How Receivership Works in Commercial Real Estate

While no one is happy when a foreclosure occurs, it does allow a lender to recoup funds it may lose when a borrower defaults. Unfortunately, because the foreclosure process takes time, and the borrower stays in control of the property and its income stream during that time, foreclosure also poses significant risks to the lender.

The borrower, apparently in financial dire straights, may use the property’s income to pay other creditors instead of making loan payments and covering the property’s expenses. Even if rents have been assigned to the lender, the borrower may be putting the property’s value in jeopardy by neglecting or abandoning its management duties.

One way to mitigate this risk is through the use of a receivership. Put simply, a receivership takes control of a property’s management out of the hands of a borrower and, at the direction of a court, gives control to a neutral third party: the “receiver.” The receiver operates all aspects of the property until the foreclosure lawsuit is resolved.

With the receiver collecting rents, maintaining and repairing the property, managing existing leases and entering into new leases, ensuring that contractors and service providers are paid, and otherwise taking all those actions necessary to preserve the property’s value, a lender can feel more confident that the ultimate sale of the property will make the lender whole. Or as close as possible.

To help you understand the role a receivership can play in a foreclosure, as well as its mechanics and benefits, this article answers the following:

  • What is a receiver, and why are they used?
  • What actions can it take to protect the property’s value?
  • Can a receiver sell the property, and if so, why would a lender prefer this to a foreclosure sale?
  • How are receivers appointed? and
  • What are the advantages and disadvantages of receiverships?

It must be noted that receivership laws vary from state to state, though there are many commonalities. In 2015, the National Conference of Commissioners on Uniform State Laws drafted the Uniform Commercial Real Estate Receivership Act (UCRERA). They believed a uniform act was necessary because:

Only a small handful of states (including California, Indiana, Nebraska, New Mexico, Ohio, Oklahoma, and South Dakota) provide a moderate amount of statutory guidance regarding the appointment and powers of receivers, and only two states–Washington and Minnesota–provide a comprehensive statutory codification of the laws governing the appointment and powers of receivers and receivership procedures.

However, the UCRERA doesn’t bind states, but instead is a template for them if they choose to enact or modify their own receivership statutes.

Accordingly, if you have any specific receivership or foreclosure issues, you should contact an attorney well versed in your state’s receivership laws.

For a detailed look at the foreclosure process, see this PropertyMetrics article.

What is a Receiver, and Why Are They Used?

UCRERA defines a receiver as a person appointed by a court to take possession of the property of another and to receive, collect, care for, and dispose of the property or the fruits of the property. In essence, the receiver completely replaces the borrower as to the operation of the property.

There are two types of receivers, general and limited. A general receiver is given control over all of an entity’s assets, often for the purpose of liquidating a business. A limited receiver controls only one or more specific assets. Receivers appointed in foreclosure actions, and thus dealing with only the property securing a creditor’s loan, are limited receivers. Some jurisdictions have viewed a limited receiver’s role as primarily custodial, and accordingly without the power to sell collateral assets. However, as discussed below, a court can grant this power.

Although a lender typically requests the receivership, the receiver doesn’t act only on behalf of the lender, but instead acts in the best interests of both lender and borrower. Though it takes direction only from the court, because the receiver owes a fiduciary to both lender and borrower, it must:

  1. Act in the best interests of the parties
  2. Not act for its own benefit
  3. Not act contrary to the parties’ interests, and
  4. Exercise its best efforts on behalf of the lender and borrower.

So long as a receiver acts within the scope of authority given by the court, it enjoys immunity from claims relating to its management of the property. However, if the receiver acts outside of this scope or fails to meet it fiduciary responsibilities, it may be held personally liable.

A lender traditionally requests the appointment of a receiver in order to:

  • Protect the value of the asset securing lender’s loan
  • Prevent a borrower from damaging the asset, including, for example, by failing to properly maintain or make necessary repairs
  • Ensure that a borrower doesn’t “skim” rent, i.e., use income generated by the property to pay non-property expenses or to pay other creditors
  • Limit liabilities arising from a borrower’s failure to properly manage the property, such as paying contractors to avoid liens against the property

If a receiver is going to afford these protections, it must be appointed fairly early in the foreclosure suit. However, receivers may also be appointed following a foreclosure judgment to protect the property pending any appeals or to enforce the court’s judgment.

The receiver doesn’t take on these duties out of the goodness of its heart. It receives a fee approved by the court and generally charge at an hourly rate. The fees are paid out of the property’s cash flow, but where cash flow is insufficient or negative, the lender fronts the fees. They’re then added to the principal loan balance owed by the borrower.

What Duties Does a Receiver Perform?

A receiver can perform all of the actions authorized under a state’s receivership statutes and, to the extent not overruled by a statute, the state’s common law. However, a court will specify which of these powers it deems appropriate for the foreclosure case before it.

