Theodore Roosevelt is credited with saying, “In any moment of decision, the best thing you can do is the right thing. The worst thing you can do is nothing.” These sentiments are applicable to a lender faced with the prospect of a significant loss in the value of its collateral. Numerous factors exist that can make inaction the most despairing of choices. When something must be done to protect the collateral, a receivership can be a lender’s most effective course of action.

Receiverships provide many of the protections afforded by bankruptcy proceedings, while having the added benefit that: (a) a receivership can be commenced by a lender; (b) the costs associated with a receivership can be less than in a bankruptcy proceeding; (c) a lender has more control over who will be operating the business and the timing of decisions related to the disposition of the lender’s collateral; and (d) recoveries can be enhanced by instituting improvements in the business operations and the pursuit of claims against third parties.

Action: The Antidote to Despair

Imagine this: A Skilled Nursing Facility receives an “Immediate Jeopardy” (IJ) tag (denoting serious quality concerns) from state surveyors. Suddenly, the facility faces civil money penalties and possible termination of its Provider Agreement with CMS (Centers for Medicare and Medicaid Services) to provide Medicare and Medicaid services. From a lender’s perspective, the facility faces losing the majority of its revenue stream overnight, and the prospect of not even being able to continue providing services.

Imagine another scenario: An owner/manager is returning poor performance reports, but the facts don’t add up. The owner/manager may be siphoning assets off for their own benefit or into other operations not permitted by the loan terms.

Or another scenario: An operator of a senior living facility suddenly notified its residents that the facility would be closing. As a result, residents left in droves almost overnight.

Unfortunately, these are all real examples where lenders were faced with a rapidly deteriorating situation and they had to choose between doing something and doing nothing.

A Lender’s Toolkit

When a lender is primarily concerned with protecting the value of its collateral in a deteriorating situation, the merits of alternative actions can be considered in terms of control, time, risk exposure, and cost:

Voluntary Bankruptcy - A lender may hope a borrower will voluntarily file bankruptcy so that the lender can get visibility into the borrower’s cash position and have the assistance of the bankruptcy court in corralling assets and putting limits on the use of cash. However, the timing of a voluntary bankruptcy petition is in the hands of a borrower, and the borrower may not act quickly enough on their own.

Involuntary Bankruptcy - An involuntary bankruptcy proceeding could expose the lender to the risk of a counterclaim for damages or being stuck with the bill for the borrower’s attorneys’ fees and costs, while leaving the borrower in charge of the business.

Foreclosure - Foreclosure is not an appealing option, because the foreclosure process can be time-consuming, there is no guaranty a foreclosure sale will generate a buyer, the lender may not want to run the risk of having to credit-bid at the foreclosure sale and take title to the property, and finally, a foreclosure sale will likely interfere with – if not stop – business operations causing a deterioration in the collateral’s value.

Receivership - Faced with these unsatisfying choices, a lender should consider a receivership. A receiver is an impartial person appointed by a court to take possession of certain specified property (the lender’s collateral) to prevent deterioration, dissipation, loss or other detriment to the party requesting the appointment of a receiver. The receiver can immediately take control of a business and assess the situation, reporting back to the court its findings. A good receiver will stabilize and turnaround the business, investigate malfeasance, and can prepare and market the assets for sale. Compared to bankruptcy, it is a cheaper alternative and with forethought, many of the benefits of bankruptcy can be sought through careful drafting of the receiver’s appointment order.

Folk singer Joan Baez once supposedly quipped, “Action is the antidote to despair.” When something must be done, a receivership can be a lender’s most effective course of action for both protecting and maximizing the value of its collateral.

Receivership: A Lower Cost Alternative

Compared to a bankruptcy proceeding, reduced costs are the first advantage of a receivership. In a chapter 11 proceeding, in addition to the borrower’s operational costs, several additional items are payable from its assets.

• First, a debtor is required to pay to the United States Trustee quarterly fees ranging from $325 to $30,000 based upon disbursements occurring during the applicable quarter.¹

• Second, in a chapter 11 proceeding, an official committee of unsecured creditors is often appointed (and other committees may be appointed by order of the bankruptcy court). Any official committee appointed by a bankruptcy court has the authority to engage professionals – e.g., accountants, financial advisors, attorneys – to aid the committee, and the fees and costs incurred by professionals engaged by official committees are payable by the debtor.²

• Third, in a bankruptcy proceeding involving a healthcare business, a patient care ombudsman may be appointed and paid from the debtor’s assets.³

• On top of the foregoing, the debtor will be paying the debtor’s own professionals, oftentimes from the lender’s collateral.

The bottom line, all these fees result in a not so insubstantial dissipation of a lender’s collateral.

In contrast, in a receivership, there are no quarterly trustee fees, there are no official committees, and the receiver generally fills the role of patient care ombudsman. In addition, while the receiver’s and receiver’s professionals’ fees and expenses are paid from the borrower’s assets, the professional fees and expenses of the borrower are not paid from the assets. Moreover, with the receiver in place, the lender’s professional fees will likely decrease, too. As a result, a receivership can be a less expensive alternative to a bankruptcy proceeding.

Lender Nominates the Receiver

In a receivership, the party seeking the appointment of the receiver (i.e., the lender) typically nominates the receiver and, subject to court approval, has significant control over the choice of receiver. Conversely, in a bankruptcy proceeding, while creditors may have input on the appointment of a chapter 7 or chapter 11 trustee, the ultimate decision is made by the United States Trustee. This distinction is important, because throughout a receivership or a bankruptcy proceeding, the receiver or trustee, as applicable, will wear many hats – e.g., CEO, CFO, COO, financial advisor, broker, investigator, etc.

