A secured creditor believes that its borrower is diverting or dissipating assets. The borrower refuses to surrender the collateral or communicate with the creditor. Generally, secured creditors cannot file involuntary bankruptcy petitions against their borrowers, so what should the secured creditor do to preserve its collateral? Under certain circumstances, a receivership can offer great flexibility, economy and other advantages to the secured creditor.
Receivers fill a custodial role, stepping in to evaluate the borrower’s situation and take control of a failing debtor. Just as a bankruptcy is either a liquidation or reorganization, a receiver may take over the troubled company and sell its assets for maximum value (or permit the secured creditor to sell the assets), or restructure the business with the consent of the secured creditor. Typically, the receiver is appointed by judicial order after the debtor’s secured creditor brings an action in state or federal court. In doing so, the creditor exercises rights provided by statute or the creditor’s contract with the debtor. Although the creditor initiates the appointment, once appointed, the receiver becomes an officer of court with fiduciary duties to act in the interest of the estate and creditors.
What is the benefit of placing the debtor into receivership? Ideally, the creditor receives protections similar to those provided in a bankruptcy proceeding, but without the time, expense, and adversarial nature of a bankruptcy case. Most importantly, the creditor has wide leeway to craft a receivership order incorporating whatever terms it considers favorable and prudent under the circumstances. For example, the creditor might request a channeling injunction, which acts as a funnel to require that other claims brought against the debtor be litigated in connection with the receivership.
It is critically important, then, that the proposed receivership order be well thought-out and carefully drafted to achieve the creditor’s objectives. A good order does a lot of heavy lifting: it names a receiver whom the creditor knows and trusts, establishes the “ground rules” of the receivership, sets the terms of a liquidation sale, provides clear title for prospective buyers, and directs the handling of claims and distributions.
In sum, receivership can be a powerful tool for a secured creditor of a distressed debtor. Whether a receivership is the best solution under the circumstances, however, will depend on a variety of considerations and the manner in which it is implemented.