Orderly Takeovers of Special Properties A Court Order Checklist

Journal Issue

Sep 2002

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Attorneys and others involved in the turnaround of troubled properties should be aware
that there is a vast difference between traditional real estate entities, such as
office buildings, and "special assets," which run the gamut from amusement parks to
restaurants. When drafting court orders for these special properties, it is critical
to view them first as businesses and only secondarily as real estate assets.

Unlike traditional or "passive" income properties—such as office buildings, shopping
centers and multi-family housing—special assets feature a retail component that typically
represents a significant portion of the value. Examples include hotels, restaurants,
convenience stores, gas stations, truck stops, senior care facilities and recreational
or theme parks. These assets typically involve a host of complex business issues, and
require specific knowledge of the business itself, not merely general real estate
management skills.

Having served as a receiver, trustee, custodian and/or manager for hundreds of
retail properties, our task is always affected by the court orders that empower us.
Court orders are critical to any takeover; careful drafting not only saves time and
helps curtail potential problems, but can significantly affect the cost to the
receivership or bankruptcy estate, and ultimately the amount recovered on the loan.

Not surprisingly, the impact on speed, cost and effectiveness is magnified when the
asset is not a simple income property, but involves the operation of a business as
well. Indeed, special assets such as hotels, gas stations and theme parks can add
several levels of complication for any receiver or trustee, as well as the operator.

Problems and needs encountered by attorneys when dealing with these properties range
from taking stock of inventories to examining franchise agreements to dealing with
environmental claims. The following are just a small sampling of the problems that can
be encountered when working with these properties, and how they can be dealt with in
the court orders. These scenarios can apply to a receiver in a pending foreclosure
action, to bankruptcy trustees or to third-party operators placed through stipulations
among parties. By covering all of these anticipated hurdles in advance, a return
visit to court for additional orders can be avoided, and assets can be protected more
effectively.

Bank Accounts. A complex property such as a hotel may have multiple bank
accounts—one for ordinary operating expenses, one for processing credit card transactions,
another for reservation deposits and yet another for capital reserves. In addition,
there will be many different cash banks for personnel such as desk clerks and
bartenders or accounts used by the owner under a different name. With this in mind,
the court order should specifically allow the receiver to seize all related accounts and
specify other entity names, if known. The receiver should be allowed to keep the
accounts open in order to receive additional deposits or transfers, but be able to
freeze all funds so no further checks can clear.

<blockquote><blockquote>
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<big><center>
[S]pecial assets such as hotels, gas stations
and theme parks can add several levels of
complication for any receiver or trustee, as
well as the operator...
</center></big>
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</blockquote></blockquote>

Inventories. The inventory of a major high-rise office building is quite simple
when compared to a hotel or even a modestly-sized restaurant. For that reason, the
court order for a special asset should allow ample time for the filing of an
inventory. An "inventory" may also include accounts receivable, which can be very
substantial and complex for an entity such as a truck stop or convention hotel. In
addition, reporting these accounts may create false hopes about collectability.

Most receivership statutes—when they even exist—refer to "receipts and disbursements,"
not profits and losses, thus implying that accounting should be done on a cash rather
than accrual basis. That being the case, it is usually advisable not to include
accounts receivable as inventories or assets, but instead to simply note the apparent
amount and then reflect any payments as income when actually received. Dollar values
should not be assigned to most inventories, since such valuations are highly subjective
and can open the door to arguments later on.

Books and Records. While rent rolls and security deposit information are fairly
straightforward in traditional real estate, much more detailed and critical business
records are involved when dealing with special assets. For example, lengthy lists of
major corporate accounts, travel agents, previous guests, daily reports and reservations
are vital for hotels, while fuel supply data and store sales records are critical bits
of information for gas stations and convenience stores. For a property such as a
theme park, it might be necessary to contact all previous season passholders before
re-opening for the season. The bottom line? Past business records are critical in
retail assets.

Franchise Agreements. A hotel, restaurant or gas station is often branded
through a franchise agreement. Most often, when an owner defaults on debt service,
there are already other defaults with vendors, taxes and franchises. In addition,
most franchise agreements include receivership or bankruptcy as a default. The particular
franchise (or "flag") can be a very substantial benefit to such an asset. Yet if
badly chosen, the "flag" can also be a detriment. Receivers, trustees and turnaround
managers experienced with such projects can not only quickly assess the flag's value and
successfully maintain the desirable identity, but can often improve on the terms of
such agreements. The court order should always allow the receiver to negotiate such
agreements.

Liquor and Gaming Licenses, Lottery Tickets. This category may seem
insignificant, but is actually an extremely important source of income for many special
assets. The survival of a gas station may be dependent on the sale of lottery tickets
or liquor sales to attract customers to its gas pumps. A convention hotel that cannot
operate its cocktail lounge or serve wine to a banquet could lose all its future
bookings. For these reasons, the receiver needs authority to continue using existing
licenses and/or to transfer or acquire licenses. A new license rarely allows for
continued operation, and often takes months of processing, whereas assignment, transfer
or merely "use" of the existing license allows for continued operation.

The administrative agencies that control these privileges are not governed by court
orders involving other parties, but an order that specifically mentions these licenses
may still be of great help. The order may simply direct the debtor not to surrender
or terminate the licenses, or to cooperate in transferring the license to the
receiver. While the legal merits of such an order are unclear, if the agency
bureaucrat believes the order to be valid and complies, the asset (and arguably all
parties) will benefit. The debtor is certainly free to object, but in hundreds of
cases, this has only happened to our firm once, and we still managed to obtain the
license.

