Fall 2013 ē Issue 49, page 6

Funding Alternatives for Receiver Certificates

By Miller, Kenneth*

Problems can make for good business. Receivers go looking for problems and problems, in turn, sometimes find them. Those problems often require the same solution, money; money for repairs, money for taxes, money for fees, money for litigation, and money for everything in between.

But itís not always obvious where that money will come from. Often, a receivership estate has little or no cash on hand and, sometimes, the property's existing creditors are unable or unwilling to fund necessities. While this is uncommon, it does happen and it requires the receiver to track down funding for the receivership estate. Whether the estate has big needs or small, third-party lenders may be the best source of those funds.

To entice a third-party lender to lend to a receivership estate, it is important to understand that lenderís perspective. Those providers of targeted capital represent their own interests, not the interests of the estate. And they charge a lot. Interest rates are normally double digits, plus fees. The market for third-party receivership financing is shallow, allowing the participants to earn a scarcity premium on their money. They bring value, and they get paid for it.

Before lending to a receivership estate, lenders will usually require issuance of receivership certificates that have priority over the existing liens on the property comprising the estate. To do this the receiver must (1) find a lender willing to lend to the estate on favorable terms, and (2) obtain court approval to issue receivership certificates in exchange for such financing.

It is generally up to the receiver to show the court that the third-party capital provider adds value worth its fees and high interest rates. The receiver will also be tasked with demonstrating to the lender that the receivership estate will be able to repay the funds, which may come from future income or the eventual sale of the property.

Providing capital may be evidence of value in and of itself, but what if the transaction doesnít close? Third-party financing is only available to a receivership estate if the receiver can make it worthwhile for that third party to pursue. What terms will motivate a lender to finance a receivership estate? No matter how straight-forward a transaction may seem, crazy stuff happens. How does a provider of targeted capital know that he isnít speculating his resources on something that wonít happen? How does the proposed priming lender know that he isnít being used as a stalking horse?

While not used in every receivership, receivership certificates can play an important role in ensuring that the estate has proper funding to carry out its duties under the receivership order. California courts have long recognized the necessity of such certificates and for certain types of receiverships, they will continue to serve an important function for many years to come.

Receivership Certificates: Mechanics and Legal Standard

Generally, the costs of a receivership are paid from the income of the property comprising the receivership estate. That being said, receivers are often appointed to manage property, both real and personal, that produces insufficient income to satisfy the requirements of the receivership estate. In these circumstances, a receiver has little choice but to borrow funds to ensure that he or she is able to carry out the receiver's duties. To do so, a receiver must apply to the court for permission to borrow funds in exchange for receiver's certificates.1

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Receiver's certificates operate as security for amounts loaned to fund the receivership estate. The certificates evidence the indebtedness of the receivership estate and, for real property, the certificates are recorded against the property, similar to a deed of trust. While there is limited case law addressing the subject, the authority to issue receiver's certificates to fund the receivership estate is left to the broad discretion of the court that appointed the receiver.2 The court also reviews and approves the provisions of the certificate, including the amount, interest rate, and repayment terms.3 While the court has large discretion to authorize borrowing in exchange for certificates,4 this discretion is ordinarily exercised with deference to a receiver's reasonable business judgment.5 The certificate becomes an obligation of the receivership estate, typically paid from the sale of the property, but is not an obligation of the receiver personally.

It is also within the court's power to authorize the issuance of certificates with super-priority lien status over all other liens, including the liens of the secured lender that sought the appointment of the receiver.6 Because of this possibility, the senior secured lender typically loans funds to the receivership estate in exchange for the certificates so that its liens are not subordinated to another lender. Nevertheless, with court approval, the receiver may borrower funds and issue receiver's certificates to a lender other than the existing senior lien holder. Obviously, this is uncommon in a rents-and-profits receivership, but when might that happen?

