Can Investor/Creditor Recoveries from Third Parties Reduce Their Claims in a Receivership?

by Ervin Cohen & Jessup LLP
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QUESTION: I am an equity receiver and I am setting up a claims procedure. I know some creditors and investors have filed suit against third parties to recover their losses. Can I consider these possible third party recoveries in fashioning the claims procedure and ultimately paying claims? a receiver appointed by a court in California in a contentious case. One of creditors has threatened to sue me in Nevada were he is located. How can this creditor sue me? I am a receiver appointed by the Court!

ANSWER: Yes. This issue is not new but was recently highlighted by the Ninth Circuit in Securities & Exchange Commission v. Capital Consultants, LLC, et al., 397 F. 3d 733 (9th Cir. 2005). There the receiver proposed that third party recoveries should reduce each claimant’s receivership claim by 50%. Initially, the receiver had proposed that third party recoveries reduce claims on a dollar-for-dollar basis. The receiver, however, changed his proposal after receiving objections. Various objections were filed to the receiver’s modified offset proposal. The court, repeating longstanding receivership law in the Ninth Circuit, noted that a district court’s power to supervise an equity receivership, and to determine the appropriate action to be taken in the administration of the receivership, is extremely broad and that a district court’s decision concerning the supervision of an equity receivership is reviewed for abuse of discretion. The court, relying on its prior decision in In re Equity Funding Corp. of America Securities Litigation, 603 F.2d 1353 (9th Cir. 1979), held that the offset provision proposed by the receiver was a reasonable compromise—balancing the goal of encouraging claimants to seek third party recoveries and rewarding them for their efforts, with the goal of distributing the limited assets of the receivership estate in a roughly equal fashion.

The court noted that under the “collateral source rule” a tortfeasor is generally not entitled to be relieved of the consequences of its tort by some third party’s compensation to the victim (because the defendant should not get a windfall for benefits received by the plaintiff, especially where the plaintiff has gone to the cost of chasing third parties). But in a receivership case the wrongdoers do not receive a windfall by offsetting such recoveries. The offset provision only affects how the assets recovered by the receiver are distributed among the innocent claimants. Given the broad discretion a district court has in supervising a receivership, the Ninth Circuit found no error in the court’s approval of the receiver’s proposed distribution plan. The court further noted that in other cases it had approved 100% offsets, as the receiver had initially proposed, in order to prevent the possibility that claimants might secure a double recovery by collecting from the receivership estate and third party defendants.

In designing your claims procedure and a distribution plan, therefore, you have wide latitude in determining how to fashion an equitable plan of distribution so that claimants receive roughly the same distribution from the estate.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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