Summer 2010 • Issue 37, page 18

Non Neutral Receivers Risk Personal Liability: How Receivers, Lenders and Special Servicers Are Exposing Themselves to Long -Term Liability for Short Term Gains

By Ormond, Richard*

Some real estate brokerage firms and management companies are approaching special servicers and lenders with offers to act as “full service” receivers in exchange for sales listings, commissions or management fees. They promise to charge nominal receiver’s fees and costs — in lieu of the receiver’s traditional hourly rate – in exchange for potentially immense listing/sale/broker fees. And no one is telling the courts of these often sub rosa arrangements.

California law requires that a receiver be an individual (rather than a corporation or other artificial entity). The abusive firms “volunteer” an in-house employee, many times without any receiver experience, to serve, to meet this requirement. The brokerage then proceeds with marketing and selling the real property—without any attention to other needs to protect the real property collateral and without any regard to the Receiver’s fiduciary obligations.

In such cases a deal is struck to manage and sell the asset without court knowledge or approval. This arrangement, quite apart from being blatantly illegal, exposes the “receiver,” his or her employer, and the lender to serious liability—including surcharges.

California Rule of Court 3.1179 (“CRC 3.1179”) dictates the following:

  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.

Ignorance of this Rule, of course, is no excuse. Many special servicers and bank officers are unfamiliar with California receivership law and the requirements set forth in CRC 3.1179. They are unaware that no “prior” deal may be made between the entity seeking the receiver’s appointment and the receiver (or the receiver’s employer).

This also underscores a common misperception – that the entity seeking a receiver’s appointment “hires“ the receiver. The receiver is appointed by the court and, as an arm of the court and judge, must be neutral without any ties – contracts, understandings, quick winks – with any of the litigating parties.

A truly neutral receiver does what is best for the particular collateral and answers solely to the court. The Receiver does not take action that would harm the collateral for the benefit of all the potential claimants against that respective receivership estate.

Brokerage firms, eying a commission for the sale in a slow market, are overlooking these neutrality and fiduciary obligations of a court appointed receiver and turning a blind eye to these conflicts in order to turn a quick profit. Unfortunately, many of these schemes work. Many judges never learn of these prior arrangements, or are unfamiliar with receivership law and the neutrality requirements, and acquiesce to such appointments without further investigation.

Banks and special servicers are under intense pressure to keep costs down, making such “one-stop shop” receiver arrangements, with receivers’ employers willing to undertake this type of appointment for virtually nothing, very appealing.

A recent, high profile case in Orange County saw a well known brokerage firm appointed as receiver over a large condominium development. While there have been no accusations of wrongdoing or conflict of interest raised yet, many receivers and receivers’ attorneys are scratching their heads at the potential for exposure for both the lender and the hybrid “broker/receiver” in this type of case.

One example of how this arrangement compromises fiduciary responsibility is the brokerage firm’s likely disinclination to shop the property listing to competing brokers, which may be willing to reduce their commissions in exchange for the listing and thus benefit the receivership estate’s bottom line.
Even worse, brokers desperate for a commission are walking into these receiverships blindly. They may be unaware of the strict fiduciary duties of a receiver, and a receiver’s need for transparency and neutrality.

A savvy borrower (or interested third party) at risk of losing its property may challenge this type of appointment. Eventually appellate courts will reinforce the strict guidelines of existing law to which receivers are subject, at great cost to these transgressing lenders and brokers.

Receivers and the Need For Neutrality
A receiver is a neutral, court-appointed officer who manages property and/or other assets and ongoing businesses that are the subject of a legal dispute. A receiver can also be appointed to act as a liquidator of such assets as necessary. In many circumstances, however, a receiver’s primary role is to preserve assets efficiently.

The appointment of a receiver is typically an equitable procedure wherein a court believes that a party to an action is not in a position (or, in some circumstances, refuses) to comply with the desires of the court. Appointment of a receiver is also a provisional remedy that allows courts to preserve and/or maintain assets, so that “waste” does not occur and the value of an asset in dispute can be preserved.

Receivers are commonly appointed when a secured lender seeks to preserve its collateral pending completion of a foreclosure or other court action. This is the predominant type of receiver being appointed by courts in today’s distressed economy.

Each appointment will differ. A receiver’s duties may be simple or complex. The receiver may be appointed to manage a rental property and collect rents until the dispute over the real property is resolved, or the receiver may have to takeover the day-to-day operations of an ongoing business in order to preserve that business.

