Winter 2006 • Issue 20, page 1

Auctions: Resolving the "Distressed Receiver's Dilemma"

By Walters, Mike & Karbelk, Stephen*

Having worked with many receivers around the country, and having occasionally served as receiver, we have come to identify what we call the “Distressed Receiver’s Dilemma”. Like being the fifth person on a double date, a receiver sometimes has trouble becoming comfortable in certain situations because of the high level of scrutiny afforded a receiver’s actions and the actual and potential liabilities every receiver takes on.

A commonplace distressed situation arises where a lender seeks and the borrowers contest appointment of a receiver over a sub-standard and mostly vacant apartment building, for example, or over a shopping center that has lost its anchor and the smaller tenants have vacated. The borrowers/defendants think they can turn the property around, but the lender/plaintiff no longer trusts the borrowers and wants an independent agent to take control. Add to this contentious situation the fact that potential purchasers of the property already smell blood in the water and want to try to steal the property at a bargain price through a quick, non-competitive sale.

In addition to these competing agendas, there is also the compensation dilemma. If a receiver facilitates a quick sale, he or she may be criticized for insufficient marketing.

But if the receiver takes his or her time in marketing the property, incurring fees in the interim in maintaining the property, she or he may be accused of milking the estate. Hence, the Distressed Receiver’s Dilemma is born. How can a receiver avoid these pitfalls?

In his Receivership News article in this issue, Kevin Cavanaugh, a CPA with the Douglas Wilson Companies, explains how a receiver can facilitate marketing of a property by (a) assembling a detailed property information package (with plenty of disclaimers), (b) extracting confidentiality agreements from prospective purchasers and brokers, and (c) vetting qualifications of prospective buyers.

An interesting aspect of this article underscores the Distressed Receiver’s Dilemma – the cautionary tone Mr. Cavanaugh adopts with respect to the receiver’s marketing actions, which is essentially to protect thyself first, and rightly so. The potential for a receiver being sued when thrust into a tinderbox of litigation is significant. We all know that no receivership appointment is worth making one’s life miserable.

The Distressed Receiver’s Dilemma will never go away because it is the essence of being a receiver – occupying the middle ground between disputing parties. There are certain important choices the receiver of a distressed property can make to minimize his or her legal exposure, however, while doing what is best for the property and all interested parties.

Private or Public Sale?
For some reason, there is a general misconception that a general brokerage transaction is the safe way to sell real property. One assigns a listing price, places the property in the multiple listing services, and waits for the offers to come streaming in. While this process does work when the broker has only one client to satisfy, such as where a non-distressed seller wants to sell an asset at a particular price, the process does not work especially well in contentious receiver’s sale situations. There are several reasons why this is so:

1. The Listing Price Dilemma. If the Receiver has market knowledge and authority to market and sell the property, the first step is to decide on the listing price. This is fairly easy for a stabilized property with an easily identifiable cap rate. But where the property is in distressed condition, lacks any relevant income, and is hemorraging monthly losses, the Listing Price Dilemma becomes much more serious. The lender unwillingly funding the monthly losses may want a low listing price to get the property sold quickly, but the borrower, who may be exposed on a personal guaranty, will want a high listing price. If the lender’s arguments prevail, the property may sell for too little, leaving a substantial amount of equity on the table. If the borrower’s arguments win out, the listing price may be set too high and the property will not sell, resulting in a stagnant listing and ever-mounting losses.

2. The Preservation Dilemma. Receivers are generally prohibited from improving property under their care, but they may take steps necessary to preserve it. A leaking roof may need to be repaired to keep the property from deteriorating during the receiver’s possession. On the other hand, maybe the best way to remedy the deficiency is to put on a new roof. The Receiver must often decide what needs to be done, and to what extent, to preserve a property’s value. I imagine all receivers have lain awake at night worrying whether he or she made the right decision to not incur an expense as necessary for property preservation. Should the receiver remediate actual or suspected mold? Should the receiver remove the potentially/ actually leaking underground storage tank? Should the receiver perform a build-out as a condition to attracting a tenant? And, if so, will the receiver be able to recover the amount spent? Should the receiver leave the work to be done by any subsequent buyer?

3. The Sales Price Dilemma. If the receiver receives an offer to purchase, the receiver then has to decide if offered sales price is defensible. In his article, Mr. Cavanaugh writes that “market knowledge equals power” as it relates to deciding whether to accept an offer. The dilemma lies in deciding whether or not the price offered is a market price. Was an appraisal done? Were multiple offers received? What is the receiver’s market knowledge and why is that knowledge better than someone else’s idea of the “market value” of the property? It might sound heretical to assert such questions but the reality is that any claim to possession of all market knowledge necessary to make an absolute judgment as to market value is probably an exaggeration.

In a hotly contested litigation situation, privately marketing and selling a property may actually increase the potential liability of a receiver. He or she could list the property at the wrong price, could choose to make changes to “preserve” the property later deemed to be improvements where the costs are never fully recovered, and might imprudently decide to accept a purchase offer that proves demonstrably below true market in hindsight or by way of a selling process later claimed to be not competitively driven.

There is an alternative way of selling that avoids some or most of these problems. Selling a property by auction avoids these imponderables and, if done properly, assures that the maximum market value will be achieved.

Sale Structure
Employing a professional auction firm to assist in developing comprehensive bidding procedures enhances a competitive sale. A level playing field is necessary to create a competitive bidding environment. When the terms of the sale are pre-defined, potential buyers do not have an opportunity to independently negotiate responsibility for the myriad costs, expenses and closing items that often make evaluating competing private sale offers a comparison between apples and oranges.

Having the appointing court approve the auction procedures in advance of sale, including terms of sale, deposit requirement, closing period, allocation of
escrow and title charges and other costs ensures a level playing field, the unquestionable legitimacy of the sale process and protects professionals against liability that may result from the potential infirmities of a traditional sale process.

Caveat Emptor (but here is everything we know)
Everyone knows the three most important elements of value in real estate: location, location and location. For the receiver selling a distressed asset the three most important elements of avoiding potential liability are: disclosure, disclosure and disclosure.

Part of a true competitive bidding environment is for every participant to be provided the same information. By employing a professional auction firm to
develop (and assist in developing) a Property Information Package (“PIP”), a receiver can be certain that full and uniform disclosure has been made. It is
customary prior to the bidding process to have auction buyers acknowledge in writing receipt of all PIP documents and, again in writing, to accept responsibility for their own due diligence. This shifts accountability from the receiver to the buyer, unless some pertinent information known to the receiver has been withheld.

(This concludes Part I of “Auctions: Resolving the Distressed Receiver’s Dilemma”! The concluding portion will appear in the Spring, 2006 issue of Receivership News.)

*MIKE WALTERS, senior partner of Tranzon Asset Strategies, a financial company specializing in real estate sales, is also a member of Tranzon, LLC, an auction marketing company with 20 offices nationwide.

*STEPHEN KARBELK is a partner of Tranzon Fox, a Tranzon, LLC affiliated company specializing in real estate marketing and sales in the mid-Atlantic region.