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Debunking the Receivership Myths

As the talk of another commercial real estate down-cycle begins to circulate, now is a good time for lenders to remember some common misconceptions about receivership that all too often interfere with maximum recovery on non-performing loans.

Remember that receivership is an “ancillary remedy” usually tacked on to an existing legal action like a foreclosure proceeding. The court appoints its own agent to serve as an impartial “disinterested third party” to take possession and control of assets that are the subject of the legal action until that action is resolved. Those assets are any and all things pledged as security for the loan.

The court will empower the receiver with whatever authority is necessary to accomplish the goal. This frequently includes taking over all real and personal property, as well as proceeds from operation of the property and – increasingly – the power for the receiver to sell the property.

The receiver for a distressed asset typically will find many inherent problems in addition to the monetary default, among them deferred maintenance, limited marketing activity and unhappy employees. If existing funds are limited, the lender may want to provide funds to the receivership estate to make repairs, management changes, environmental mitigation, etc., – ultimately maximizing value for a possible sale.

In the following article, we analyze and debunk common myths about receivership.

Myth Number 1: Receivers are Very Expensive

Compared to what? Loss of asset value, neglect in management, potential liability costs? Unlike bankruptcy, which is historically a relatively new concept, receivership law provides a wide berth for the court to do whatever it deems appropriate to protect the assets and the parties’ interests. Bankruptcy at its foundation was designed to protect borrowers and close debtor’s prisons. Receivership in its current form is primarily used to protect people with a legal interest in property (like lenders) during a dispute.

Bankruptcy has volumes of rules and strict forms, procedures and timelines.

Receivership law in many states is limited to a few pages and gives the court broad discretion “in equity” to do what is fair and right.

Receiver fees are typically billed hourly, but the hourly rate alone does not predict actual cost. Will the receiver have to hire his own lawyer to explain his job? Will accountants, management companies, consultants and various other vendors be hired? Will the receiver be billing hours to review the work of all those other professionals? There are multiple ways a receiver can save significant total costs for the lender. When a property owner is headed toward foreclosure, the receiver can step in to control operations, protect the value of all assets, monitor and approve expenses and determine the best course of action for the property. This may include ceasing or continuing operations, preserving or liquidating collateral and/or preparing the property for a quick sale. If construction has not yet been completed, the receiver will advise the lender of the cost and benefit. The lender will decide whether to loan money to the receivership estate if the property has insufficient cash of its own. The receiver will have already seized cash from any accounts connected with the property or comingled in other accounts. Often referred to as “rents and profits,” this includes future income as well as any past income that can be found. This can range from pennies to many thousands of dollars and more.

The receiver will guard against further losses to the property, striving for optimal returns while preventing physical and financial damage. He/she will maintain oversight of all aspects of accounting, including receipts and disbursements, and other financial records.

Time is not the lender’s friend in default cases. The key is to get the receiver in as quickly as possible to prevent diverting or misuse of funds for other than the direct benefit of the secured asset. An experienced receiver knows how to find and control funds quickly.

Existing and future income can be used to address deferred maintenance and other operating expenses – or even to cover expenses associated with the receivership itself. Since the receiver is not responsible for past debt and the funds go to maintaining/operating the property, a more favorable recovery is achieved for the lender.

Myth Number 2: Appointing a Receiver Raises a Red Flag that a Property is in Distress

The mere filing of a foreclosure action brings negative attention to the property. The move to appoint a receiver can – and should – signal the lender’s attention to remedy all of the other on-site problems that are often apparent even before the monetary default. In reality, a receiver can help improve the public perception of the property. In the face of chaos, receivers can bring an objective management perspective to the business, instilling a higher level of professionalism to project management, operations, accounting and reporting which probably deteriorated during the period preceding the loan default.

An effective receiver will move swiftly to cure poor management, and correct on-site conditions that have an immediate impact on outside perceptions, while protecting the property that represents the security for the loan.

A receiver can help shield a lender or servicer from any potential bad press. In some cases, certain tenants have generated negative publicity, putting the servicer or lender’s name in a bad light in print or social media. But once the receiver is named, the press will tend to use that company’s name instead of the servicer/lender when writing about the project.

Also important to note: by the time the property goes into receivership, the people who affect its value – tenants, prospective tenants, the market, brokers – already know the property is in trouble. This is apparent because of vacancy issues, deferred maintenance, minimal money for tenant improvement – and the good old-fashioned rumor mill. The appointment of the receiver marks the “turn-around” point and can help signal the “upswing” of a property.

Myth Number 3: A Receiver Can’t Help a Property that is Already in Trouble

A receiver’s primary role in protecting a lender’s security interest is only part of what is accomplished. The receiver will get a quick start on assessing the project’s current status, determining operating expenses, planning options for optimal recovery and preparing the property for sale through appropriate strategies.

Strategies include applying for and maintaining all necessary permits and licenses; verifying that documents are being properly recorded; securing approvals; selecting and monitoring vendors and contractors; and, most importantly, assuring the project moves along carefully and swiftly.

