Receiver's in Bankruptcy: Strangers in a Strange Land
By Oliner, Ron*
What happens when you are holding and operating a 20-unit apartment building as receiver and the owner of the building files a bankruptcy petition? Do you have to relinquish control? If so, to whom? Can you retain possession under some circumstances? And, most important perhaps, how are you to be paid for the services you have provided (and are providing)?
Let’s start with a hypothetical. Plaintiff Bank sues in state court to judicially foreclose on a deed of trust and has a receiver (you) appointed over the Bank’s collateral securing its lien — a 20-unit apartment building. The lien extends to rents, issues and profits. You take over management of the property.
Defendant/owner of the property files a Chapter 11 bankruptcy petition in order to pull the rug out from under the Bank and frustrate its foreclosure action, and immediately demands that you turn over the property and disgorge all collected rents. The demand letter is nasty and describes, among other things, the ramifications of any continuing violation of the automatic stay found in Bankruptcy Code § 362. The letter states that since Section 541 of the Bankruptcy Code defines “property of the estate” to include “property, wherever located and by whomever held,” the apartment building is surely included. It also points out that Section 543 of the Bankruptcy Code requires that a “custodian” of property of the estate deliver the property and related proceeds, rents and the like to Defendant, now a debtor in possession under the Bankruptcy Code. (“Custodian” is defined elsewhere in the Bankruptcy Code to include “a receiver or trustee.”)
Your failure to do so, states the letter, violates the Section 362 automatic stay and may subject you to substantial litigation risks and sanctions.
The last thing you want to do is run afoul of the Bankruptcy Code or needlessly expose yourself to the ire of the bankruptcy judge. But neither do you wish to fail in your duties set by the appointing state court judge. What to do?
A closer look at Bankruptcy Code Section 543 is in order. The Bankruptcy Code provides that a custodian with knowledge of the commencement of a case under the Bankruptcy Code concerning the debtor may not make any disbursement from, or take any action in the administration of, property of the debtor, proceeds, product, offspring, rents or profits of such property, or property of the estate, in possession, custody, or control of such custodian, except such action as is necessary to preserve such property (more on this below).
Section 543 further provides that a custodian shall deliver to the trustee (or debtor) any property of the debtor held or transferred to such custodian, or proceeds, product, offspring, rents or profits of this property, that is in such custodial possession, custody or control on the date that the custodian acquires knowledge of the bankruptcy case. The custodian must also file an accounting of any property, including rents, issues and profits, within a timeframe prescribed by the Bankruptcy Court.
Finally and perhaps most importantly, Section 543 provides a mechanism by which a custodian — you — can remain in control of the property in spite of the bankruptcy filing. The court may so order if it finds that it is in the interests of creditors to allow a custodian to retain possession. This is the tool a good Plaintiff’s lawyer will use to keep a receiver in control of real property during the bankruptcy. This job is easiest where Plaintiff’s counsel can marshall compelling reasons to “preserve the status quo.”
In this author’s experience, to the extent Plaintiff’s counsel can prove (a) the receiver’s good management of the property and impartiality, (b) Defendant’s previous poor management, (c) an eve of foreclosure bankruptcy filing, (d) an incomplete set of bankruptcy schedules, and (e) other facts otherwise demonstrate that Defendant merely wants to wrest control of the property back in order to continue to collect rents without any exit strategy, a properly written motion should result in the Bankruptcy Court directing a previously appointed receiver to remain in custody.
What are possible “other facts” that may justify keeping a receiver in possession? Defendant may have allowed the property to become so run down that orders of abatement have issued, may have allowed property taxes to go unpaid, or may have deferred maintenance to the point where there is a clear danger to tenants. Plaintiff may have been required to force-place property insurance where Defendant allowed its policy to lapse. Maybe there is a good deal of police activity at the property. These aren’t good facts for creditors, tenants or the property, but are facts that can make a Section 543 motion winnable.
What about the practical aspects of the situation? In our hypothetical the receiver is looking squarely at a lawyer’s threatening letter that describes the horribles that will befall the receiver if she does not immediately hand over the keys to the property. Ignoring the demand letter is not the answer, and may have dire consequences. Rather, immediately upon learning of the bankruptcy filing the receiver should contact Plaintiff’s counsel and advise him/her of the pending bankruptcy case (and any demand letter). The receiver should advise Plaintiff’s counsel that she will comply with the turnover requirements of the Bankruptcy Code unless a motion to excuse turnover is immediately brought, on shortened time if possible.
In the interim, the receiver should probably do nothing other than to hold the rents she had collected to date, collect additional rents which may come due during this very short interim period, and preserve the property (including paying necessaries like utilities). Unless a motion to excuse turnover is promptly brought and there is a resolution in very short order, the receiver may have no alternative but to hand over the keys and rents to the debtor in possession as required by the Bankruptcy Code.
What about payment to the receiver for her services, and to those persons and entities (a property manager, perhaps counsel, and for other payment obligations incurred post-receivership and prior to the filing of bankruptcy case) to whom and for which the receiver has become obligated? The answer is found in Bankruptcy Code § 543, Subsection (c), which provides that the court, after notice and a hearing, shall “protect all entities to which a custodian has become obligated with respect to such property or proceeds, product, offspring, rents or profits of such property; and provide for payment of reasonable compensation for services rendered and costs and expenses incurred by such custodian.”
These receivership obligations cannot be paid without an approving order of the Bankruptcy Court, however, regardless of whether the receiver winds up turning over the property to the debtor or is directed to remain in control, there is clear statutory and case authority by which the Bankruptcy Court can (and should) authorize these payments to be made out of the receivership estate assets.
Perhaps the most important point to be made is that Receivers should be able to fully protect themselves when a bankruptcy case interrupts an ongoing receivership if they keep calm and are generally familiar with these fundamentals of bankruptcy practice and with local practice requirements in the district where the bankruptcy case is pending.
*RON OLINER is a shareholder with Buchalter, Nemer, Fields & Younger, resident in its San Francisco office, where he has been practicing for over ten years. Ron focuses on bankruptcy and creditors’ rights, and has handled many receiverships throughout Northern California, representing receivers and financial institutions. He is also a court-appointed trustee in bankruptcy and the immediate past president of the California Receivers Forum, Bay Area Chapter.