Commercial Real Estate Receiverships – An Alternative to Foreclosure?
History, Factors, and Types of Receiverships
Historically, receiverships for commercial real estate were used to collect rents and fees generated by income producing properties prior to the completion of foreclosure sales on those properties. While receiverships are still being used for that purpose, receiverships also may be used as an alternative to foreclosure, as a method to actually sell real estate collateral.
No specific factors are provided in the statutory scheme for when the appointment of a receiver is appropriate. The Virginia Code simply states that a receiver may be appointed “[w]henever the pleadings in any suit make out a proper case” The two most common grounds for the appointment of a receiver are (i) a provision in the loan documents for the appointment; and (ii) exigent or emergency circumstances, such as a failure to maintain the premises and possibly even the collection of rents and fees and the failure to make payments to the lender.
A receivership may proceed either with or without notice. Notice of the receivership proceeding does not have to be provided in those cases in which an emergency exists and it is necessary to preserve the subject matter. However, in such cases the receivership order must state the emergency and necessity for immediate action. In the appropriate circumstances, it could be argued that the continued collection of rents and the failure to make payments to the lender justify the appointment of a receiver without notice.
However, it may be more difficult to obtain the appointment of a receiver without notice, as courts generally prefer that notice be provided to the adverse parties whenever possible. Also, if a receivership is obtained without notice, a surety bond is required to cover all damages and injury properly and naturally flowing from such emergency appointment. Finally, if a receiver is appointed without notice, the appointment is limited to a period of not longer than 30 days, during which time the court shall hear the matter, upon notice to the owner(s) and all lienholders, to determine whether the receivership is appropriate. However, often a borrower/owner will not contest an appointment without notice if sufficient grounds exist. Also, aside from obvious instances in which there is an immediate need for a receiver to preserve the property, if there is a concern that funds in the borrowers bank account from rents previously collected will no longer be available if notice is provided, an appointment without notice should be considered.
For either the initial hearing or the subsequent hearing after the appointment without notice, notice must be provided to the defendant(s) and to all other parties having a substantial interest, either as owners of or lienors of record and lienors known to the plaintiff in the subject matter. It is important to note that, even though some of these parties are not technically defendants, they must be served in the same manner as if they were defendants and they were being served with process in a civil action. At the hearing on the receiver it may be necessary to establish the basis for such relief by introducing the loan documents that provide for a receiver and the existence of the default, and/or by establishing the emergency or exigent circumstances that require the appointment of a receiver. The receiver should also be present at the hearing and prepared to establish their qualifications.
The Receiver’s Duties
Aside from the management and preservation of the property there are several additional things the receiver should do upon entry of the receivership order and the filing of the surety bond, if required.
Perhaps the very first thing the receivers should do is to gain control of any bank accounts regarding the property. This will prevent the borrower/owner from removing the funds in any such accounts and may provide funds for the continued operation and management of the property. The receivership order should contain a paragraph specifically authorizing the receiver to take control of such accounts upon its presentation of the receivership order to the financial institution.
Next, the most obvious function of the receiver is to take control of the property, which is accomplished by appearing at the property with a certified copy of the order and sufficient personnel to take over at least the short term operation of the property. The receiver can then determine which employees, if any, should be retained. The receivership order should contain a provision authorizing the sheriff to evict any owners representative who will not leave the property upon the receivers request.
When a receiver is appointed they are required to prepare a list of creditors of the person or entity for which they are receiver, and promptly notify such creditors of their appointment. Very often, it may be difficult for the receiver to compile the list of creditors. The Virginia Code states that the court may compel any defendant for whom a receiver is appointed to furnish and deliver a list of creditors to the receiver. Once again, the receivership order should contain such a provision.
The cost of the receiver can vary and is dependent upon whatever terms the secured lender and the receiver can negotiate. It can be done hourly or for a flat monthly fee, a percentage of gross monthly collections, or some combination thereof, usually with a startup fee included. Very often, if the receiver or one of its affiliates also will be listing the property for sale, the receiver’s fee will be lower.
To the extent there are not sufficient operating funds to do so, the secured lender will be responsible for funding the operation, management, and preservation of the property, including the receiver’s fees. The receiver us also likely to look to the secured lender for the payment of any attorneys’ fees it may incur in performing its duties, although the secured lender may prefer to utilize its counsel to perform whatever legal requirements that may be appropriate.
The Sale Process Itself
Typically, the receiver will market the property for sale using the same methods as it would for any other commercial property. It will install signage on the property, list the property with the appropriate online commercial listing services, notify local brokers, and advertise in appropriate trade presses. It may be advisable for the receiver, usually through the secured lender, to obtain an appraisal of the property so as to be able to establish at the sale hearing that an acceptable sale price was obtained.
Once the receiver, in consultation with the secured lender, obtains an acceptable offer for the sale of the property, a motion can be filed, often by the secured lender with the consent of the receiver, to approve the sale.
At the sale hearing, the secured creditor should be prepared to establish the various steps the receiver took to market the property and why the receiver believes the proposed sale price is fair and reasonable. If necessary, the appraisal may need to be introduced.
Special problems can arise when dealing with certain liens of the federal government. The United States should be named a party in any civil action to foreclose a mortgage or other lien upon real property on which the United States has or claims a mortgage or other lien. The Complaint must set forth with particularity the nature of the interest or lien of the United States. Also, for tax liens, the complaint must include the name and address of the taxpayer, and if a notice of tax lien was filed, the identity of the internal revenue office, and the date and place such notice of lien was filed.
The Closing of the Action
The sale order should require that the receiver file an accounting of its activities as receiver within so many days of the sale of the property. Once that has been filed the secured lenders counsel can file a motion to terminate the receivership. The Virginia Code states that the accountings of special receivers shall be presented to a commissioner in chancery “unless their accounts have been previously verified and approved by the court, and ordered to be recorded”. [emphasis implied] Therefore, if the order terminating the receivership specifically verifies and approves the receiver’s accounting, and orders it to be recorded, the receiver should not have to file an accounting with the Commissioner in Chancery. However, care should be taken to ensure that the accounting is actually recorded, as required.
In situations where it appears likely that the borrower/owner will file bankruptcy once aggressive collection action is taken, and the lender believes that bankruptcy may be an acceptable forum for the resolution of the matter, it may be advisable to move for the appointment of a receiver rather than to proceed with a foreclosure. A borrower/owner that is likely to file bankruptcy to stop a foreclosure sale is also likely to file bankruptcy to stop a receiver appointment, and the costs to get to the receivership hearing are likely to be less than the costs to get to a foreclosure, simply considering foreclosure advertising costs alone.
While the filing of a receivership action where the real property is located appears to be the most logical venue, no specific venue provisions address receivership actions. This can be a particularly significant issue when there are multiple parcels of collateral located in different jurisdictions or the loan documents provide for a venue other than the one where the real estate is located.
While the secured lender can force place insurance, if necessary, to protect its collateral, very often the receiver can ascertain the borrower’s insurance coverage and contact the insurer and be added as an additional insured on the policy pursuant to its status as receiver.
Often, a commercial real estate receivership can be a worthwhile alternative to foreclosure. These receiverships can be less expensive to complete than a foreclosure, while still accomplishing the same goals. Receiverships should be considered as an option for lenders looking to liquidate commercial real estate collateral.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2021.