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Alternatives to Bankruptcy (Receivership)

Alternatives to Bankruptcy from Bankruptcy Law Specialist Christy Myatt

June 28, 2016

The general notion behind receiverships is to preserve property pending the outcome of a case, or the foreclosure of real property  or such other time as the Court deems a Receiver is not required.

The Receiver is usually an unrelated third party or attorney familiar with process.

I. State Court Receiverships

A. Purpose of Receivership

A Receiver plays an important part in three common situations:

(1) Dissolution of a business
(2) Preservation of property
(3) Collection of a debt

B. Why should a Receiver be Appointed

A Court can appoint a Receiver for variety of reasons including:

(1) Dissolution of an insolvent corporation;
(2) Dissolution of a limited liability company;
(3) Enforcement of a judgment;
(4) Prosecution of a debt adjuster;
(5) Estate of a missing person;
(6) Administration of insolvent banks or insurers; or
(7) Administration of the property of a person or entity violating the Consumer Finance Protection Act.

C. Authority for Receivership

(1) Statutory Authority

A Receiver may be appointed:

(a) Before judgment upon the application of a party to establish an apparent right to property which is the subject of a foreclosure action and in the possession of the adverse party and the property or its rents and profits are in danger of being lost or materially injured or impaired;
(b) After judgment, to carry the judgment into effect;
(c) After judgment to dispose of property according to judgment;
(d) In cases of property located in the state which may be owned by a foreign corporation or corporation outside the state;
(e) Where restitution is sought for violations of the Unfair and Deceptive Trade Practice Act; and
(f) In cases involving the partition of real property.

(2) Equitable Authority

In addition to the statutory authorizations, a state court also has the inherent equitable power appoint a receiver. Lowder v. All Star Mills, Inc, 301 NC. 561, 576 (1981); Petition of State ex rel Hutchinson, 182 S.C. 369, 189 S.E. 475 (1937).

II. Federal Court Receiverships

In federal court, the appointment of a Receiver generally is allowed under F.R.C.P. 66 and is governed by 28 U.S.C. § 959. A federal court may appoint a receiver to take control of a failed bank, to liquidate the assets of insolvent company or to administer the assets of investment company. Further both state and federal governmental agencies such as the Attorney General, U.S. Securities and Exchange Commission and U.S. Commodity Futures Trading Commission, can petition the Court for the appointment of a receiver in instances of alleged fraud.

III. How is a Receiver Appointed

In order to have a Receiver appointed, a court must appoint the Receiver in connection with an “action”. Examples of such actions include:

(1) A motion to appoint a Receiver with respect to the dissolution of the company;
(2) A motion to appoint a Receiver in connection with the protection of assets pending a judgment; or
(3) A motion filed in connection with a foreclosure proceeding where the property involve rents and revenues.

IV Duties and Powers of a Receiver

The receivership statutes set out only in general terms the duties and powers of a Receiver. These powers include:

(1) The authority to take possession of the debtor’s property;
(2) A call for an examination of persons and papers in an effort to discover the debtor's financial condition;
(3) Foreclosure of mortgages for the benefit of the debtor; and
(4) Sale of property pending litigation.

As these powers are only general in nature, the Order appointing the Receiver (the “Receivership Order”) should also include the following specific powers:

(1) Collect all obligations and money due the company;
(2) Perform all functions of the company in the name of the company which are consistent with the appointment as Receiver;
(3) Preserve and conserve the assets and property of such company; and
(4) Liquidate the company and distribute the proceeds to the company’s creditors.

The Receivership Order further should require:
(1) That the Receiver provide an initial inventory report;
(2) That the Receiver provide periodic reports;
(3) Court approval for the sale of certain property or expenditures over a certain amount; and
(4) Timing for applications of compensation of the Receiver and the Receiver’s professionals and agents.

The Receivership order can also include direction to third parties requiring:

(1) Turn over of the debtor's money, property and papers of the Receiver;
(2) Cooperation with the Receiver including conveyance of title to any real property; and
(3) Stay of any action in which the debtor is the defendant and restraint against third parties from taking any action which might interfere with the performance of Receiver’s duties.

IV. Procedure for the Appointment of a Receiver

The procedure for obtaining a Receiver is generally as follows:

(1) A Receiver can be appointed ex-parte for a company only by a Superior Court Judge (North Carolina) or Circuit Judge (South Carolina);
(2) The appointment is generally temporary and can only made permanent pursuant to notice and further hearings;
(3) In order for a Receiver to be appointed for a company in North Carolina, the company must -

(i) be insolvent or have suspended its ordinary business for lack of funds or be in imminent danger of insolvency,
(ii) have forfeited its corporate right
(iii) have its corporate existence expired by limitation, or
(iv) be a party to an action for judicial dissolution.

