When a Receiver is Appointed Does this Prevent Former Officers & Directors from Filing a Bankruptcy Petition on Behalf of the Entity Placed in Receivership?

by Ervin Cohen & Jessup LLP
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QUESTION: I have noticed language in a number of receivership orders providing that the receivership entities’ officers and directors are removed and their powers are vested in the receiver and further enjoining the officers and directors from filing a bankruptcy petition on behalf of the entity placed in receivership. Are such provisions effective in preventing former management from commencing a bankruptcy for the receivership entity and, if a petition is filed, can the receiver easily have the case dismissed because the persons filing the bankruptcy petition have no authority to do so?

ANSWER: Had you asked me this question a month ago, I would have said: “of course the provisions are effective”. The court, by its order, has removed the former officers and directors from their positions and vested their authority in the receiver. Therefore, only the receiver has the ability to file a voluntary bankruptcy petition on behalf of the entity placed in receivership. This view follows a long line of receivership cases that hold that when a receiver is appointed for a corporation, former management loses its power to control the corporation and run its affairs, and that power is instead vested in the receiver. First Savings & Loan Ass’n v. First Federal Savings & Loan Ass’n., 531 F. Supp. 251, 255-256 (D. Hawaii 1981) [“When a receiver is appointed for a corporation, the corporation’s management loses the power to run its affairs and the receiver obtains all of the corporation’s powers and assets.”]; SEC v. Spence and Green, 612 F. 2d 896, 903 (5th Cir. 1980) [“as a general rule a receiver, standing in the shoes of management, holds the full right…to direct the litigation of the corporation whose care he is entrusted.”]. Prairie States Petroleum Company v. Universal Oil Sales Corp., 3d 753 (1980) [“Upon appointment of a receiver, the 88 Ill. App. functions of the corporation’s managers and officers are suspended and the receiver stands in their place”.].

However, a very recent case from the bankruptcy court in Arizona has called this into question and, indeed, has held that such provisions are not valid and cannot prevent the removed officers and directors from commencing a voluntary bankruptcy case for the entity placed in receivership. In In re Corporate and Leisure Event Productions, Inc., 351 B. R. 724, (Bankr. D. Ariz. 2006), creditors filed various state court actions asserting they had been defrauded by 13 related corporations and sought the appointment of a receiver. The superior court in Arizona appointed a receiver for the entities and the receivership order authorized the receiver to remove any officers, directors, employees or agents of the receivership defendants from control of, management of, or participation in the affairs of the receivership defendants. The order further enjoined the former officers and directors from taking any action to interfere with the receiver’s custody and management of the receivership assets and specifically enjoined them from filing “any petition on behalf of the Receivership Defendants for relief under the United States Bankruptcy Code…without prior permission of this court”. One of the former officers, in violation of the superior court’s orders, filed Chapter 11 petitions for the entities and removed the receivership proceedings to the bankruptcy court. The receiver then filed a motion to dismiss, on the ground that the former officers were not authorized to file the bankruptcy petitions.

The bankruptcy court, while conceding the dispute over the authority to file a bankruptcy petition in such instance is not governed by the Bankruptcy Code and that, ordinarily, it would be governed by the law of the state of incorporation of the entity, held that because creditors had sought the appointment of the receiver federal common law applies. After going through a lengthy analysis and reviewing numerous cases, the court held that the appointment of a state court receiver with full power to act for the corporations does not affect the right of the former officers or directors to act on behalf of the corporation and file bankruptcy proceedings.

The court held that the receivership orders and injunctions preventing bankruptcy filing are unconstitutional. “[I]t is fundamental that a state court receivership proceeding may not operate to deny a corporate debtor access to the federal bankruptcy courts…a state court receivership specifically restraining the debtor corporation, its stockholders, officers, and directors from instituting federal reorganization proceedings is an unconstitutional deprivation of the right to bankruptcy relief.” The court went on to say that it makes no difference whether the corporate officers and directors are actually removed by the receiver or the receivership order merely enjoins their interference or filing of a petition. “In either case, the state law withdraws their authority to file for bankruptcy relief and yet in both cases unanimous federal common law holds that they are nevertheless entitled to do so.”