California courts have defined a receiver as:

A receiver is a ministerial officer, agent, creature, hand, or arm of, and a temporary occupant and caretaker of the property for the court, and he represents the court appointing him, and he is the medium through which the court acts. Pacific Independent Co. v. Workman’s Compensation Appeals Bd., 258 Cal. App. 2d 35, 65 Cal. Rptr. 429 (1969).

A receiver, as an appointed officer of the court, has a fiduciary duty to act in the best interests of the estate and all the creditors, and the party seeking the receiver has no control over the actions and responsibilities of the receiver. Security Pacific National Bank v. Geernaert, 199 Cal. App. 3d 1425, 1431-32 (1988).

The Pacific Independent Co. delineates the true function of a receiver: being the “arm of the court” and acting as the court’s “medium.” Security Pacific National Bank further clarifies that no party controls the receiver, not even the party seeking the receiver’s appointment.

The distressed asset managers at lending institutions and special servicers, many of whom had never been exposed to an economic downturn, may or may not be familiar with these restrictions and requirements. Brokers see a new opportunity to generate sales. This is a recipe for disaster in that both the lenders and the brokers are exposing themselves to serious liability if the neutrality of the receiver is compromised.

In the case of Pacific Ry. Co. v. Wade, 91 Cal. 449 (1891), the court said:

The receiver is indifferent between the parties. His possession is the possession of the court for the benefit of all persons interested, whether named as parties in the action or not, and it cannot be disturbed without the consent of the court. No one claiming a right paramount to that of the receiver can assert it in any action without the permission of the court. No sale can take place, no debt can be paid, no contract can be made, which does not receive the sanction of the court.

Surcharges to the Receiver and Risks for the Plaintiff
Where there is a failure of full disclosure, banks, special services and receivers may be subject to liability including a surcharge or other monetary damages. Courts are consistent in surcharging receivers when they act contrary to their neutrality requirements.

In Shannon v. Superior Court, the court held that the receiver is obliged to act in the best interests of all parties involved in the action and will be exposed to a surcharge to the extent it can be shown he acted contrary to his responsibilities. Shannon v. Superior Court, 217 Cal.App.3d 986, 266 Cal.Rptr. 242. Similarly, the court in People v. Riverside University held that where a loss has been sustained through receiver’s misconduct proper procedure would be to surcharge the receiver rather than to grant a conditional discharge. People v. Riverside University, 35 Cal.App.3d 572, 111 Cal.Rptr. 68.

Obviously, these surcharges or other penalties can compromise the value of the receivership estate and may compromise the plaintiff’s ability to pursue its borrower effectively. In extreme cases, the lender’s collateral may be forfeit.

Avoid this Potential Liability
Judges must review the appointment order carefully and verify the receiver’s neutrality. When a receiver is wearing multiple “hats” in his or her appointment, a judge should question whether that is appropriate, whether it is properly disclosed and what arrangements were discussed or agreed to with the appointing party.

Some red flags that judges should be aware of are:

  • Receivers (or an affiliated company) who will act as the broker for the sale of the estate’s assets;

  • Receivers that have never been appointed in other matters (while not to discourage new receivers—which are needed—it allows the judge to question the motives of the appointing party and the receiver);

  • Cases in which the borrower acquiesces or does not participate (because the borrower’s rights may not be properly asserted);

  • Flat fee receiverships (because, in many of these cases, the “arrangements” require a reduced fee for the receiver in exchange for a bigger pay out with management fees or broker fees down the line).

Lenders and special servicers should seek qualified counsel to evaluate those cases where a receiver is necessary, and to review the qualifications of the potential receivers carefully.

Choosing the right counsel and the right receiver will reduce lenders’ and special servicers’ exposure and liability. It can avoid situations such as a borrower unwinding a receivership estate or a foreclosure. It can prevent a borrower or third party from unwinding a sale of assets by a receiver and it can protect the lender or special servicer from punitive damages connected with a wrongful appointment.

As the number of assets in distress increases, the potential for exposure increases as well. As such, it is critical for attorneys, lenders, special servicers, receivers (new and experienced) and, most importantly, judges to be fully aware of the pitfalls of appointing an unqualified receiver who has not lived up to his or her oath of neutrality, and/or his or her fiduciary responsibility.

*Richard Ormond is a member of the Los Angeles/Orange County chapter of the California Receivers Forum and a partner in Buchalter Nemer’s Los Angeles office. He specializes in real estate and commercial/business litigation, receiverships, corporation disputes and intellectual property litigation.