In North Carolina, the test for insolvency is “whether or not the entire assets of the person or entity in question equals or exceeds in value the total indebtedness of such person or entity.” This is the same definition of insolvency in the Bankruptcy Code.

An action for judicial dissolution which a Receiver may be appointed can be brought in the event of a shareholder deadlock or when an execution against the judgment debtor has been unsuccessful.

In South Carolina, a Receiver may be appointed, before judgment, when a party establishes an apparent right to property which is the subject of an action and the property, or its rents and profits, are in danger of being lost or materially injured or impaired.

In addition, a Receive may be appointed after judgment to carry the judgment into effect or to dispose of property according to the judgment or preserve it during an appeal. A Receiver may also be appointed when a corporation has been dissolved or is insolvent or is in imminent danger of insolvency and, in like cases, of the property within South Carolina of foreign corporations. Finally, the statute provides that Receivers may be appointed in such other cases as are provided by law or may be in accordance with the existing practice, except as otherwise provided in the South Carolina Code. § 15-65-10 S.C. Code Ann. (1976)

VI. Posting of Receivership Bond

Once a Receiver has been appointed, the Receiver (in North Carolina) must post a bond as set by the Court. A debtor can defeat the appointment of a Receiver by posting a bond in the amount of double what the petitioning party is seeking in the underlying action. The bond must be secured by two sureties and can be posted either before or after the appointment of a Receiver. If the debtor posts the bond after the Receiver has been appointed, the Court will dismiss the receivership.

There is no statute or rule of law in South Carolina which requires that a bond should be exacted from a plaintiff, but it is customary for the Circuit Court to require the posting of a bond. Similar to North Carolina, a party may defeat the appointment of a Receiver by posting a bond in “double the value of the property” sought to be placed in the hands of the receiver. § 15-65-50 S.C. Code Ann. (1976)

VII. Length of Receivership/ Retention of Jurisdiction

A receivership can last a few weeks, months or years. In North Carolina, any resident Judge of the Superior Court Division or any nonresident Judge of the Superior Court Division assigned to district who appoints Receivers may in his or her discretion retain jurisdiction and supervise the original action of the Receivers appointed any other civil actions pending in the same district involving a Receiver even though he or she may rotate out of the district.

In South Carolina, any resident Circuit Judge has jurisdiction over the receiver and, in the absence of a Circuit Judge within the circuit, a non-resident judge may act. Generally, the judge granting the initial receivership application does not retain exclusive jurisdiction, due to the rotational nature of the South Carolina Circuit Court.

VIII. Liquidation of Assets

Pursuant to statutory law, the Receiver has the power to sell property either through private or public sale or any combination thereof. A Receiver may list real property with a real estate agent. The Receiver further can conduct a sale similar to a going out of business sale. Any specific directions or limitations on the Receivers powers and duties must be placed in the Receivership Order. For example, parties may want certain sales to be confirmed by the supervising Court after notice and a hearing especially in the case where a substantial portion of the assets are being sold.

Sometimes a Receiver is not appointed as Receiver of a corporation but can occur in the context of dissolution of marriage to facilitate a property distribution or in other circumstances in which the Receiver must only preserve property. In those circumstances, a Receiver cannot sell property unless so ordered by the Court. If the Court does enter an order authorizing the sale, the property must be sold under the provisions for a judicial sale found in N.C.G.S. § 1-339.1.

If a dispute arises regarding the effect of the legality of liens on encumbrances on real personal or property, a procedure exists for selling the property and having the liens attached to the proceeds of sale. Following the sale, the Receiver is required to report to the resident Judge of the District Court or the Judge holding court in the district in which the property is sold to request confirmation of the sale. Prior to the hearing, the Receiver must publish in a newspaper in the county or newspaper of general circulation in the county where there is no newspaper, a notice directed to all creditors and persons interested in the property that the Receiver will make application to the Judge at a certain place and time for the confirmation of his or her report which notice shall be published at least 10 days before the time fixed for the hearing.

XIV. Claims Process/ Priorities and Payment

The statutes provide a framework for the process by which creditors of a corporation may assert claims against the Receivership estate. Generally, the Receiver will send out a notice to file claims together with a claim form for the creditor to be completed and then filed with the Court. The Court will set the deadline within which such claims may be filed and can provide that creditors and claimants failing to file the claim by the deadline be barred from participating in any distribution of the company’s assets. The Court may also prescribe what notice, by publication or otherwise, must be given to creditors of such claims bar date.

Upon receipt of the claims, the Receiver may file an objection to the claim similar to the claims objection process in the Bankruptcy Court. If an objection is filed, a creditor is entitled to a trial by jury on the objection. The creditor however must respond to the objection and in a response request a jury trial, otherwise the right to a jury is waived. If the Receiver has no objections to claims, the Receiver will simply file a report with the Court indicating that such claims have been allowed and approved by the Receiver.