Take the case of a property that has been damaged and insurance proceeds are due. A receiver will collect all proceeds from multiple insurers and dispute those that they don’t feel are appropriate. In a recent example, a monsoon created a flashflood which took out a bridge and caused debris and mud to run down two 18-hole golf courses and fill a tunnel – with mud overflowing into homes surrounding the courses. There were eight insurance carriers for a claim value of over $2.3 million. In this case, claims from the homeowners were successfully disputed and the receiver’s ability to prove business interruption losses was a key part of the claim.

In addition, a receiver can perform tenant improvements to drive value for future sale of a property. In another recent case, a major tenant wanted to lease 240,000 square feet in a “Tenants in Common” owned office building. With tenant improvements exceeding $10 million dollars, the receiver was able to execute the lease, manage the construction with funds provided by the master servicer. The receiver then sold the property at a price that exceeded the loan balance.

Receivers also have the ability to help drive value on maturing loans to assist in refinancing. In another recent case the borrower’s property had 100,000 square feet of vacancy, which prevented them from refinancing. A Letter of Intent had been negotiated for a tenant to take the entire space, but the borrower did not have the funds for the tenant improvements. The receiver was able to execute the lease, manage the construction with funds provided by the existing lender, and keep the borrower in place as manager under the receiver’s control. When the tenant improvements were completed, the borrower was able to refinance, pay off the first lender, and the receiver returned possession to the borrower.

In the event a borrower files bankruptcy to regain custody of a property after a receiver has been appointed, the receiver may be excused from returning possession if that would endanger the value of the property. Judges have allowed us to remain in possession of the collateral, making our receiver an agent of the bankruptcy court under a variety of titles. In some of those cases a receiver can be named the Liquidating Trustee.

Additionally, a receiver can:

    • Protect entitlements: liquor, water rights, licenses, permits and land uses
    • Save grandfathered height permits, signage, zoning (avoid vacancy to maintain current zoning, maintain building permit)
    • Clean up documentation and liabilities prior to foreclosure
    • Obtain copies of all leases, contracts, licenses, permits, reservations and deposits
    • Locate and seize property, related funds, securities, deposits
    • Correct code violations and life safety
    • Assess environmental risk
  • Determine true value. Is the rent roll accurate? Are the tenants paying? Is borrower’s reported NOI accurate?

Myth Number 4: Some People Will do the Work for Free

In the good old days, the local saloon offered “free lunch.” This is another myth that was quickly followed by grandpa’s sage advice, “There is no free lunch!” The free lunch came after you bought a drink. Free receivership work is done in exchange for some other payment or financial benefit. The most common example is when a broker offers to waive all receiver fees in exchange for the listing when the property goes to sale. While there are very few limitations on anyone calling himself or herself a receiver, the strict limitation is that the receiver must be a “disinterested third party” with no other business relationship with either party in the case, and cannot have any other business interest in the case. Working for “free” without disclosing that you are being given a future benefit is lying to the court about your legal qualifications.

Will anyone find out? Judging from our last serious downturn, probably not, unless someone tells the judge. But who would do that? Not the plaintiff/lender. Maybe an unhappy borrower whose counsel discovers it? The penalty for the receiver could be discharge, problems with ever getting appointed again, disgorgement of fees (but wait, there weren’t any, right?). And anyway, that’s the receiver’s problem, not the lender’s. Lenders probably only have to worry about Lender Liability, and how bad could that be?

In actuality, the consequences of hiring someone on the cheap can be disastrous. An inexperienced or unqualified receiver can generate a slew of costly mistakes, from unnecessary payment of pre-receivership debt to loss of franchise, liquor or gaming licenses.

Since receivership has very few hard-core rules and regulations and written guides, the court has very wide discretionary powers, allowing the receiver great latitude. This makes it even more important for lenders to enlist a competent, qualified professional.

The Bottom Line

Receiverships are an increasingly viable option during the period between default and foreclosure for a variety of reasons. Receivers can often clear up issues of potential liabilities tied to health, safety and environmental concerns; homeowner association regulations; existing liens; franchise agreements; and possible future warranty issues in residential tract developments or condominium conversions.

As an agent of the court, a receiver’s liability is limited to the assets of the receivership estate itself, as long as the receivership is properly conducted, and cannot be held personally liable.

In addition to limiting liabilities, receiverships steer the eyes of vendors, franchisors, supplies and others away from the lender’s pocketbook. Unlike the business owner, the receiver is not required to pay pre-receiver debts, and as such, can provide a clean break between borrower and prospective buyers. While the borrower remains as legal owner during the receivership, the receiver has sole legal possession.

Examining the myths surrounding receiverships actually sheds light on the truth of the matter. Turning to a receiver can help bring value to assets, making them more attractive to prospective buyers and investors. A well-managed receivership can restore and create an atmosphere of order and professionalism. Ultimately – and contrary to those myths – these improvements benefit the business on a long-term basis, well beyond the term of the receivership.