His counsel sets up a Nevada LLC, to which he contributes all of his accounts receivable, in return for the LLC’s issuing all of its stock to him, along with the LLC’s agreement with him to assume all of his debts. Immediately, his counsel sends the LLC his Statement for $100,000 for legal services rendered. Ten days later, not having been paid, counsel sues the LLC to collect $100,000, plus interest and attorneys’ fees in the Superior Court in Los Angeles and seeks appointment of a receiver over the LLC and its assets.

Revealing an unusual level of cooperation between debtor and supposed creditor, the LLC admits all allegations of the complaint and consents to a receiver’s appointment. The receivership court appoints counsel’s nominee as receiver. The Order Appointing Receiver contains an injunction that purports to bar anyone in the world from taking any legal action against the receiver or the assets within the receiver’s official custody.

A claims procedure is established whereby creditors submit proofs of claims by a specified date otherwise they are forever barred. The administration of this receivership leaves the assets in the control of the nominated receiver but follows a claims procedure similar to a bankruptcy proceeding – without the cumbersome web of a code, regulations and rules, and without subjugation of title to the debtor’s assets generally to a trustee.

The initiator of this proceeding designed it to be friendly and to hopefully leave the Debtor relatively unscathed. It is not really ancillary or provisional; rather, it, like a bankruptcy, is an end in itself, but, so the initiator hopes, with a blissful ending. Courts, however, are likely to see through this type of “friendly” receivership.

Hypothetical No. 2.
Two co-equal business partners are suing each other in the dissolution and winding up of their business, and both of them acknowledge that they don’t trust each other and need a neutral custodian to take over and keep assets intact. Consequently, they agree to a receiver’s appointment.

U.S. Supreme Court Says “No Friendly Receiverships”
In 1928, Chief Justice Taft wrote, for the U. S. Supreme Court¹:

[T]here should be no "friendly" receiverships, because the receiver is an officer of the court and should be as free from "friendliness" to a party as should the court itself. Each court should examine with nicety the question of the right of the parties to have a receiver and should advise itself in regard to the circumstances making it its duty to exercise this delicate jurisdiction. . .

The Supreme Court opinion reviewed and analyzed a complicated procedural history that caused the lower federal courts to make contradictory rulings. The facts were these: For some time, shareholders of a corporation had been suing it in a state court sympathetic to their cause, and the shareholders’ attorneys made known their intent to seek the appointment of a receiver over the corporation. The corporation’s attorney learned of the shareholders’ plans and stalled for time, by engaging the shareholders’ attorney in bad-faith settlement meetings stretched out over several weeks. Meanwhile, the corporation’s attorney located a “friendly” corporate creditor, as well as a “friendly” receiver, in league with the corporate management. The “friendly” corporate creditor, represented by a “friendly” attorney acting at the direction of the corporation’s attorney, brought a federal court suit against the corporation and applied to the court, on an emergency basis, for appointment of a receiver. The corporation agreed to the appointment of a receiver, and the federal court obliged the creditor by ordering a receivership. As soon as the shareholders’ attorney learned that he had been duped, he moved for, and obtained, the appointment of a receiver in the state court in which the shareholders’ suit was pending. The judge handling the shareholders’ suit was not sympathetic to the “friendly”- attorney’s argument that he had already obtained a federal court receivership and therefore refused to yield.

On appeal, however, the creditor’s attorney persuaded the appellate court to fall back on the general proposition that the first receivership must take precedence over other courts’ subsequently-created receiverships.² The U. S. Supreme Court refused to take such a mechanical position, condemned the trickery employed by the “friendly-receivership” gang and ruled that the later receivership sought by the shareholders took precedence over the earlier, contrived receivership.

Stay Focused on the Basics of Receiverships
Conspiratorial receiverships are not very common. Even so, given the warnings laid down by the U. S. Supreme Court and the risk of considerable expense and embarrassment, it is imperative to remember some fundamentals about receiverships.

1. Receivership is a remedy that is ancillary to litigation. There is no such thing as a cause of action for a receivership.

2. The lawsuit with which a receivership is associated must contain a meritorious cause of action.

3. Parties cannot create a receivership by agreement, disassociated from a meritorious suit.

Usually, courts do not, on their own initiative, appraise the genuineness of a complaining party’s cause of action, unless the words stated in the cause of action reveal the absence of legal merit. Judicial passivity is not, however, acceptable when a judge must make a decision whether or not to appoint a receiver. Rather, the court must conduct a careful, and, if necessary, independent inquiry into the facts before it utilizes its adjudicative powers to put its agent (the receiver) in charge, separating assets from their owners.³

If parties contrive to manufacture subject matter jurisdiction, then the court must protect itself from such an imposition, by looking beyond form to substance and entirely reject the proceedings.⁴ This situation came to the U. S. Supreme Court on the following facts: An individual was conducting a business as a sole proprietor. His creditors were many, and he was insolvent. Most creditors were rather torpid, so he sensed that a receiver would discourage litigation and, as a practical matter, enable him to reorganize his financial affairs. However, he was a resident of a state that did not allow receiverships over businesses owned by individuals. In order to circumvent this obstacle, he formed a corporation and conveyed all of his assets to it, in consideration for which he received all of the shares of stock issued by the corporation. He then persuaded a cooperative creditor to bring a lawsuit against the corporation and ask for the appointment of a receiver. The corporation accepted service of process and immediately answered the complaint, admitting its allegations and consenting to the receiver sought by the plaintiff. The local court obliged and appointed a receiver.

A rebellious creditor sought to levy execution notwithstanding the receivership and was stayed by the court. The matter found its way to the U. S. Supreme Court, where Justice Benjamin Cardozo denounced the entire plot in memorable language, determining that the business owner’s corrupt scheme completely voided his sham transactions – including both the lawsuit and the receivership.⁵

Some Non-Disputed Receiverships Are Proper if Motives Are Pure
Courts are supposed to hear and decide matters in controversy. However, a judge’s job description does not include catering to litigants’ conniving maneuvers. There are innumerable types of disputes over which courts preside, ranging from the incendiary hatred of divorces to a legal action for money owed. These legal controversies may become the basis for the appointment of a receiver, and it may be appropriate for the parties to the litigation to agree to appointment of a receiver.6
The parties may actually reach settlements that are rational, but until then, they may see the wisdom of placing the assets in which they both have claims and interests in the hands of a neutral, official custodian. Their agreement to a consensual receivership in such a situation is generally proper.

¹ Harkin v. Brundage, 276 U.S. 36, 55 – 57, 48 S. Ct. 268 (1928).
² See Shields v. Coleman, 157 U.S. 168, 177 – 178 (1895).
³ See Harkin, supra, 276 U.S. at 55.
⁴ Shapiro v. Wilgus, 287 U.S. 348, 353, 53 S.Ct. 142, 77 L.Ed. 355 (1932).
⁵ Shapiro v. Wilgus, supra, 287 U.S. at 353.
⁶ In re Metropolitan Railway Receivership, 208 U.S. 90 (1908).

*Mr. Coleman is an Attorney and Officer and Director of the California Receivers Forum and has served as Receiver in many cases for more than 30 years.