facts would question the receiver’s ability to properly perform the assigned responsibilities.

2. Before an appointment, a receiver should disclose to the appointing court and the parties all matters required by applicable law, any actual or potential conflict of interest or relationship, or other information of which the receiver is aware that reasonably could lead a person to question the receiver‘s impartiality. This duty of disclosure continues throughout the assignment and requires the prompt disclosure of any interest or relationship that arises that the party recalls or discovers.

Sources: Fed. R. Civ. P. 53(a)(2) and (b)(3); CCUSJ, Canon 3.C: CCJE, Canon IF: ABAIAAA Code, Canons I and II: JAMS Guidelines, V.

Rule 5: Disqualification

1. Federal: A receiver may not have a relationship with the parties, counsel, action, or appointing court that would require disqualification of a judge under 28 U.S.C. § 455, unless waived by the parties with the court’s approval after full disclosure of any potential grounds for disqualification.

2. State: A receiver shall comply with the applicable state statutes and court rules governing disclosures, conflicts of interest, and disqualification.

3. Financial interest: A receiver may not own a legal or equitable interest, however small, in a party, nor have a relationship with a party such as serving as its director or advisor.

Sources: 28 U.S.C. Section 455: CCUSJ, Canon 3.C; ABAIAAA Code, Canons 1.11 and I; JAMS Guidelines, VII.

Rule 6: Confidentiality

1. A receiver should avoid making public comment on the merits of a pending action, except as appropriate in the course of official duties.

2. A receiver should never disclose confidential information received in the course of official duties, except as required in the performance of those duties.

3. These restrictions on disclosure continue to apply after the conclusion of the receiver’s service, unless modified by the appointing judge.

Sources: CCUSJ, Canon 3.A(6); CCJE, Canon 3.D; ABAIAAA Code, Canon VI.13; JAMS Guidelines, IV.

Rule 7: Compensation/Time-keeping/Gifts and Favors

1. A receiver’s compensation for official duties shall be determined by the appointing court.

2. Reimbursement for expenses incurred in the course of service as a receiver or for outside activities shall be clearly disclosed and shall he limited to the actual costs and overhead the receiver reasonably incurs.

3. A receiver should not solicit or accept anything of greater than de minimus value from anyone doing business with the receiver or with the appointing court, or from anyone whose interest may be substantially affected by the performance of the receiver’s official duties. Upon completion of an assignment, a receiver may not accept gifts of any kind until a period of time has elapsed sufficient to negate any appearance of a conflict of interest.

Sources: Rule 53(h); CCUSJ, Compliance Section (B); CCJL, 4.E; ABAIAAA Code, Canon VII; JAMS Guidelines, V.G.

The point of applying these rules to receivers is not to punish them, but to make sure the court and the litigants are fully advised of facts that could lead to questions regarding the integrity of the receivership and the impartiality of the receiver.¹⁶

Proposed Checklist for Judges
Here is a suggested checklist for judges to employ when evaluating whether to approve a particular receiver nominated by a party to litigation. Proposed receivers will have to provide more disclosure than is currently provided in order for the checklist to be completed.

This checklist is not exhaustive. But completion of the suggested checklist and the filing of the checklist in the court’s records will provide any reviewing court a much better record of what the appointing court had before it when it made the decision to accept or reject a party’s choice of receiver. It also provides adverse parties with a checklist of questions to follow up on with receivers being interviewed for possible nomination.

Receiver Selection Checklist

Step No.	Issue	Answer - Yes/No Comments
1.	Does the receiver have any contract, agreement, arrangements or understanding with any party regarding: The receivers role with respect to the property after foreclosure or the receivership? How the receiver will administer the receivership? How much the receiver will charge for services? How much the receiver will pay for services of third parties? Who the receiver will hire? What capital expenditures will be made on the receivership property? Does the receiver intend to hire a person to serve the receivership estate who is  connected with the receiver?
2.	Is the receiver proposing to deposit funds of the receivership into a bank account? Where the deposits are not fully insured? Where the financial institution is a party to the action? Where the receiver owns stock in the institution or is an officer, director or employee of the institution?
3.	How many receiverships has the receiver been appointed in for the party requesting the appointment over the last five years?
4.	Does the receiver have any existing or previous relationship with any of the parties or attorney involved in the lawsuit?
5.	Has the receiver or a relative of the receiver ever received an offer of employment or been employed by a party?
6.	How many similar receiverships has this receiver handled?
7.	Has the receiver ever been removed as receiver before the approval of his or her final account and report?
8.	Has a surety on a bond posted by the receiver ever paid on a claim?