Prior to the time that the Receiver makes a motion requesting the distribution or a discharge of the Receivership, the Receiver must produce to the Court a receipt issued by the U.S. Post Office showing that such notice has been mailed to each such claimant’s last known address at least 20 days prior to time set for hearing on the motion. Notice should be sent by registered mail although proof of mailing, not proof of receipt of notice, is required by the statute.

There is no statutory authority for the prioritization of claims in a Receivership. Generally, the Receiver will pay claims to the extent the property subject to a lien has been sold in which case the secured creditor will be entitled to the first payment of the proceeds up to the full amount of the creditor’s claim. Such liens may include deeds of trust, judgments, security interests, mechanic’s liens or material liens, and tax liens.

After payment of any secured claims, administrative claims can then be paid subject to Court approval. These expenses can include insurance premiums, rent payments, taxes, professional expenses, and any other costs incurred in connection with collecting, preserving and distributing Receivership assets. The allowance of administrative expenses is subject to appellate review and can not the overturned unless clearly inadequate or excessive.

After priority secured creditors and administrative claims are paid, the following claims would likely be paid in order of priority:

(1) Claims of the United States for taxes;
(2) State tax claims;
(3) Employee claims for wages rendered within two months prior to the filing of the action;
(4) General unsecured creditors (likely receive pro rata distribution of
remaining assets
(5) Shareholder or member equity claims

There may be certain circumstances in which the Receiver may want to give a higher priority to certain creditors or a low priority for equitable reasons. If so, the Receiver will set forth in his or her report the proposed distribution scheme. If a creditor has an objection to that report, it must object to the report in order to preserve the issue and can wait to appeal for the Order granting the proposed distribution.

X. Avoidance Actions

Under the receivership statute, there is no authority for a Receiver to recover preferential payments to creditors or to insiders which occurred prior to the receivership. However, under the Assignment for the Benefit of Creditor’s statute discussed below, a trustee can recover property transferred or conveyed within four (4) months prior to the registration of the assignment. Thus, if the order appointing a Receiver provides that the transfer of title of debtor’s assets to the Receiver is considered an assignment for the benefit of creditors, a Receiver could argue that he or she has the powers granted to a ABC trustee to avoid preferences.

In South Carolina, Receivers of property of foreign or other corporations shall be allowed such commissions as may be fixed by the Court appointing them. § 15-65-100 S.C. Code Ann. (1976). In general, it is left to the sound discretion of the Circuit Judge to fix the Receiver’s compensation. Turner v. Washington Realty Company, 125 S.C. 109, 118 S.E. 30 (1923).

A Receiver does have authority to avoid certain transfers made by the debtor under the Uniform Fraudulent Transfers Act (“UFTA”). These can occur when:

(1) a transfer of property has been made for less than reasonably equivalent value; or
(2) was made with the intent to delay, defraud or hinder creditors.

A Receiver also can avoid a transfer to an insider under the UFTA if:

(1) the transfer was made for an antecedent debt;
(2) the debtor was insolvent at that time; and
(3) the insider has reasonable cause to believe that the debtor was insolvent.

A Receiver may not avoid an entire transfer:

(1) to the extent the insider gave new value to or for the benefit of the debtor after the transfer was made unless the new value was secured by a valid lien;
(2) made in the ordinary course or financial affairs of the debtor and insider;
(3) made pursuant to a good-faith effort to rehabilitate the debtor and the transfer secured present value given for that purpose as well as an antecedent debt of the debtor.

An action to avoid an insider transfer must be brought within one year of the date of transfer.

XI. Payment of Receivers

A Receiver receives compensation for his or her services as a Receiver either by statute or by agreement.

The statute provides that a Receiver can receive up to 5% of receipts and disbursements and the cost of administration during the proceedings. The statute does not mandate a Receiver be paid only by commission; rather the statute puts a cap on compensation at 5%. In situations where the Receiver is also an attorney, the Receiver can receive compensation for legal services provided to the Receivership in addition to the Receiver compensation.

XII. Final Report/ Discharge

After the Receiver has disposed of all assets and filed a final report with the Court, the Receiver can request a discharge and a release of his or her bond.

VIII. Advantages and Disadvanages of a Receivership

There are many advantages to receivership.  these include:

(a) easy, quick method of liquidation of assets;
(b) avoids investigation of preference claims by bankruptcy trustee;
(c) requires court oversight of the liquidation;
(d) stays creditor actions; and
(e) relieves directors of any self-dealing liability.

The disadvantages to a receivership is that:

(a) it is still a judicial process;
(b) it does not stop involuntary bankruptcy;
(c) assets, if any, are sold for nominal value; and
(d) the receiver can still pursue fraudulent conveyance actions.

When questions arise regarding the available options for liquidation of a company, or preservation of a company’s assets, contact one of the members of the Bankruptcy/Creditor’s Rights Group at Nexsen Pruet for advice.