Receivership - Legal Considerations

Difficult economic times that increase the numbers of troubled properties and foreclosures create opportunities for real estate managers to serve as court-appointed receivers. This role has very specific legal requirements that must be met. In addition, many types of documents have specific legal implications. Not only management agreements, but maintenance contracts, leases, and promotional materials require periodic review by legal counsel to ensure that they provide adequate protections for the management firm within the current business environment.

Lenders seek appointment of a receiver because a loan has been defaulted. The default can be monetary (e.g., nonpayment) or non-monetary (e.g., allowing the property to fall into disrepair). The lender’s petition to the court to appoint a receiver may be concurrent with an action to foreclose—most receiverships will ultimately end in foreclosure (or the debtor agreeing to surrender the deed in lieu of foreclosure). In asking to have an independent party take possession of the property during foreclosure proceedings, the lender’s objectives are to prevent the borrower from using the income from the asset for any purpose other than payment of the loan, or lowering the value of the property in any way (e.g., through neglect), and to halt the deterioration of the property.

Appointment as a receiver requires an awareness of the responsibilities of the role and the attendant issues of liability. Because there is potential for conflict between the lender who is seeking to foreclose the property and the previous owner who has defaulted on the loan, the receiver has to be impartial and prevent the property from being used by either party against the other. The receiver’s primary goal is to conserve the value of the real estate asset until the receivership is dissolved by the court.

While acting as a receiver there are several things a manager can do to minimize potential legal problems. First, and foremost, is to comply with the directives of the judge who is overseeing the case. Also, the manager should have access to his or her own legal counsel, as the manager’s interests may be different than those of either the financial institution or the borrower. To ensure proper conduct of the receivership role, the manager should:

• Fully disclose all negotiations and obtain the necessary approvals, in writing, before taking any action.
• Maintain detailed records of each and every financial transaction during the receivership period.
• Document any differences between the records of account and leases, invoices, etc.
• Make all reports to all parties on a timely basis and in as complete detail as is practical.
• Not let one side or the other sway him or her into making decisions that are not favorable to the property.

The court will likely impose a specified amount of liability insurance that must be carried by the receiver, and that policy must remain in effect during the entire term of the receivership. While the court is not likely to require it, having a substantial errors and omissions (E&O) insurance policy is just good business.

The court order of appointment gives the receiver authority to monitor leases and sign new ones. However, written approval should be obtained from the court before any long-term leases are signed. In addition, a receiver should have the authority to collect all rental income, protect the property and maintain it (at least in its current condition), honor the rights of tenants on the property, and safeguard the health and welfare of occupants and guests. If the receiver is submitting monthly reports to everyone concerned (property owner, lender, the court) stating exactly what actions are being taken, how much money is being collected, and how much is being spent, it will be difficult to challenge the receiver’s actions at a later time.

To protect the appointed receiver and the management company from liability, an attorney should be hired to represent the receiver, and the receiver should be named on all insurance policies covering the property in receivership. If the receiver’s own company will provide management services, this action requires prior approval from the court. Court approval should also be sought for any extraordinary expenses to avoid liability in the event those expenses are contested. Use of a separate service corporation to hire existing on-site employees from the property in receivership is also recommended.

To avoid being held liable as an individual, the receiver should sign no documents pertaining to the receivership other than as the receiver (in all cases, the order of appointment issued by the court should be referenced). A final report should be completed at the end of the receivership period absolving the receiver of any liability pertaining to the property, and the “order of discharge” should reference the final report. While a bond protects the lender and the property owner from any inappropriate actions of the receiver, it does not protect the receiver.

Source: Business Strategies for Real Estate Management Companies, 2nd Edition, by the Institute of Real Estate Management