The court goes on to note that if the removal of corporate officers and directors by a receivership order were sufficient to prevent a bankruptcy filing “creditors who seek their state court remedies…would routinely obtain receivership orders with such boilerplate language.”

The bankruptcy court’s decision is disturbing on a number of grounds. First, it ignores other established federal and state law on who controls a corporation once a receiver is appointed. If former officers and directors have been removed from their positions, it seems illogical that, despite their removal and the vesting of their corporate authority in someone else, that they can still take the corporate action necessary to institute a bankruptcy proceeding. Second, despite the court’s repeated statement in its decision that there is no authority holding otherwise, the court not only ignores the cases cited above, concerning who controls a corporation when a receiver is appointed, but it actually cites to a Ninth Circuit case that seems to hold just the opposite, which the court apparently relegates to dicta because the debtor in that case was ineligible to file bankruptcy anyway.

The case in point, Oil & Gas Company v. Duryee, 9 F. 3d 771 (9th Cir. 1993), though not a receivership case, has language that appears to call into question the bankruptcy court’s decision. Oil & Gas Company was an insurance company and the Ohio state court had appointed a rehabilitator to run it. The state court issued a temporary restraining order enjoining the company’s former president from filing bankruptcy on its behalf. Undaunted, he filed a chapter 11 petition anyway. The bankruptcy court dismissed the petition because Oil and Gas Company was a domestic insurance company and, hence, was precluded from filing bankruptcy. An attorney purporting to represent the company filed an appeal to the District Court which affirmed and then the attorney appealed to the Ninth Circuit. The Ninth Circuit noted that it had “difficulty figuring out who the appellant talent is”. It noted the state court’s order appointing the rehabilitator specifically provided that he “shall have all the powers of the directors, officers and managers of the Defendant, whose authorities are hereby suspended”. Based on that language, the Ninth Circuit held “The only person then, who could go to court on behalf of Oil & Gas was Fabe [the rehabilitator]. And he not only failed to authorize these actions; he opposed them. Therefore, when Becker-Jones purported to file the bankruptcy petition on behalf of Oil & Gas he was an imposter; his action is null and void. The same is true of whoever appealed the dismissals of that petition in the bankruptcy court and the district court. We, therefore, remand to the district court for dismissal of the petition as fraudulently filed”.

Based on the Ninth Circuit’s language, the bankruptcy court’s relegation of this opinion as dicta seems questionable: the remand was not because the company did not qualify as a debtor, but because the persons who commenced the case had no authority to do so because their powers had been suspended by the state court’s order. It seems right on point.

There are a few other lower court decisions that also conflict with the holding of the Arizona bankruptcy court, which it ignored, despite its pronouncement that there is no case law to the contrary. See, Commodity Futures Trading Commission v. FITC Inc., 52 B.R. 935 (N.D. Cal. 1985) where the district court had appointed a receiver and issued a TRO. The president then filed a chapter 11. The district court held, citing the cases at the beginning of this article, “Once a court appoints a receiver, the management loses the power to run the corporation’s affairs. The receiver obtains all the corporation’s power and assets. Thus it was the receiver, and only the receiver, who this court empowered with the authority to place FITC in bankruptcy”. See also, U.S. v. Vanguard Inv. Co. Inc., 667 F. Supp. 257 (M.D.N.C. 1987).

Despite the Ninth Circuit’s decision and the general case law regarding the affect of the appointment of a receiver on the powers of former management, it appears, at least for now, that an order appointing a receiver, removing former management, or enjoining the filing of a bankruptcy petition may not be effective in preventing a subsequent bankruptcy filing. It should be noted that much of the underlying reasoning for the Arizona bankruptcy court’s decision seems to come from the fact that it was a state court order that appointed the receiver and the preemption argument that the bankruptcy laws supersede state law remedies. Had the receivership order and injunction been issued by a federal court, the bankruptcy court may not have reached the same result.

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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