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Receivership vs. Bankruptcy

 

 

December 10, 2010

 

Facing bankruptcy? Try using a receivership first

 

By Kevin Hanchett, Resource Transition Consultants

On June 10, 2004, the new Receivership Act became effective in Washington State.  Shortly thereafter, The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was signed into law on April 20, 2005, with the explicit intent of discouraging filings under the Bankruptcy Code. At the time of the enactment of these two statutes, the economy was still booming.  Little did debtors and creditors know what a significant change these statutes would have on their rights and remedies when the economy turned sour.

For the past several decades, when borrowers and creditors have faced a deadlock or a default they have often looked for the resolution of their disputes in the Bankruptcy Courts. The Bankruptcy System has provided extraordinary remedies, specialized commercial judges, and an expedient, cost-effective forum for relief. However, the Bankruptcy System has become extremely expensive. Bankruptcy attorneys charge hourly rates near the upper end of all lawyers' fees. Even the simplest case requires extensive administration because of the number and cost of court fees, required filings, meetings, and court hearings. As a result, the prospects of an economically viable outcome have been substantially reduced.

An alternative to filing a bankruptcy is to use the tools available under the Washington State receivership act and assignments for the benefit of creditors. The laws are less comprehensive and are local in nature; they are however cheaper and are largely administered by the parties and their attorneys and an experienced receiver.

Receiverships are most common in real property foreclosure situations. During a foreclosure, secured lenders often desire that their collateral be placed in the hands of an independent party. The right to have a receiver appointed in the event of default is routinely included in deeds of trust and loan documents. This permits the appointment of a receiver, while a party seeks non-judicial relief, such as a non-judicial foreclosure for real property or a UCC personal property foreclosure sale.

One of the most significant benefits to a secured creditor is that they can obtain a court order to have the receiver take control of and sell the collateral without the secured creditor having to go into title.  This allows the secured creditor to secure, protect and improve their collateral in advance of any foreclosure and in some cases may eliminate the need to institute foreclosure proceedings. In addition, by remaining outside the chain of title  the secured creditor can avoid the liability which might arise from going into title on properties such as condominiums, gas stations or other types of collateral that have greater liability for the property owner.

Receivers can also play a valuable role in deadlocked or dissolving business entities. Complaints seeking dissolution or division of assets often include a request for the appointment of a receiver to hold the assets being liquidated or divided, or to sell and distribute the assets. While the court may limit the powers and duties of a receiver, the statute makes clear that the receiver can exercise all the powers of a corporation in place of the board of directors, executive committee, or officers, as reasonably necessary to carry on the ordinary business of the corporation and manage its affairs in the best interests of the shareholders and creditors.

Receiverships can be very effective where there are allegations of fraud, breach of fiduciary duties, or Ponzi schemes. Receiverships can assist victims in preserving assets while criminal or civil fact-finding is completed in order to prevent the perpetrator from causing further waste or fraud pending completion of the investigation.

Receiverships have been used increasingly in the recent downturn in the economy, both in real estate and business cases. Lenders are allowing borrowers additional time to raise capital or sell assets, so long as the collateral is being overseen by a receiver. Defaulting borrowers and their lenders are agreeing to receiverships so that feasibility studies and appraisals can be conducted and, when appropriate, stalled projects can be financed and completed.

Receiverships do not have strict timelines like those imposed by the bankruptcy laws. Cases may remain pending while the parties search for a business solution. Bankruptcy relief remains an option should the parties' interests diverge precipitating foreclosure, litigation, or funding termination.

Unlike an involuntary bankruptcy, which is generally not available for a secured creditor, a petition for the appointment of a receiver is normally filed by a secured creditor.  If a debtor has 12 or more creditors, in order to file an involuntary bankruptcy, there needs to be three or more unsecured creditors with non-contingent, non-disputed and liquidated damages.  The wrongful filing of an involuntary bankruptcy leaves the petitioning creditors and their attorney exposed for actual and punitive damages.  A petition for the appointment of a receiver does not have the same requirement of coordinating creditors nor does the petitioning party have the same exposure for punitive damages.

The filing of a bankruptcy results in the issuance of an automatic stay. This stops all collection proceedings, all collection attempts and all litigation. Under the Washington Receivership Act, the assets of the case are now protected by the same type of automatic stay.  Unlike the Bankruptcy Code, the stay under a Receivership ends after 60 days unless a party moves for an extension.

 

The Bankruptcy Code allows a bankruptcy court to sell a property, passing clean title with all liens, claims and encumbrances attaching to the proceeds. When there is a sale of troubled property involved in litigation or property subject to title disputes, the Bankruptcy Court can order and approve the property's sale with liens and claims against the property transferred to the proceeds of the sale. Under the Washington Receivership Act, the same type of title cleansing process can occur pursuant to RCW 7.60.260.  No longer do the parties have to rely upon a long foreclosure process to sell property and to clear subordinate liens.

 

When a business is subjected to a burdensome lease or an executory contract that is interfering with its continued operation or its reorganization, the Bankruptcy Code allows such a lease or contract to be rejected. The non-debtor party is given a "pre-petition" claim against the business and the debtor is excused from performance on the lease or contract. Under the Washington Receivership Act, the Receiver now has this same power allowing the debtor entity to restructure and focus on the profitable aspects of the business operations.

 

The bankruptcy laws continue to provide certain remedies and procedures that are unique. That being said, business parties may not always be willing to turn over their financial fates to a bankruptcy judge. A less intrusive receivership proceeding may, in certain instances, be more desirable. When a developer finds himself upside down in a project and a handful of creditors are owed money and can look to the build out of the project, receivership may be a quicker, less expensive and more appropriate workout tool, than a bankruptcy case.

 


Kevin Hanchett is a principal at Edmonds-based Resource Transition Consultants, which specializes in custodial and general receiverships. He has more than 23 years of experience in debtor-creditor, commercial litigation and corporate financial matters.

 

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