Control is Critical to Stabilization & Turnaround

Upon a receiver’s appointment, the receiver will immediately take control of the management and control of bank accounts, including the management of cash flow to slow or stop the “cash burn.” As a result, unlike a bankruptcy proceeding where the borrower may continue operations as a debtor in possession, a receivership immediately removes the borrower from control of the assets upon the appointment of the receiver. Because distressed assets are frequently the result of theft, fraud, general malfeasance, mismanagement, or a combination of the foregoing, timely removal of the borrower from the business is critical to preserving value. In addition, where a borrower operates in a regulated industry, substitution of the receiver for the borrower can prove helpful, particularly where (as often is the case) the borrower is at odds with its regulators.

Bankruptcy Qualities at Receivership Costs

Despite the highlighted cost savings, some lenders may be concerned that a receivership will not provide the same protections as a bankruptcy proceeding. For example, there are no reporting requirements imposed on the borrower and there is no automatic stay in a receivership. However, these issues can be addressed by careful drafting of the order appointing the receiver and establishing the receivership.

The power of a non-bankruptcy court can be used to obtain injunctive and other similar relief, making a receivership operate in similar fashion to a bankruptcy (while still preserving the costs savings). So with forethought, many of the advantages of bankruptcy can be obtained by seeking appropriate relief from the court in connection with the appointment of a receiver.

Tips for a Successful Receivership

Appoint an Experienced Receiver - The authors recommend that a receiver be chosen who has specialized experience in both the operation and turnaround of (i) distressed businesses and (ii) businesses in the particular industry within which the borrower operates. Turnaround experience is needed because the receiver will likely immediately be confronted with working capital shortfalls, and previous turnaround experience will prove invaluable in navigating the business’ cash flow issues. Turnaround experience will also help the receiver diagnose problems and identify strategic opportunities to increase market value and performance. In addition to instituting strategic changes to improve business performance, a receiver with industry experience can provide credibility.

Often businesses in receivership have some history of mismanagement, theft, corruption, or worse. A receiver can provide legitimacy to financial operations and statements and speak to potential buyers about the business’ past history. The healthcare sector provides a good example of why industry experience is important. A receiver with healthcare-specific experience is critically important to protecting the assets because of the complexity of Medicare and Medicaid regulations. The receiver will assess any clinical risks and identify patient safety issues. Neither bankruptcy proceedings nor receivership proceedings provide a safe harbor from government enforcement actions related to healthcare regulatory noncompliance. Also, in the healthcare sector, there are unique publicly available data sets (due to government reporting requirements) that other industries do not have. Using this data the receiver can benchmark performance metrics and turn to addressing the poorly performing areas.

Select Jurisdiction Wisely - The ultimate goal of the receiver is to stabilize, improve, and then market the business for sale in order to monetize its value. A receiver can sell property “free and clear” similarly to what is known in bankruptcy as a “363 sale.” On this point, appointment of a receiver in a state or federal court can matter. Namely, federal statutes and federal caselaw recognizing that the federal district court has broad equitable powers to foreclose out liens through receivership sales provide the framework for a sale free and clear, similar to the protections provided under a “363 sale.”⁴

In contrast, state statutes differ widely and may offer limited or no protections, leaving a receiver to rely upon equitable arguments and the equity power of the receivership court. Accordingly, a lender should review the state statutes on receivership sales and any local court rules when considering the court in which to commence a receivership. Due to the statutory framework provided by federal law, the authors recommend federal court receiverships where possible.

Pursue Legal Claims - In the event the receiver is unable to achieve a full recovery from the sale of the borrower’s business, a receiver may enhance creditor recoveries by pursuing claims that belong to the borrower. For example, a receiver could pursue claims against a borrower’s officers and directors for, among other things, breaches of fiduciary duty. Similarly, a receiver may be able to pursue certain claims for fraudulent transfers, similar to the same types of claims asserted in bankruptcy proceedings. In all instances, decisions are typically made by a receiver in consultation with the receiver’s constituency – namely, the lender.

Act - Don’t Watch the Paint Dry - In our experience, the receivership option has oftentimes led to positive results in scenarios where the bankruptcy or foreclosure path would have resulted in substantially diminished recoveries.

To paraphrase Shooter, Dennis Hopper’s character in the basketball classic “Hoosiers,” these are not times to “get caught watching the paint dry.” Waiting leaves the lender with very few plays to run.

Endnotes

¹  28 U.S.C. § 1930 (establishing United States Trustee fees in bankruptcy cases).
²  11 U.S.C. § 1102 (authorizing the appointment of official committees); 11 U.S.C. § 328 (authorizing official committees to retain professionals under 11 U.S.C. § 327); 11 U.S.C. § 330 (authorizing professionals retained under 11 U.S.C. § 327 to seek an award of fees and expenses); 11 U.S.C. § 503(b)(2) (claims for fees and expenses under 11 U.S.C. § 330 are administrative expenses payable by the estate).
³   11 U.S.C. § 333 (requiring appointment of patient care ombudsman); 11 U.S.C. § 330 (authorizing award of fees and expenses for a patient care ombudsman); 11 U.S.C. § 503(b)(2) (claims for fees and expenses under 11 U.S.C. § 330 are administrative expenses payable by the estate).
⁴  See 28 U.S.C. §§ 2001, 2002, and 2004; Spreckles v. Spreckles Sugar Corp., 79 F.2d 332 (2d Cir. 1935) (explaining courts have long been able to sell property free and clear of liens and other interests); see also Van Huffel v. Harkelrode, 284 U.S. 225 (1931) (explaining federal courts sitting in equity have long exercised the power to sell free and clear).