10.11 Interplay of Receivership Law with the Bankruptcy Code

• Library: Enforcement of Liens and Judgments in Virginia (Virginia CLE) (2019 Ed.)

10.11 INTERPLAY OF RECEIVERSHIP LAW WITH THE BANKRUPTCY CODE

10.1101 Receiver's Role When the Entity Files for Bankruptcy Protection.

A. Termination. A "custodian" as defined under section 101(11) of the Bankruptcy Code includes state court-appointed receivers. At the moment of the bankruptcy filing, section 543(a) of the Bankruptcy Code requires the receiver to refrain from further administration of the debtor's property except "as is necessary to preserve such property." ¹⁸⁸ For example, a post-petition payment by the receiver for real estate taxes was proper under section 543(a) because it was necessary to preserve the debtor's estate. ¹⁸⁹

B. Receivers and Bankruptcy Trustees. A receiver is "a disinterested person or organization that the court appoints to safeguard property that is the subject of diverse claims." ¹⁹⁰ A bankruptcy trustee is appointed by the United States Trustee to become the representative of the bankruptcy estate and has a fiduciary obligation to all parties with interests in the bankruptcy estate. ¹⁹¹

C. Curtailment of the Receiver's Powers. Under section 543(b) of the Bankruptcy Code, the receiver must turn over the corporation's property to the bankruptcy trustee and account for the property that was in the receiver's possession. Section 543(d), however, permits the bankruptcy court to ignore the requirements of sections 543(a) and (b) when, for example, it is in the best interest of

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the creditors and if the debtor is not insolvent. ¹⁹² If the receiver stays in place after the bankruptcy filing, the receiver must continue to act consistently with the orders of the state court. ¹⁹³ But the bankruptcy court has the power to rescind, amend, or complement the receiver's duties pursuant to the state court's orders. ¹⁹⁴

D. Review of the Receiver's Conduct by the Bankruptcy Court. Under section 543(c), the bankruptcy court may review the receiver's pre-petition administration of the estate and its compliance with the state court order that granted the receiver's powers. The justification for the bankruptcy court's intervention in state court matters is that the receiver made pre-petition decisions affecting the property that ultimately becomes part of the bankruptcy estate. ¹⁹⁵ However, a bankruptcy court is not given unfettered power to investigate the receiver's conduct, and the receiver is not liable for actions that the state court ordered. ¹⁹⁶

10.1102 Involuntary Filing Considerations.

A. Forcing the Corporation into Bankruptcy. Section 303 of the Bankruptcy Code contains numerous prerequisites for forcing an entity into involuntary bankruptcy. For example, if the entity has 12 or more creditors, at least three such creditors with claims aggregating a minimum amount must join in the involuntary petition. Assuming that these preliminary criteria are met, section 303(h) provides two mechanisms for having a debtor forced into bankruptcy protection.

1. Insolvency: Inability to Pay Debts as They Become Due. The first trigger for forcing a corporation into involuntary bankruptcy is when the entity is not paying its debts as they come due. ¹⁹⁷ The burden of proof is on the petitioning creditors. ¹⁹⁸ Claims in a bona fide dispute are excluded from the calculation of debts. ¹⁹⁹ Nevertheless, a claim is subject to a bona fide dispute for purposes of section 303 if there is a genuine meritorious and existing defense that

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bears upon the debtor's liability to the petitioning creditor's claim. ²⁰⁰ The creditor has the burden of proving that the liability is not in bona fide dispute. ²⁰¹

2. Appointment of a Custodian. The second mechanism for forcing an entity into involuntary bankruptcy protection is when a custodian has been appointed to oversee or take possession of the entity's assets within 120 days before the entry of the order of relief. ²⁰² In other words, if the debtor's assets are being subjected to a liquidation or reorganization without the protection of the Bankruptcy Code, the creditors have the right to trump state law and seek the protection and benefits of the Bankruptcy Code. ²⁰³ This definition of a "custodian" is narrower than that under section 101(11) because section 303(h)(2) applies only to custodians that have control over substantially all of the debtor's property. ²⁰⁴ While this may seem to be a trivial distinction, liquidators of personal property are not custodians within the parameters of section 303(h)(2). ²⁰⁵

B. Risks to the Creditor of Filing an Involuntary Bankruptcy Petition. An attempt to place an entity into involuntary bankruptcy is not without its risks. Not only must the creditors post a bond pursuant to section 303(e), but the creditors face the risk of having to pay the debtor's costs and damages—and possibly punitive damages—if the court dismisses the involuntary petition. ²⁰⁶ In seeking state court receivership, other than complying with pleading rules, a creditor is not subject to any statutory damages provisions for an unsuccessful effort to have a receiver appointed.

C. Abstention. Pursuant to section...