Unusual Vendor Relationships. A special asset's relationship with vendors is often
less than straightforward. For example, when a customer pays at the pump at a local
gas station, often the credit card proceeds do not go to the owner or operator of
the station, but are deposited directly into the account of a fuel supplier or
"jobber." These receipts can represent the majority of sales, so cash flow at the
property may be limited. Jobbers also typically require substantial deposits before
delivering fuel. If the tanks need filling every day to meet demand, the receiver
may need to borrow cash immediately to stay open, and additional debt requires prior
court approval, which leads to the following discussion about receiver's certificates.

Receiver's Certificates. Special assets often depend on going-concern value as
much as, if not more than, real estate or improvements value. A closed hotel is
worth only a fraction of an operating one, even one that loses money. Some hotels
take years to become established and stabilize, so closure can be fatal. The lender
may be prepared—particularly if forewarned—to fund operating losses of the business in
order to maintain or enhance the ultimate sale value of the asset. If this can be
anticipated, the order appointing receiver should also grant permission for the receiver
to borrow money. The loans can be added to the underlying indebtedness as additional
advances, or receiver's certificates can be issued as a separate debt. Most judges
are reluctant to agree in advance to such borrowing, so it will be important to be
prepared to explain a critical need. Some receivers and trustees are also experienced
as expert witnesses in their field, and should be able to assist your legal counsel
in drafting such requests. This is merely one example of why it is important to have
a receiver who is knowledgeable about both receivership law and the specific business
or industry.

Accounts Payable. Generally, a receiver has no obligation (or even right) to
pay pre-receivership debts. The court may allow exceptions when the receiver feels they
are necessary to protect or benefit the estate. When such expenditures can be
anticipated—i.e., for unpaid wages—the initial order should allow either for the
specific payment, or for discretion of the receiver.

Management Companies. Because of the cost savings and easy transition upon
foreclosure, many lenders and servicers prefer to use a receiver who is connected to
a management company (although this is harder to find with retail properties). The
court's order should not only grant authority to hire a management company, but include
a company in which the receiver is a principal, employee, etc. Naturally, the
relationship should be disclosed, and management fees should be competitive.

Intercepting Mail. When dealing with retail businesses rather than traditional
commercial income properties, it is typical for owner/operators to have many unique or
personal methods of conducting their business. It is not uncommon for payments from
major accounts, for example, to be directed to a location other than the subject
property. For that reason, the receiver should have authority to intercept mail and
to have the postmaster redirect business mail to the receiver's offices.

Environmental Audits. It is frequently vital for the lender (plaintiff) to
request an assessment of any environmental issues. Since it is also of importance to
the receiver, along with health and safety issues, the order should specifically
provide for access to conduct such inspections and audits.

Retaining Legal Counsel. Aside from routine evictions or collection matters, most
judges do not like receivers to automatically retain legal counsel. If the need for
separate legal counsel for the receiver is expected, the purpose should be carefully
detailed to facilitate the court's approval. An experienced receiver should not need
to consult with legal counsel for most matters.

Personal property. With special assets such as restaurants, hotels, convenience
stores and other businesses, very often the personal property may be leased. The
receiver will need to determine who the actual owner is, and whether or not to
continue honoring such leases. It may be beneficial to have the court "order" other
parties not to remove leased equipment. However, in the case of a foreclosure
action, third-party lessors are not necessarily subject to that court's jurisdiction.

Restraining Orders. Orders appointing receivers commonly also include temporary
restraining orders, which prevent the debtor from canceling insurance policies, removing
property or interfering with the receiver's responsibilities and duties.

Bonds. Every court seems to have its own method for determining what size bond
the receiver should post. Some judges, in dealing with traditional commercial real
estate, feel that one month's rent receipts is an appropriate amount. This is based
on the theory that once a month, when rents are collected, the receiver will have
that much money on hand. However, the receiver of a hotel or restaurant will rarely
if ever have such an amount at one time, and a bond in that amount could be more
than $1 million. Counsel should be prepared to suggest a reasonable amount to the
court, with supporting reasons, since the cost of the bond is also an expense to
the receivership estate.

Ex Parte or Noticed Motion? The typical hearing on a motion for appointment of
a receiver is scheduled after appropriate notice to all parties, and may be set for
a date days or weeks in the future. In some cases, counsel may seek an ex parte
motion on an expedited basis. The hearing can be held as quickly as the following
day, with the notice to the other party sometimes being a simple phone call. Courts
are naturally reluctant to grant a motion that removes an owner from his/her property
on such short notice, so it is important to have a compelling reason. A gas station
that is being forced to close because it can't pay for fuel delivery or a hotel that
is about to lose its franchise would be good arguments for an ex parte motion.

<h3>Conclusion</h3>

Careful drafting is naturally important in all legal documents. However, the order
appointing a receiver or directing a trustee becomes even more critical when an operating
business comprises a substantial part of a real estate asset's value. Because of the
unique nature of these properties, the lender and its legal counsel should be extremely
prudent when drafting the court order and take careful note of all the issues addressed.

While there are dozens of other "standard" items that should be included in every court
order—as well as many more special issues to be addressed for different types of
assets—this article should provide a checklist for such special properties. If possible,
input from the proposed receiver and/or management company should be solicited at the
earliest opportunity. A return visit to the courtroom for supplemental instructions and
orders is expensive and time-consuming, and a delay of even a day or two can sometimes
be fatal to the financial health of a business.

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<h3>Footnotes</h3>

<a name="1">1</a> An attorney, licensed real estate broker, Certified Hotel Administrator and court-appointed receiver, William J. Hoffman is
president of Trigild, a property management firm that has handled hundreds of special assets from hotels to amusement parks. <a href="#1a">Return to article</a>

Journal Authors

William J. Hoffman

Journal Date

Sunday, September 1, 2002 - 12:00

Bankruptcy Rule

2002