Professionals recognize that receiverships can provide a cost-effective and efficient way to liquidate failed businesses, and that receiverships can provide some bankruptcy benefits without the high cost or lengthy proceedings associated with bankruptcy cases. Receivership professional fees tend to be less than those incurred in a restructuring or liquidation under the Bankruptcy Code. Accordingly, and particularly since BAPCPA’s enactment, the number of receiverships has significantly increased.
The “perfect storm” that recently hit the U.S. economy has made 363 sales under the Code far more difficult to close due to lower business valuations, a lack of debtor-in-possession/acquisition financing and equity sponsors' illiquidity. As a result, there has been a spike in the number of businesses that have been liquidated by their senior creditors. In turn, receiverships are often indicated to better control the wind-down and liquidation of a business and to maximize asset-recovery levels. The increase in receivership activity has been noteworthy in two industry sectors—real estate and auto dealerships.
Real Estate Receiverships
Neglect, waste and deterioration of real estate assets may result when borrowers no longer adequately attend to their ownership obligations. For example, when a borrower defaults, it may fail to pay real estate taxes, normal property management and maintenance may suffer, rents to which the lender is entitled may not be remitted in an appropriate and timely manner and entitlements granted by municipalities may expire. The appointment of a receiver is often the best solution for a senior creditor seeking to prevent further deterioration of its collateral prior to foreclosure. In addition, an independent receiver enables the creditor to gain a greater understanding of what is going on at the property level prior to foreclosure and make better decisions on asset disposition. We will discuss two brief case examples.
Case 1: The single-family project development. A large regional land developer had acquired and was developing more than 35 single-family residential communities with more than 7,000 lots when market conditions slowed sales. Despite efforts to sell the portfolio and attract investors, the borrower was unable to raise the equity needed to adequately support the projects. The borrower failed to pay property taxes, and due to lack of funds available to support staffing, entitlement problems ensued, homeowner association fees went unpaid and property maintenance deteriorated. The secured lenders exercised their contractual right to appoint a receiver in court, and the court granted the relief. The receiver was able to make a realistic assessment of the funds needed to maintain the assets, and within weeks, a comprehensive budget was developed and implemented. The lenders were then able to make the right decisions to best protect collateral value.
Case 2: A mixed-use waterfront development. The borrower had acquired and was repositioning a waterfront property for entitlements necessary to build a mixed-use project that included a marina, residential housing and retail shops. Market conditions deteriorated, and the project stalled. The borrower was unable to sell the property or contribute the sufficient equity necessary to maintain the loan and property. The loan went into default and the lender petitioned the court to appoint a receiver, while at the same time it began appropriate filings to foreclose the asset. In many jurisdictions, the foreclosure process can take months to complete. During this period, certain critical entitlement renewals were needed to maintain the value of the collateral. As such, in addition to maintaining the property, the receiver was able to obtain the appropriate entitlement extensions and protect the value. The foreclosure date was set, and the bank foreclosed on the project, at which point the receivership was dissolved. The bank had accomplished its goal of protecting value by maintaining entitlements.
Car Dealership Receiverships
Situations confronting a secured lender with respect to an underperforming auto dealership often fall into one of two characterizations:
• Inventory Units Sold and Unpaid (SAU): Some lenders are willing to prove additional funds to support turnarounds in such situations. This usually occurs in circumstances where the dealer is determined to be in a SAU status, but has other assets to commit and has hired professionals to assist in developing or implementing a restructuring plan.
• Inventory Units Sold Out of Trust (SOT): These situations are often comparable to distressed real estate transactions in that engineering a turnaround in today’s environment is not a likely outcome. The focus is on the preservation of the capital on behalf of the creditors. SOT situations are the most conducive for receivership opportunities.
When a dealer is determined to be SOT and lacks the asset value to adequately capitalize the business or secure new advances, senior creditors may seek the appointment of a receiver in order to secure and preserve the value of assets supporting its loan. Here is a case as an example.
SOT Dealership. An automotive and truck dealership was out of trust with its senior lender and losing money at both of its locations. The lender suspected the possibility of fraud and, in order to avoid the cost of a chapter 11 bankruptcy, sought the appointment of a receiver to quickly liquidate the business’s assets. Assuming control of the business—and its premises and assets—the court-appointed receiver located and identified missing vehicles in the dealership’s records and implemented “24/7” security of the assets. The receiver also coordinated the sale at auction of approximately half of the vehicles and oversaw the sale of the remainder of the assets. As a result of the receivership, the dealership was successfully sold out of bankruptcy, and the lender’s recovery was higher in this case by avoiding the cost of a chapter 11 filing.
Being an Effective Receiver
The receiver is an appointed officer of a federal or state court and, as such, generally has a fiduciary responsibility to act to maximize the value of the receivership assets. An effective receiver should possess the following qualities:
• should be well-versed in all facets of running the business in question;
• should be a disinterested third party;
• must be knowledgeable about bankruptcy, commercial finance and receivership law;
• must have experience handling issues in litigation effectively;
• must have a successful track record reporting to the court that establishes the receivership;
• must be able to handle internal accounting controls to ensure cash is being reported and managed properly and accurately; and
• should have the capacity to provide the necessary bonding levels for the case.
In the case of real estate, a receiver should have access to strategic partners in construction, sales, auction, marketing, land management, property management and leasing that can handle any type of real estate project in any kind of circumstance.
About the Authors: John Bambach Jr. is the managing director of Focus Management Group’s Philadelphia office and is a Certified Turnaround Professional. Jay Kelley serves as the managing director of Focus Management’s Real Estate Practice and currently serves as the court-appointed receiver for a variety of real estate properties.