The Need for Third Party Financing and Receivership Certificates

There are numerous instances that might require the receiver to borrower funds in exchange for certificates to ensure the property is managed and cared for, as set forth in the receivership order.

Suppose the existing lender is a private fund in bankruptcy or receivership and has no cash on hand? A lender with no cash to protect its own interests might have been unheard of six years ago, but not today. Suppose the receivership is for health and safety? An existing lender may be so far underwater that it simply declines to go in any deeper for a dilapidated property. Suppose the receiver believes that a claim is critical to the value of the estate and therefore should be litigated, but the existing lender disagrees? Or, a receivership estate may be the defendant in litigation that threatens the property comprising the estate. Suppose the amount of the receiverís request is simply too large for the existing lender to manage?

For example, when a receiver is appointed to manage real property that has not paid its property taxes in many years there may be the threat of a tax sale looming. While an existing lender would usually advance funds to pay the outstanding property taxes, this may not always be possible. As mentioned above, the lender may not have available cash to do so; this may be particularly true when there are many individual or very small lenders who have financed the property. They may lack both the funds and the coordination to advance the property taxes. In this circumstance, finding third party financing is vital to protecting the property. Because the stakes are so high, and the value undeniable, it is very likely a court would be willing to approve receivership certificates that prime the existing lender's liens in this situation.

As it is generally the duty of the receiver, as an appointed officer of the court, to protect the value of the estate, third-party financing can be an important tool. Further, given the varied nature of receivership estates, third party financing through receivership certificates will stem from a wide variety of situations and vary widely in complexity. The receivership certificate process might be straightforward, but getting to the finish line takes time and resources. Lenders will build such risk into the financing terms to ensure their return is acceptable.

Nonetheless, when push comes to shove, the most likely provider of receivership certificate financing is the current, senior lender. Third-party lenders know this too so both the receiver and the proposed lender should ensure that the existing lenders are unwilling to provide financing before incurring the time and expense to prepare a proposal and document the transactions.

Given the complexities associated with issuing receivership certificates and obtaining third party financing, hiring the right legal counsel with experience in these matters is essential. Third-party providers of receivership certificate financing should similarly be top of mind. For a host of problems, they may be just the right fit.

* Kenneth A. Miller is President of Guardian Capital Advisors, Inc., a private real estate lender and debt advisory firm in the Bay Area. He has been advising capital providers on the placement, valuation, structuring, restructuring, and liquidation of mortgage assets for the last decade. Ken is a real estate broker with a Masters in Economics, University of San Francisco and a Chartered Financial Analyst.

1 See Cal. Code. Civ. Proc. ß 568; see also California Judicial Council Form RC-310 for Order Appointing Receiver ("The receiver and the parties may at any time apply to this court for further instructions and orders and for additional powers necessary to enable the receiver to perform the receiver's duties properly.").
2 Title Ins. & Trust Co. v. California Development Co., 171 Cal. 227, 233 (1915) ("[W]hether receiver's certificates should be issued and whether those certificates when issued should be given priority over the other indebtedness of the defendant, rested largely in the discretion of the court below."); Barclays Bank of California v. Superior Court, 69 Cal.App.3d 593, 600 (1977) (a court's appointment of a receiver and administration of a receivership must be "according to the principles Ö of equity, and the question 'is largely one in the discretion of the court.'"); see also McLane v. Placerville & S. V. R. Co., 66 Cal. 606, 629 (1885).
3 Miller & Starr, California Real Estate ß 33.12.
4 City of Santa Monica v. Gonzales, 43 Cal.4th 905, 931 (2008) ("Typically, however, court rulings on receivership matters are afforded considerable deference on review . . . . Such deference is the rule, even where the court confirms extraordinary action by the receiver, such as a sale of real property.") (citations omitted).
5 See id. at 931-33.
6 Miller & Starr, California Real Estate ß 33.12 (3d. ed. 2009); Schreiber v. Ditch Road Investors, 105 Cal. App. 3d 675, 679 (1980).