The Nature of Equity Receivership and Why it Happens

An equity receivership, or equitable receivership, is a form of receivership which is neither a plain care-taking pending foreclosure nor an action initiated by the government. A receivership remedy is an equitable form of remedy, one which emerged in the English chancery courts, where receivers were appointed to oversee and safeguard real property. A receivership is a legal remedy open to secured creditors to recover funds owed under a secured loan in cases where the company defaults on its loan payments. Another role of a receiver is to be appointed in a shareholder dispute to complete a project, liquidate assets or sell a business.

How the Process Works

The process starts with the appointment of a receiver by a secured creditor under a security agreement or by the Court on behalf of a secured creditor. Only a Licensed Insolvency Trustee is eligible to act as a receiver. The powers and rights of Court Appointed Receivers are outlined in the court order that appointed them.

The receiver is entrusted to take possession of the assets secured by the security agreement and sell or liquidate them to repay the debt left owing. Under a receivership, both a secured creditor and the Court itself are able to appoint a receiver-manager to handle the company until such a time as it is sold as a going concern.

Additionally, a receiver’s duties include giving creditors notification that the receivership is taking place and regular reporting on the status of the receivership to the Official Receiver, who is a representative of the Office of the Superintendent of Bankruptcy and of the Court.

Receivership and bankruptcy are not mutually exclusive. A receivership can occur in the absence of a company going bankrupt. The same entity can perform the roles of both trustee and receiver, but commonly there are different firms appointed to the distinct roles.

It is the job of the receiver to sell the assets secured under the security agreement. Then, after subtracting the receivership’s fees and expenses, the receiver disburses the profits from the sale to creditors in a priority-driven manner. For cases where the proceeds from the sale of assets are insufficient to cover the liabilities of the secured creditor in full, no realizations are to be accessible for distribution to the unsecured creditors.

Advantages of a Receivership for Creditors

Once a company enters a period of financial instability, the first reaction for many creditors is to try to place the indebted party under bankruptcy. Yet an equitable receivership may be the more advantageous action available.

The main advantages of a receivership are twofold. Firstly, an equity receivership supplants management with the receiver straightaway, whereas a bankruptcy keeps management in place indefinitely. If finances were truly the issue, bankruptcy might present a good course of action. But in cases where money problems are just a symptom and the real problem lies with management, then a receivership may prove a better circumstance for creditors.

The second advantage of an equitable receivership is that it presents greater flexibility than a bankruptcy. Any person or team that is able to serve well as receiver can be appointed. A receivership judge can demarcate just about any procedure that is found suitable.

The Wells Fargo Case

In a battle between a receivership court’s inherent equitable powers and property rights that were pre-existing, that is, the Wells Fargo case, the Eleventh Circuit had examined whether a district court’s inherent authority to establish a claims submission process permitted the Court to terminate a security interest in real property based only on an unfortunately timed proof of claim.

Secured creditors across the land were glad to see that the Eleventh Circuit determined that the district court had erroneously discontinued the creditor’s pre-existing property rights in those circumstances.

Background Information on Wells Fargo

Equity empowers a district court to set out procedures for the submission of claims to a receiver, and to establish a claims bar date. In the Wells Fargo case, the SEC sought and attained the appointment of a receiver over several entities that perpetrated a failed Ponzi scheme.

Though not a named party to the receivership action, Wells Fargo Bank, National Association (Wells Fargo) possessed security interests in three properties taken over by the receiver.
After appointing the receiver, the district court entered an order that outlined procedures for submitting claims to the receiver, set a due date for submission of claims, and prevented any claims submitted after the due date from being upheld.

The receiver thus mailed a claims packet to Wells Fargo, who did respond, but only deigned to identify one of its three secured loans in the claims form.

Approximately one and a half years following the expiration of the claims due date, Wells Fargo filed a motion to argue that either it was unnecessary to file a proof of claim to preserve its security interests, or that leave to file a late proof of claim should be granted.

The district court ruled against Wells Fargo, concluding that it had failed to preserve its security interests because it failed to comply with the court orders establishing the claims procedure. Wells Fargo then appealed, and the Eleventh Circuit reversed.

Let’s Analyze This

The Eleventh Circuit decided that even though a secured creditor can submit a proof of claim that in turn submits the secured creditor to the jurisdiction of the receivership court to preserve its ability to recover an unsecured part of its debt from general receivership assets, it is not required do so in order to preserve its inherent rights.

Tough questions arise from the issue of whether the broad powers of receivership courts can affect the interests of a third party. The Wells Fargo case puts to bed one of these ambiguities, by having concluded that the pre-existing security interests of secured creditors do survive a receivership, despite a court-established claims submission process.

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