By: Gregg Davis, Mark Weibel and Steve Schoettmer
Thompson & Knight, LLC.
Commercial real property receiverships have received tremendous interest, discussion and comment in the current economic cycle.
The Fall ’11 issue of Commercial Insight featured “Public and Private Sales of Real Property by Federal Court Receivers,” by John C. Murray and Kenneth R. Jannen of First American Title. That article provides a very good background and overview of several advantages and reasons to use receivers to resolve distressed or defaulted loans, focusing on federal court receivers and defaulted commercial mortgage-backed securities (“CMBS”) loans. It also set out the jurisdictional and statutory basis, and example forms, for appointment of a federal receiver and sale of property.
This article will focus on a few current topics and recurring themes from recent workouts and litigation involving receivership appointments, to illustrate some of the advantages of and reasons to use receivers. To provide a variety of perspectives, Mark Weibel, Steve Schoettmer, and Gregg Davis discuss and respond to frequently asked questions, based on their experiences in cases involving commercial real property receivers.
Question 1: Lenders sometimes move very quickly to seek receivers. Why is that?
MW. Often, to get control of the cash flow -- cash is the most important issue -- and to get the management of the property out of the hands of the borrower as soon as possible. That’s especially important if the lender is concerned that the borrower may be withholding or misappropriating cash flow from the property.
SS. If the borrower files bankruptcy after a receiver is appointed, the cash collateral will usually continue to be collected by the receiver, rather than being controlled by the borrower. If a receiver is not in place when bankruptcy is filed, the lender can certainly seek a cash collateral order to limit the borrower’s use of cash, but the lender is in a much stronger position if the cash belongs to the receiver rather than the borrower, before the bankruptcy is filed.
As the lender’s trial lawyer, I also want to stop a borrower from using the lender’s cash collateral to pay borrower’s counsel to try to hang on to property after a default.
GD. If a hard lockbox is in place to capture cash flow, or if the borrower is cooperating with the lender and providing timely and detailed cash flow reports showing the cash flow is not leaking or being misappropriated, then the need for a receiver becomes less immediate. But there are still other, longer term advantages of a receiver.
Question 2: What are some other advantages of a receiver?
GD. A sale of the property with a CMBS loan modification and assumption can generate huge value for the lender, that otherwise would be lost. If a defaulted CMBS loan is foreclosed, the lender incurs a “locked in” loss that cannot be reduced through a new loan or seller financing when the lender re-sells the foreclosed property. But if there is a receiver the locked in loss can be deferred or avoided. Subject to court approval, the lender and receiver can work together to simultaneously close a receiver’s sale of the property to a new owner, and a modification of the defaulted loan, resulting in the new owner assuming a modified loan and the lender obtaining a significantly greater recovery than if the lender foreclosed. We’ll discuss an example of that later, on an Arizona property.
MW. Also, it is easier for the lender to trust the project revenue figures because they are prepared by the receiver as an independent third party, rather than the borrower.
Question 3: Are certain types of property more suited to receiverships than others?
GD. Generally, the more day to day operation is required at a property, the more appropriate a receiver will be. Hotels often make good receiver candidates. Guests arrive and depart daily, and restaurants and liquor sales and licenses require specialized attention. Often, the hotel’s franchise agreement with its franchisor (the “flag” or brand) is in default. The borrower’s failure to perform deferred maintenance to keep the condition of the hotel up to the flag standard is a common problem, and can give the franchisor a right to leave the property. Everyone, particularly the lender if the loan is nonrecourse, has a real problem if the hotel is left without a “flag” to market and accept reservations for the property. A receiver is in a position to negotiate with the franchisor to keep the flag in place while a new purchaser is identified and, if necessary, while interim improvements are made. Even if a flag change is ultimately required, a receiver often is in a better position than the borrower and the lender to at least keep the existing flag in place on a temporary basis, until new ownership and a new franchisor can be identified.
Question 4: Are receiver appointments usually contested?
SS. I hate to say it, but “it depends” really is the answer. In my experience, there usually is not a serious disagreement over whether a default has occurred and the lender is entitled to a receiver under the loan documents. In the rare cases where those truly are open questions, then the receiver’s appointment is likely to be contested, the parties will have a chance to argue, and the court will decide whether to appoint a receiver. But in many situations, the borrower and lender are able to negotiate an agreed receivership.
Some borrowers will contest a receivership in order to try to gain a negotiating advantage. However, CMBS loans often provide for full recourse liability of the guarantor if the borrower opposes the lender’s request for a remedy (like appointment of a receiver) that is set out in the loan documents. In those situations, or if the borrower knows it is in default and wants to limit the battles it fights with the lender, an agreed receivership can be negotiated.
Question 5: Are receivers ever appointed over the objection of a borrower? If so, are properties ever sold over the objection of a borrower?
MW. Although we like to gain the borrower’s cooperation by explaining the benefits to everyone (including the borrower) if a receiver is controlling the property, a receiver can be appointed over a borrower’s objection. We had a case like that in Arizona. The outstanding debt on a portfolio of seven (7) multifamily properties was about $164 million. Everyone agreed that the property was worth less than the debt, so the borrower had no equity in the property. The guarantor, who later took control of the borrower, was essentially trying to force the lender to modify and reinstate the loan with a reduced principal balance of $82 million. That 50% write-down would have locked in a loss of more than $82 million for the CMBS lender. At the outset, the borrower simply stopped operating the project, leaving no management in place and causing numerous mechanics liens to begin getting recorded against the project. Although securing a receiver in Arizona is unique, we argued that, not only was a receiver appropriate, the receiver was necessary for several reasons. A receiver could address immediate life-safety issues (like payment of utilities), provide a way for the lender to stabilize the property without incurring lender liability risk, and act as a third party reporting on the current condition and cash flow of the project. Ultimately, the court agreed to appoint a receiver. We thought that was the right decision all along, but Steve can pick up the story from there.
SS. Property can be sold by a receiver, even if a borrower objects. In the Arizona case Mark mentioned, the receiver was able to work with the lender, obtain multiple offers for the property, and ultimately identify a purchaser willing to purchase the property for $133 million, which was about $50 million more than the borrower was willing to offer. And the purchaser’s offer included $10 million of new cash equity, which would not have been available if the borrower retained ownership of the property. Because of all those advantages, the lender was willing to restructure the loan to fit the new purchaser’s plans to reposition and hold the property, to give values an opportunity to recover, and put everyone in a much better position than if the borrower retained ownership or if the lender simply foreclosed.