Conclusion
In light of the “great recession” that has afflicted our country, receivers are being appointed more frequently and oversee literally billions of dollars of property owned by parties to litigation. The existing and suggested ethical standards that courts should insist receivers comply with before serving as agents of the appointing court will help ensure that the impartiality and integrity of both the court and the receiver are preserved and, even, enhanced.

*Jess R. Bressi, Esq. is a partner in the Orange County office of Luce, Forward, Hamilton & Scripps LLP. Mr. Bressi’s primary areas of expertise involve financial remedies, bankruptcy, business litigation, and secured transactions involving real property. He is past president of the Orange County Bankruptcy Forum and a long-time member of the California Receivers Forum.
 

¹ See three article series, “In Las Vegas They’re Playing with a Stacked Judicial Deck,” Los Angeles Times, Section A, June 8, 9 & 10, 2006, Michael J. Goodman and William C. Rempel, available at www.judicialaccountability.org/articles/judgeslosvegas.htm
² The Author doesn’t intend to single out brokers to ridicule. You could just as easily substitute “Big Bad (former) Developer” or “Big Bad Property Manager” for Big Bad Broker.
³ See Murray v. Etchepare (1901) 132 Cal. 286, 64 P. 282; Cal Rules of Court, Rule 3.1179: “The receiver is the agent of the court and not of any party. . .”
⁴ Security Pacific National Bank v. Geernaerit, et al. (1988) 199 Cal. App. 3d 1428, 1431, 245 Cal. Rptr. 2d 712,716 [“ In other words, he acts as a fiduciary on behalf of both parties as a representative and officer of the court.”]; Shannon v. Superior Court (1990) 217 Cal. App. 3d 986, 992-993, 266 Cal. Rptr.
⁵ Security Pacific National Bank v. Geernaerit, et al. (1988) 199 Cal. App. 3d at 1431, 245 Cal. Rptr. 2d 712,716.
⁶ California Code of Civil Procedure, Section 566(a).
⁷ CRC, Rule 3.1179.
⁸ Rule 3.850(a).
⁹ Id.
¹⁰ Rule 3.855(b)(2).
¹¹Rule 3.855(b)(1)(A).
¹² Code of Civil Procedure, Section 1281.85 provided the Judicial Council the directive to “adopt ethical standards for all neutral arbitrators effective July 1, 2002. These standards shall be consistent with the standards established for arbitrators in the Judicial Arbitration program and may expand but not limit the disclosure and disqualification requirements established by this chapter. The standards shall address the disclosure of interests, relationships, or affiliations that may constitute conflicts of interest, including prior service as an arbitrator or other dispute resolution neutral entity, disqualifications, acceptance of gifts, and establishment of future professional relationships.”
¹³Ethical Standards for Neutral Arbitrators in Contractual Arbitration, Standard 7(a).
¹⁴ Id.
¹⁵ See, Appointing Special Masters and Other Judicial Adjuncts – A Handbook for Judges and Lawyers, 2009, Academy of Court-Appointed Masters, ISBN 0-9786438-0-1, www.courtappointedmasters.org
¹⁶Authority exists in the federal system for judges to impose the Code of Conduct for Judicial Employees upon masters or other judicial adjuncts. The Code of Conduct for Judicial Employees provides “[c]ontractors and other non-employees who serve the Judiciary are not covered by this Code, but appointing authorities may impose these or similar ethical standards on such non-employees as appropriate.”