Equitable Receivership as an Alternative to Bankruptcy
| Publication year | 2011 |
| Pages | 41 |
2011, December, Pg. 41. Equitable Receivership as an Alternative to Bankruptcy
December 2011
Vol. 40, No. 12 [Page41]
The Civil Litigator articles address issues of importance and interest to litigators and trial lawyers practicing in Colorado courts. The Civil Litigator is published six times a year.
Coordinating Editor
Timothy Reynolds, Boulder, of Holme Roberts and Owen, LLP-(303) 417-8510, timothy.reynolds@hro.com
An equitable receivership may provide better relief for investors in or creditors of a troubled company than a bankruptcy reorganization. Receiverships immediately replace management, are more flexible, and can be more closely tailored to the situation.
"If the only tool you have is a hammer, you treat every problem like a nail."
-Abraham Maslow
When a company gets in financial trouble, the immediate reaction of many creditors and investors is to seek to put it into bankruptcy. Although this approach sometimes works, many times it makes matters worse. Often, an equitable receivership may be the better course of action. For purposes of this article, an "equitable receivership" is a receivership that is neither: (1) simply care-taking the property during a foreclosure; nor (2) initiated at the request of the government pursuant to statutes or regulations.
There are two primary advantages of an equitable receivership over a bankruptcy. First, a receivership immediately replaces management (with the receiver), whereas a Chapter 11 bankruptcy proceeding tends to entrench management and give it even greater authority as a debtor-in-possession. Where the company would be sound but for management, a receiver often is the better solution. Stated differently, if money is really the problem, bankruptcy may be a good course of action. If money is just a symptom, however, and the actual problem is management, a receivership may be a far superior approach for creditors and investors.
The second advantage of an equitable receivership is that there are virtually no statutes or rules that control a receivership in the manner that the Bankruptcy Code and Rules control a bankruptcy. Therefore, a receivership has much greater flexibility than does a bankruptcy. There is no panel or pool of lawyers from which receivers are selected, allowing a party seeking the appointment of a receiver to select the individual or company best suited to serve as receiver. A receivership judge, in the appointing or subsequent orders, can set out virtually any procedures, rules, or mechanisms that are appropriate under the circumstances. This allows the receivership to be tailored to the circumstances of the case to a much finer degree than a bankruptcy.
Bases for Appointment of an Equitable Receiver
Colorado Rule of Civil Procedure (C.R.C.P. or Rule) 66 provides for appointment of a receiver when the plaintiff "establishes a prima facie right" to property, an interest therein, or that the property (or profits therefrom) are in danger of being lost, injured, or removed from the jurisdiction. It further provides for a receiver at the behest of a judgment creditor or "in other cases where proper and in accordance with the established principles of equity." Federal Rule of Civil Procedure 66 is even simpler, providing for appointment of a receiver in "accord with the historical practice in federal courts or with a local rule."
In either case, appointment is considered an "extraordinary remedy" and usually is done only when there is no adequate remedy at law, or even a less drastic equitable remedy, available.(fn1) A receiver can be appointed for the company itself, or for some or all the assets of the company. The appointment of a receiver creates an estate, similar to a bankruptcy or trust estate.
The test for appointment is simply that, considering all the factors a court sitting in equity should consider, the appointment of a receiver is appropriate to preserve assets in which the plaintiff may have an interest.(fn2) The appointment of a receiver is reviewable on an abuse-of-discretion standard.(fn3)
The circumstances in which a receiver might be a good idea are limitless. There are, however, some recurring situations where an equity receiver is appointed with some regularity. These are discussed below.
Impotent Management of a Business
This situation occurs where management is not being effective and the usual methods of replacement do not work. Following are some examples.
Deadlocked shareholders or partners. In many privately owned companies, the stock (or equity) is owned equally by a small number of people. When this number is even, there is the chance (some would say the certainty) that the shareholders or partners will cease seeing eye-to-eye on how to run the business. Two 50% shareholders or partners whose failure to agree is causing the company injury is an excellent scenario for the appointment of a receiver.(fn4)
Bad management. At times a controlling shareholder may not be doing what is best for the company, but is not really susceptible to a shareholder derivative suit. He or she may be judgment proof or have abandoned his or her role, or perhaps the suit will take too long and significant damage to the company is imminent. The appointment of a receiver may solve these problems.(fn5)
Mistrusted management/limited receivership. A receiver may be appointed for a limited function when there is concern about who really is management. In the Yellow Cab case, the receiver was appointed to supervise the election of management where there was a concern about voting fraud in the election of management. The idea was that the receiver would make sure the election was fair, and it was only after the election process was completed that the parties would know who management truly was.(fn6)
Trusts
As with a business, a trust may give rise to circumstances where the appointment of a receiver is useful. Following are some examples.
Intra-beneficiary dispute. Where there is a dispute among the actual or potential beneficiaries of a trust, the appointment of a receiver may allow the trustee to satisfy his or her duty to distribute or otherwise maintain the status quo until the dispute is resolved.(fn7) It may be preferable to an interpleader action, because the distribution can be invested rather than simply placed in the registry of the court.
Beneficiary/trustee dispute. Where there is a dispute between the beneficiaries and the trustee of a trust, the appointment of a receiver may be in the interest of the beneficiaries, because the trustee often uses the trust corpus to fund the litigation.(fn8) Even if the beneficiaries prevail in such a typical case, the corpus may have been adversely affected in the meantime. If the receiver controls the trust, however, it will be much harder for the trustee to use the corpus to pay for the litigation.
Domestic
Often during a divorce, issues will arise regarding ownership or management of a family business.(fn9) A receiver may be advisable in such a situation to avoid management problems and preserve the business pending a final dissolution and disposition of assets and liabilities.
After Judgment
C.R.C.P. 66(a)(2) expressly provides that a receiver may be appointed after judgment to dispose of the property subject to the judgment. This will ensure that the disposition is handled in a reasonable manner and with a focus on obtaining appropriate value.
Mechanics of Appointment of Equity Receiver
A receivership action is still a court case, and at its beginning resembles most other civil litigation. After the receiver is appointed, however, it proceeds somewhat differently, as described below.
The Complaint and Motion
A receivership action is...
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