The Use of Receiverships in Pre-Bankruptcy Litigation

Spilman Thomas & Battle, PLLC
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Spilman Thomas & Battle, PLLC

As we continue our series on bankruptcy litigation, we want to discuss the use of receiverships as an important aspect of a fully developed creditors' rights practice. Creditors often face recalcitrant corporate debtors who continue to reap the rewards of their business while ignoring all attempts by creditors to collect amounts owed to them. Sometimes, those debtors' intricate corporate structure makes it harder for creditors to trace money and assets and easier for debtors to hide them.

In these situations, creditors lose vital time and money by hesitating to act. Once it has become clear that a debtor refuses to pay despite continued operations, particularly where a creditor has direct evidence that the debtor is hiding assets or otherwise refusing to account for them, one important tool for a creditor to consider is the remedy of receivership. Most simply, a receivership involves appointing a neutral third party to take over the business affairs of the debtor while the receivership order remains in place.

That said, the success of a receivership often depends on the nuanced consequences of the language in the order appointing the receiver. What does the receiver actually control? When does his control start? Does the debtor's current management retain any control? What are the outside limits of the receiver's power? The ideal answer to those questions will define the type of order a capable creditors' rights team will propose to the court.

Each of these questions has important consequences. If the receivership order places a receiver in control of only some or all of the debtor's assets, then a receiver has the power only over those defined assets. Corporate control remains with the debtor's current management, and serious tension can still result. Moreover, a debtor might file bankruptcy after the appointment, causing wasted time and effort if the creditor can't effectively fight back through motions practice in the first days of the bankruptcy.

On the other hand, if the receivership order places the receiver in control of the operations and management of the debtor itself, then the debtor most likely cannot file bankruptcy unless the receiver approves. Either a receiver could move to dismiss such a petition, or the receiver could assert control in the bankruptcy (or even proactively file bankruptcy himself). The latter would be especially useful in situations where a debtor tries to shed profitable business contracts or assign them to other affiliated entities prior to the receiver's appointment. This use of a receiver also circumvents the inability of a secured creditor to file an involuntary bankruptcy petition on behalf of its debtor.

As is the case in many situations, the best place to construct the "ideal" language begins with the loan documents or a carefully worded forbearance agreement. If a debtor voluntarily agrees to broad receivership language in loan documents or forbearance documents, then it can hardly object in a receivership proceeding to broad powers being granted. On the other hand, if the language in the loan documents only allows for the appointment of a receiver to take control of collateral, then the creditor faces an uphill battle to broaden the powers of a receiver beyond the contractual bounds.

If loan documents are silent as to the right to appoint or the powers of a receiver, then a creditor will be at mercy of various state statutes and case law regarding the appropriate limits of powers and, even, whether a receiver can be appointed in the first place. As a result, creditors and their counsel should always take a fresh look at their "form" loan documents and forbearance agreements to determine whether and to what extent the default rights include appointment of receiver. A creditor could easily lose valuable time and early control absent such a right.

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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