April 2018

State Receivership: An Alternative to Bankruptcy

Filing for Chapter 11 protection can be an expensive procedure for borrowers and lenders. Keri Wintle discusses another option, state receivership, which can offer a more frugal avenue to achieve the same goal while offering all parties more privacy and greater flexibility.



Keri L. Wintle, Associate, Duane Morris

Keri L. Wintle, Associate, Duane Morris

Secured lenders are often more familiar with Chapter 11 bankruptcy proceedings than they may prefer to be and less familiar with a potentially cheaper and faster alternative: state court receivership.

Overview

The goals of a Chapter 11 proceeding and a state court receivership are similar: preserving and maximizing the value of an operating business for the benefit of claims and interests holders. In many cases, a receivership can offer secured lenders some of the same safeguards and protections available in a Chapter 11 filing with more flexibility in terms of cost, timing and procedural requirements.

State court receivership is an equitable remedy that provides for the court appointment of a neutral and independent third party to act on behalf, and for the benefit, of all interested parties. A receivership action is typically initiated by a secured lender, although in some cases a borrower or its shareholders may seek the appointment of a receiver. The receivership order places the borrower’s property under the dominion and control of the receiver and delineates the receiver’s duties and responsibilities. The appointed receiver typically operates the business and conducts a sale in accordance with court authority and is responsible for distributing the proceeds.

The receiver is not an agent of the secured lender, but an officer of the court with a fiduciary duty to all the interested parties. But the petitioning creditor usually submits a proposed order appointing the receiver and establishing the scope of its duties and authority. Thus, receivership offers secured lenders a bit more control from the inception of the case.

Fewer Costs and Faster

Receiverships are often less expensive than a Chapter 11 proceeding due to less-stringent procedural requirements and fewer constituencies involved.

The significant procedural requirements imposed by the Bankruptcy Code, the Bankruptcy Rules and applicable local rules, can translate into significant costs and expenses. In a receivership, there is no Section 341 creditors’ meeting, no requirement to file a plan and disclosure statement, no solicitation process or confirmation hearing. Fewer hearings and filing requirements translate into fewer court costs and expenses for all parties.

Moreover, in a Chapter 11 case, a secured lender’s collateral is often used by the debtor to pay the debtor’s fees for counsel, accountants, financial advisors, the U.S. Trustee and the professionals hired by a duly appointed creditors’ committee. These fees are not required in a receivership.

The lifecycle of a receivership proceeding is also typically shorter than a Chapter 11 case since there are fewer hearings and procedural requirements.

Inconsistency Among States

While some states have enacted comprehensive receivership statutes, many have not. Moreover, some states’ receivership statutes are far more comprehensive than others. Michigan is the latest to enact the Uniform Commercial Real Estate Receivership Act, effective May 7, 2018, which applies to both real estate and to personal property. The Uniform Act grants a receiver with authority similar to a bankruptcy trustee, including the ability to sell assets free and clear of certain liens, and permits a secured creditor to credit bid at the sale.

Given the jurisdictional inconsistencies, receivership may be less practical in a case where a borrower maintains assets in various states. Moreover, in jurisdictions that do not have laws governing receivership proceedings, courts may not be receptive to this remedy, and acceptance may vary from court to court within each jurisdiction. Some state courts may be reluctant to approve the appointment of a receiver. However, the absence of comprehensive receivership legislation may benefit secured lenders seeking an appointment, as it provides the court further flexibility to tailor the receivership order.

Careful drafting of the proposed receivership order can provide a secured lender with many of the protections and safeguards afforded by the Bankruptcy Code and may even offer additional control to lenders dealing with distressed borrowers and their collateral. From a borrower’s perspective, the advantages of bankruptcy also can be afforded through careful drafting of the proposed receivership order. For example, the automatic stay afforded to debtors by Section 362 of the Bankruptcy Code may be replicated in the receivership order in a provision enjoining creditor action against the borrower or its property during the pendency of the receivership.

Another difference between Chapter 11 and receivership is the level of transparency and publicity involved. Unlike a bankruptcy proceeding, a borrower under a receivership order is not required to file schedules of assets and liabilities or a statement of financial affairs with the court. In a Chapter 11 case, unless the bankruptcy court has authorized a request to impound certain documents, most filings are publicly available on PACER, while pleadings in state court are typically filed in paper format and less readily available to the public. As such, a receivership may also be preferable in circumstances where the stigma of a bankruptcy filing could result in the loss of customers and good will.

For certain distressed businesses, such as those in the rapidly growing cannabis industry, state court receivership may be the only available option, since some bankruptcy courts have held that such businesses, which remain illegal under federal law, cannot be afforded the protections of the Bankruptcy Code.

Other Options

There are additional alternatives to a Chapter 11 bankruptcy not discussed in this article, including, but not limited to, assignments for the benefit of creditors and federal receiverships.

Secured lenders should consider receivership as an inexpensive, but efficient, alternative to bankruptcy and consult with counsel on the advantages and disadvantages under the case-specific circumstances and jurisdictional issues.