The court identifies these powers and duties in an order, and are generally classified as either: (1) presumptive actions the receiver can perform without additional supervision, and (2) actions that require the court’s consent. Because each receivership is different, and state laws vary as to a receiver’s powers, it’s important the court’s order is comprehensive and detailed.

That being said, receivers commonly handle the following actions and responsibilities:

  • Secure the Property. The first step in taking custody and control of a property is securing the physical asset (e.g., changing locks) and the information needed to operate the property (e.g., copies of leases, contracts, bills and software managing this information).
  • Establish Itself as New Management. Before the receiver took over, tenants, contractors, insurance companies, service providers, utility companies and all other parties related to the property had all dealt with the borrower or its management company. Accordingly, the receiver, stepping into the borrower’s shoes, has to notify these parties that it’s the new contact person. Where necessary, the receiver replaces the borrower’s names with its own on accounts relating to the property. It can’t pay the utility bills if they’re still being sent to the borrower…
  • Manage Leases. The receiver reviews all existing leases to make sure their obligations are being met. Additionally, in the interest of maximizing a property’s value, a receiver can analyze rent rates and tenant performance to determine whether a tenant’s lease, upon its expiration or a tenant’s default, should be renewed or terminated.
  • Enter Into New Leases. Where there are vacancies, a tenant decides to move on, or the receiver decides an underperforming tenant’s lease shouldn’t be renewed, the receiver may be authorized to enter into new leases. Because the property may ultimately be foreclosed upon, the court will often require new leases to address whether the new tenancy survives the foreclosure.
  • Collect Rents. Because rental income is the only source of funds to those pay property expenses needed to preserve the asset’s value, as well as to make loan payments to the lender, putting the collection of this income in the hands of the receiver is paramount. It’s worth noting that preserving a property’s value benefits both lender and borrower. If proceeds from a sale are large enough, the borrower may be able to avoid any further financial liability, whether by a deficiency judgment, obligations to pay under a recourse clause, or claims by guarantors who had to make up a shortfall.
  • Maintain the Property. Diligent maintenance of the asset not only preserves its value, but also lessens the likelihood of new claims relating to the property’s deterioration.
  • Make Necessary Repairs. Because not all repairs are necessary to preserve or increase the value of the asset, the parties may ask the court to define in its receivership order those specific repairs the receiver will make. Further, because it’s possible new repair needs might come up, the court’s order may also outline under what circumstances new repairs can be made.
  • Negotiate and Pay Property Expenses. Expenses can include such things as property taxes, insurance premiums, and amounts owed to contractors and service providers. Ensuring that these are paid in full and on time can prevent liabilities such as tax liens, mechanics liens, or uninsured losses. Additionally, where property-related contracts with the borrower are expiring, or additional contracts required, the receiver can negotiate their pricing and terms.
  • Borrow Money. In the cases where the asset’s rental income isn’t sufficient to cover receiver’s cost to perform its duties, the receiver may be authorized to borrow funds to make up this shortage.
  • Sell the Property. As noted above, because the receiver in a foreclosure action is often classified as a limited receiver with only a custodial role, not all jurisdictions authorize to it to sell the asset. However, because the courts recognize a receivership sale, as opposed to a foreclosure sale, might be in the parties’ best interests the trend has been for courts to grant receivers the power to sell. This grant is then conditioned on the consent of the parties and the court.
  • Retain Professionals. While receivers are expected to have expertise in many aspects of commercial real estate, there are areas where engaging and paying a third party professional to help in the receivership duties makes sense. For example, if the property is still in construction, the receiver could hire a general contractor to complete the project. Or if the receiver has been authorized to sell the property, it would be reasonable and prudent to hire legal counsel that understands local contract, zoning and permitting laws.
  • Appeal Property Taxes. As a part of its efforts to maximize a property’s income by in part minimizing its expenses, the receiver may appeal the asset’s property taxes or contest the property’s valuation.
  • Report to the Court. Receivers must make regular reports to the court of its activities, expenses, property income and other items specified in the receivership order. When the receivership ends, the receiver then makes and files a final report.

All of the above actions require some expenditure by the receiver. If the court finds these expenses unreasonable, it can deny or modify their amounts.

The Benefits and Process of a Receivership Sale

Instead of pursuing a foreclosure action to its completion through final judgment and auction, having the property’s receiver market and sell the asset can have significant benefits to all parties. The receiver sale can reduce the cost of selling, bring in a higher sales price, and protect a lender from certain liabilities. Advantages include:

  • Elimination of Trustee Fees. If a non-judicial foreclosure sale is used (as is the case in a deed of trust state or when a mortgage authorizes a non-judicial foreclosure process), then the trustee performing the sale is entitled to a fee traditionally equal to a percentage of the sale price. If the receiver performs the sale, this fee is avoided.
  • Quicker and Cheaper. The time required to complete a foreclosure lawsuit can be very lengthy, and the litigation costs substantial. A receivership sale can be consummated fairly quickly, and eliminating litigation costs means greater net proceeds to the lender.

