Roles, risks and rewards in property receiverships

Left holding the debt of a struggling real estate investment? What US fund managers need to know about entering into receiverships. By Anthony Theophilos of Starr Finley

Anthony Theophilos

Receiverships are making their way back into the real estate lexicon now that an increasing number of US commercial properties – a tidal wave according to many estimates – are going from mere “distress” to loan default and foreclosure.

Investors and fund managers contemplating the purchase of distressed real estate debt secured by a mortgage or deed of trust should understand the circumstances under which the appointment of a receiver is necessary or desirable. Understanding receiverships can put buyers in a better position to understand and more fully capture the asset’s value.

This brief article will explain the basics of receivership, why the prompt appointment of a receiver upon the filing of foreclosure is both prudent and necessary, and offer some practical tips and tactics that will help avoid some commonly made mistakes.

How does it work?
In general terms, a receiver is a neutral third party appointed by the court in a foreclosure action to take control of the property. Most importantly, a receiver is an agent of the court, and not the debt holder. Typically, a particular receiver is requested by the debt holder and then appointed by the court. However, some courts maintain their own list of qualified receivers from which to choose. Interestingly, under many state laws a receiver must be an individual, rather than a corporation.

The current economic crisis has depressed real estate values dramatically. Foresight Analytics estimates that over $800 billion in US commercial property is in significant distress, and will lead to foreclosure in many instances. If the value of a property has fallen significantly below the loan balance, there is usually little incentive for the borrower to pay down the loan to a level acceptable to the holder of the debt and as routinely required by the loan documents.

Furthermore, if the amount required to “rebalance” the loan is too large, the borrower often simply abandons the property. In that increasingly common case, once foreclosure begins the borrower will stop servicing the debt, stop paying property taxes, stop paying the cost of maintenance and insurance, but continue to collect rents for its own account. In fact, institutional borrowers often have less motivation than private borrowers in changing the property’s status quo. Although some loan documents carve out personal liability for the borrower when it fails to pay the bills and attempts to pocket the rents, not all do, particularly if the borrower is an institutional owner.

Court orders that appoint receivers
A properly drafted court order appointing a receiver will specify the receiver’s authority, which should include the right to collect the rents, maintain the property, pay the bills and hold excess cash flow pending completion of the foreclosure action or reinstatement of the debt (as is permitted under most state laws) or repayment of the note. The court then turns the funds held by the receiver to the debt holder or the borrower, as the case may be. In today’s reality, it is usually the lender who receives the funds held by the receiver and gains title to the property.

Equally important to the debt holder, a receiver protects it from liability as a “mortgagee in possession”.  A mortgagee in possession is a debt holder that has taken over the management and maintenance of a property (even if pursuant to the terms of the loan documents), acting in most respects like an owner. By doing so, the debt holder becomes liable to third parties as an owner for any liability arising in connection with the property, including liability for environmental problems and, under certain circumstances, liable to the borrower as well.

Tips, tactics and avoiding liability
The decision to seek the appointment of a receiver in order to take control of the property and the cash flow from the borrower without exposing itself to liability as a mortgagee in possession should be made contemporaneously with the filing of the foreclosure action. There are a number of tips and tactics that will help a debt holder navigate this minefield.

  • Don’t blow the basics: Whether the receiver is the one requested by the debt holder or selected by the court, there are three considerations that are of foremost importance. First, the receiver should have experience managing the type of property in question and move quickly to stabilise the property. Second, the receiver should have an appropriately staffed back office to provide the necessary bookkeeping and financial accounting to the court and the debt holder. In addition, the receiver should have proven resources and relationships in order to engage the services typically needed in owning a property, such as leasing agents, property managers, locksmiths, security personnel and the like.
  • Avoid liability and over bonding: A bond is typically required in connection with the appointment of a receiver and until it is issued, the receiver has no authority to act. The bond is not issued to protect the debt holder, but to protect the court and the receiver from liability. Debt holders, under the mistaken impression that they are protecting themselves, often request or otherwise agree to a bond in a significant amount, with a large and unnecessary premium. There is generally no need for the amount of the bond to exceed one month’s cash flow.
  • Receivers need room: The authority granted to the receiver should be as broad as possible, since the receiver can only perform duties for which it has been granted authority pursuant to the court order appointing the receiver. For example, it is important to give the receiver the authority to amend leases, enter into new leases and to engage property managers and attorneys when needed. Further, it is always helpful to give the receiver the express authority to sue the borrower to recover security deposits and tenant files. In some situations where cash flow is insufficient to pay the expenses of owning and maintaining the property, the receiver should have the authority to borrow the necessary funds from the debt holder as a protective advance under the mortgage or deed of trust.
  • Receiverless redress: If there is any doubt whether the court will grant the appointment of a receiver, it is important to be prepared with a backup plan. If the request for a receiver is denied, there are two alternatives to consider presenting to the court. First, if the court is reluctant to allow a complete takeover of the property, it may nonetheless be willing to allow a “limited purpose” receiver in which the authority of the receiver is curtailed. For example, the note holder could request a receiver solely to audit the financial records relating to the property. The second alternative which is often overlooked is to request a protective order in which the borrower is ordered to collect the cash flow, pay the bills and to provide to the court regular financial statement delivered under penalty of perjury.
  • Oft overlooked-property tax appeals: In most cases, the receiver should immediately appeal the property tax assessment, but this tactic is often overlooked. Assuming the debt has been purchased for significantly less than the outstanding principal balance, a good argument can be made that the value of the property has fallen enough to justify a reassessment for the tax year in which the receiver was appointed.

The appointment of a receiver is a critical tool for the holder of distressed real estate debt. However, care must be taken to insure that the proposed receiver has the appropriate background, staff and industry relationships to competently manage the type of property facing foreclosure. Also, it is important to give the receiver the specific authority to do what needs to be done and to cause the bond to be delivered as soon as possible. Finally, before the hearing to appoint a receiver, the investor should be ready with a backup alternative ready in the event the court denies the appointment for any reason. With these factors in mind, an investor in distressed real estate debt is positioned to maximise its recovery.

Anthony Theophilos is an attorney with San Francisco based Starr Finley LLP, an active real estate investor and developer, and an experienced Receiver of assets ranging from commercial and multi-family properties to operating companies. He can be reached at