Receiverships: Panacea or Dodo Bird?

• December 1, 2005

Reprinted with permission of the King County Bar Association

By Diana K. Carey

On June 10, 2004, a comprehensive receivership statute took effect in Washington.  Its intent was to give greater guidance to the bench and bar on the powers and duties of a receiver, in some cases codifying existing receivership law and, in other cases, expanding or modifying prior law.

Receivership advocates have long contended that for selling or   liquidating small or medium-sized businesses, a state court   receivership is an attractive alternative to the cost and stigma of a  Chapter 11 bankruptcy. The new statute has now been in effect for over  a year. Is it indeed the panacea that might replace Chapter 11 as  a corporate liquidation vehicle? Or is its viability threatened because it  might be preempted by federal bankruptcy law, rendering it extinct?

These are critical questions as insolvency practitioners struggle with the implications of the Bankruptcy Abuse Prevention and Consumer  Protection Act of 2005 (BAPCPA). Although the BAPCPA’s name  implies that it primarily affects consumers, there are numerous  provisions that affect (and often restrict) how corporate debtors  operate in a Chapter 11 case, including new reporting requirements for  small business debtors.

On the basis of a small sampling of practitioners, this author concludes that, although the Washington statute now has more procedural  requirements, receiverships still provide a viable alternative to  bankruptcy for the right case.

Advantages of a Receivership
There are numerous reasons why a  receivership may be a better approach than bankruptcy in dealing with  a troubled company. First, where the company might be able to survive  as a going concern, a receivership may have less negative impact on  vital customer and supplier relationships. This permits retention of the going-concern value so that the entity can be sold. Second, an   experienced receiver may be able to implement needed operational  changes more promptly than existing management whose prior failure to change may have contributed to the company’s decline. Third, it may be easier for a company’s employees to deal with a receivership than a bankruptcy.

Even if a company has ceased operating, a receiver may be the ideal person to complete the liquidation of assets in an orderly and  cost-effective fashion. A receivership can be beneficial where two or  more owners of a privately held business are engaged in a  life-or-death dispute. The appointment of a receiver can move the  fighting out of the company and into court where there is an orderly process for resolving disputes.

Once the receiver is in place, other parties have no control over the business other than through the court. Company personnel continue to  operate the business under the direction of the receiver. An added  feature of the new statute is an automatic stay of actions against the  debtor and its properties, which expires 60 days after the appointment.

A receivership often is triggered when a secured creditor believes the value of its collateral has been impaired and that management either  cannot or will not protect the lender from continuing losses. Typically, the creditor then petitions the superior court to take control of the  business and appoint a qualified, independent person to manage the  business for the benefit of all interested parties. Courts exercise  caution in appointing a receiver and the party seeking appointment of a receiver will need to clearly demonstrate an interest in assets and that the appointment of a receiver is necessary to “secure ample justice to the parties.”

The statute sets forth the grounds and circumstances for appointment of a receiver, either a general receiver or a custodial receiver. The general receiver is analogous to a bankruptcy trustee, controlling all the assets and operating the business with the intent to either sell it as a going concern or liquidate the assets. Successful examples during the past year include a raceway park in Spokane and liquidation of a rail products company in King County.

A company can now voluntarily assign its assets for the benefit of creditors. Once the assignment is filed with the court, it converts an assignment for benefit of creditors (ABC) proceeding into a general receivership.

A custodial receiver only takes possession of a designated asset and operates and/or sells it – a remedy not available in bankruptcy. A prime example is a receivership appointment made solely to collect rents during the pendency of a foreclosure. Custodial receivers also operate free of many of the requirements imposed on a general receiver and have been used in the past year in Washington to sell hotels and small businesses, manage distressed real estate and liquidate farm crops.

Requirements for a Successful Receivership
Receiverships, which are ancillary to another proceeding such as an action for foreclosure or corporate dissolution, generally are more  successful when undertaken with the consent of the key parties,  including the primary lenders and a majority of the owners or  shareholders. The parties need to find an independent, capable  businessperson who is available and willing to accept the assignment.  Prior experience in the industry may be helpful, but is not critical. Management expertise and good communication skills together with  turnaround management experience and a healthy dose of common  sense are, however, essential.

Another requirement is the cooperation of remaining management and employees. The receiver will need to reassure the workers about continuation of the company and, in some cases, may seek court  approval to provide incentives for key employees and/or management (a step that is increasingly problematic under the BAPCPA).

Finally, the receiver must have adequate support, including in-house staff and outside professionals. The receiver’s counsel and  accountants should understand the receivership process and work  closely with the receiver to accomplish objectives.

Receiverships generally have fewer procedural rules and statutory regulations than bankruptcies. The statute specifies a number of  duties, including preparation of schedules of assets and liabilities,  notice to various parties and reporting requirements. In addition, the  appointment order may include case specific duties, authority and responsibilities of the receiver.

The receiver is a fiduciary whose primary duty is to the court. The statute clarifies that, at least with a general receivership, a sale of  assets can be free and clear of liens and other interests, similar to a  bankruptcy. The receiver disburses proceeds to the creditors  according to the priority of their interests, which priorities are now  specified in the statute. At the end of the receivership, the receiver files  a final report summarizing the receivership’s operation and total receipts and disbursements. Upon approval of the final report by the  court and evidence of payment of all administrative costs, the  receivership will be dismissed and the receiver’s bond exonerated.

Some creditors still prefer bankruptcy, believing that it operates under a more well-developed body of federal law, thus lending predictability  to the process. But with continued experience under the new  receivership statute, creditors may eventually become more  comfortable with the receivership process.

Such experience also could reduce efforts by owner/managers who, when faced with a receivership, want to retain control by threatening to  place the company into bankruptcy. Several would-be receiverships  in Washington during the past year have ended abruptly when a  bankruptcy filing was initiated, either by the owner/managers,  involuntary petitioners or, in one case, the receiver himself.

In a recent decision, Sherwood Partners Inc. v. Lycos, Inc.,2 the Ninth Circuit Court of Appeals held that federal bankruptcy law preempted  California’s statute governing preference recoveries by a voluntary  assignee for the benefit of creditors. Some commentators have  suggested that the Sherwood decision raises doubts about whether receivership actions can co-exist with the Bankruptcy Code, given that  receivership law parallels many provisions in the Code.3 It is  anticipated that there may be challenges inWashington and elsewhere  to a receivership scheme that mimics or attempts to supplant remedies in the Bankruptcy Code.

In the interim, receiverships are increasingly touted as a viable alternative to Chapter 11 filings in these post-BAPCPA times. They continue to offer a flexible, cost-effective alternative to bankruptcy as a method for liquidating the assets of a small or medium-sized business.

Diana Carey is a shareholder in the Bankruptcy and Creditors Rights Group at Karr Tuttle Campbell. She can be reached at  moc.elttutrraknull@yeracd or 206-224-8066.

1 RCW ch. 7.60.
2 394 F.3d 1198 (9th Cir. 2005), cert. denied, 2005 U.S. Lexis 7186 (2005).
3 See, e.g., Crabbe, D., Preemption and the Bankruptcy Code, ABI Journal, June 2005, p. 24.