Additionally, even following the foreclosure sale, a borrower may have redemption rights that prevent the property’s buyer to take title until the redemption period expires. This period is generally one year, but in at least one state (Rhode Island) redemption rights can tie up a property for three. If a receiver sells the asset, typically the sale contract will require the borrower to waive its right of redemption and both parties to waive their right to appeal the foreclosure decision. Freeing the property of redemption and appeal rights increases the asset’s marketability and value to potential buyers.

  • Higher Sales Price. An experienced receiver with the aid of a knowledgeable broker will have access to many more buying prospects than if the property was sold on the courthouse steps. The greater the number of potential buyers, the greater the potential sales price. Additionally, the receiver can analyze and market the property’s characteristics that make it valuable, e.g., desirability of location, favorable entitlements, building features, etc. A trustee on the other hand, won’t have the same expertise to show and market the property’s valuable aspects, and further, often isn’t charged with more than handling the sale. This means bidders have to figure out the property’s worth, and the lender has to hope they valued appropriately.
  • Keep Distressed Asset Out of Lender’s REO Inventory. If the lender ends up being the highest bidder at the foreclosure sale, it has to add the property to its REO inventory. Banks aren’t in the business of holding real estate, and would prefer to avoid the possibility of “winning” the foreclosure auction.
  • Eliminate Chain of Title Liabilities. If at any point the lender takes title to the asset, it will be liable for any debt or liability claims against the property. Additionally, simply being in the chain of title can expose a lender to certain liabilities such as (i) federal and state environmental claims, and (ii) construction defect claims if construction was required to bring the property to a marketable state. If a receiver sells the property, the buying transaction is between the borrower and the new buyer, and any chain of title liabilities are avoided.
  • Borrower Can Negotiate Favorable Workout. Borrowers may prefer a receiver’s sale not only because it can benefit borrower by resulting in greater net proceeds to the lender, but also because the borrower knows lenders generally prefer a receiver sale and the court won’t allow the sale to happen without the borrower’s consent. Armed with this leverage, a borrower may be able to negotiate a more favorable resolution to its default, including for example, getting the bank to release any personal guarantees on the loan in exchange for the borrower’s consent to the sale.
  • Receiver Can Sell Portions of the Property. This power can be especially attractive where a project is only partially developed. If the parties agree, the receiver could sell outparcels and generate immediate income for the benefit of all.

If the parties and court agree on a receiver sale, the parties can take steps at the outset to avoid disagreements in the sale process. For example, the parties may agree on the terms and form of the sales contract, initial listing price, listing broker and marketing strategies.

Once a sale is negotiated, the receiver typically gives notice of the sale to all parties who might have a claim against the property. Such parties would include not only junior lien holders, but also unsecured creditors, taxing jurisdictions, contractors, etc. This notice is made to ensure that the borrower, lender and court know all of the potential claims against the asset, and their impact on the property’s value.

If the sale is approved, generally the property is sold without representations, warranties, or liens. While the liens will no longer burden the property, they will, as in a foreclosure action, be enforced against the sale proceeds in their order of priority.

How is a Receiver Appointed?

Most commercial mortgages give the lender the right to request a receiver upon a borrower’s default. While some courts find this is sufficient authority to grant an order of receivership, others require some showing that the request is reasonable and necessary. Generally, the decision to appoint a receiver is completely within the discretion of the court.

Depending on the terms of the mortgage, a lender may request a receiver upon the borrower’s default or as a part of its foreclosure action. Following such request, some courts will grant a receivership ex parte, meaning it grants a receiver based on the lender’s request and supporting evidence without notice to the borrower. However, the borrower may contest the ex parte order at a subsequent hearing.

There are no universal eligibility requirements for a receiver, though the courts generally demand that the receiver has experience in the areas required for receivership (e.g., property management, development for unfinished properties, sales and marketing where a receivership sale is contemplated, etc.). The UCRERA suggests that receivers only be appointed if the lender shows (i) it has an interest in the property, (ii) the property is in danger of waste, loss, or impairment, and (iii) the property maybe subject to a voidable transaction. Some courts also require a receiver to provide a sworn statement that it’s independent.

The order appointing the receiver details their powers and duties. Some of the items typically covered include: (i) a description of the property, (ii) the reason why receivership is justified, (iii) the specific powers of the receiver, including those powers that aren’t universally granted, such as the right to sell, borrow funds, and engage other professionals, (iv) the timing and substance of the receiver’s reports to the court, and (v) the receiver’s right to possess the property and borrower’s records relating to property.

When the receivership ends, in addition to the final report, the receiver asks the court to be formally discharged.

Advantages of a Receivership

            Advantages to Lenders

A receiver protects the property’s value (and thus the lender’s ability to recover its funds), and a good receiver will even increase the property’s value. It protects against theft from the property, vandalism and illegal dumping of trash. It collects rents and ensures they are applied only to the loan balance and property-related expenses. It fills vacancies with income-producing tenants. It makes improvements to the property. It resolves potential claims with unpaid insurance companies and contractors. It works with local governments to address construction, permitting and land use violations. It works with title companies to make the title as marketable as possible. And if the power of sale is authorized, the lender enjoys all of the receivership sale benefits described above.

If a defaulted borrower remains in control of the property during a foreclosure suit, none of these actions may occur.

Experienced receivers can also benefit lenders by tapping into their existing CRE relationships. They know which companies provide the best services at the best prices. Where receivers manage multiple properties, they can leverage this position to negotiate better terms with service providers for the borrower’s property.

Further, allowing a receiver to manage the property, as opposed to the lender taking on that duty, eliminates the possibility that the lender becomes a “mortgagee in possession (MIP).” In title theory states, when a borrower grants a mortgage or deed of trust, upon that grant it conveys title to the property to the lender (as opposed to in lien theory states, where only a lien interest is granted). While a borrower has the right to possess the property when a mortgage is granted, the mortgage also provides the lender may take possession if the borrower defaults. If lender exercises this right and takes possession, it becomes an MIP.

Lenders generally avoid MIP-status because if they do, they have a duty to treat the property “as a provident owner would do.” Accordingly, if a lender takes direct possession it must collect rents, maintain and repair the property, manage tenants, etc. The risk here is that a borrower alleges the lender didn’t meet its MIP duties, and sue the lender for damages. Even when such claims may be without merit, they sometimes occur because the threat of such an action (and potential damages) may move a lender towards settlement or loan workout.

            Advantages to Borrowers

Like the lender, a borrower benefits from the appointment of a receiver if it increases the property’s value through improved management. The greater the net proceeds from a foreclosure or receiver sale, the less the borrower’s liability to lender.

Additionally, receivers may be ideally equipped to broker a settlement, an option generally more attractive to both parties than foreclosure. Receivers have this ability because they’re required to act in the best interests of both the borrower and lender, as opposed to the parties’ lawyers. This neutrality can give a credibility to its advice that other parties may not have. Further, by virtue of operating the property the receiver gains a unique understanding of its value. Once trust and objective valuations are on the table, and so long as the receiver has proven it’s protecting the property’s value, a lender may be willing to give a borrower time to find additional capital or negotiate workout options. Again, these are outcomes a lender would much prefer to foreclosure.

Disadvantages

Lenders and borrowers tend to have the same two concerns about receiverships: (1) they lose control of the property’s income stream, the property itself, and potentially its disposition, and (2) the receivership costs may be greater than any property value a receiver could preserve or increase.

If no receiver is involved, the court makes its decisions by weighing the lender’s arguments against the borrower’s. This gives the parties some sense of control. However, when the court appoints a receiver, it’s inclined to listen to the neutral receiver’s recommendations. The parties view this as losing some degree of control.

As an example, after analyzing a property’s operation and value, a receiver recommends the asset should be sold. The lender disagrees. While the lender may still explain its objection to the court, it may believe they would have been in a better position to protect their interests if a receiver had never been appointed.

Loss of control may also be a large factor when a borrower in default is trying to get a project back on its feet. It’s looking for additional capital, preparing marketing strategies, and negotiating with new tenants. If a receiver is brought into the picture, and takes over management of the property, there is the possibility the receiver will implement an entirely different strategy. The receiver will only do this if it believes the new strategy is in the best interests of the borrower (and lender), but the borrower may believe it would’ve been better off if a receiver had never been appointed.

Lastly, as to the fear of receivership costs, lenders and borrowers will look at (i) the receiver’s potential fees, (ii) property management fees if the receiver outsources those duties, and (iii) the projected cost of professionals engaged by the receiver to help with the receivership. The question then becomes whether these costs outweigh the value the receiver creates by (a) preserving or increasing the asset value and (b) limiting potential party liabilities.

In the end, the decision to use a receiver is a math question. What are the property’s potential liabilities? Environmental concerns? Additional construction needed? Has the borrower completely abandoned its management responsibilities? How long will the foreclosure process last? Will the property benefit from special marketing efforts?

With the aid of legal, financial and CRE professionals, generally the answer to this math question is clear.

Have you ever had to answer these questions? Or worked with someone considering a receivership? If you have, or if you have any comments or questions, please share them below!

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