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Law360 (April 16, 2020, 4:16 PM EDT) --
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| Steven Mroczkowski |
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| Mark Silverman |
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| Jonathan Aberman |
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| Edward Weil |
Notwithstanding that lenders and governments are attempting to mitigate the crisis's effects,[1] loan defaults are anticipated to be increasing, and accordingly, so will loan enforcement lawsuits.
In lawsuits stemming from the COVID-19 crisis, where the default was caused by more than just a lack of money — fraud, mismanagement, neglect, waste, misconduct — litigants, and the courts, may increasingly turn to equity receivers to help protect collateral and manage struggling businesses.
Equity Receivership Framework in Illinois
Illinois already has a framework in place for equity receiverships. However, two distinctions need to be made at the outset.
First, an equity receiver is not the same as a receiver for real property. A real property receiver manages real property subject to litigation (often a foreclosure proceeding), is often agreed-to in advance in loan documents, and has statutory authority as outlined in the Illinois Mortgage Foreclosure Law.
Second, just because there is a default on a commercial loan does not mean that an equity receiver can be appointed. Other extenuating circumstances (outlined below) are required as the appointment of an equity receiver is considered a drastic remedy.
Illinois trial courts have the discretion to appoint equity receivers. Early case law established that doing so can enable the court to accomplish justice among the parties by preserving property or assets subject to the litigation for the benefit of all stakeholders. A plaintiff seeking appointment of an equity receiver needs to show a right to the property over which the receiver will preside and that the property was, broadly speaking, obtained by fraud, or, is in danger of loss from neglect, waste, misconduct or insolvency.
Equity receivers are not mere conduits through which a lender can impose its will. Court-appointed receivers are officers of the court and represent all parties in interest. The receiver is bound by court orders and cannot exercise discretion on a whim.
An equity receiver's purpose is to protect, preserve, and maximize the value of the business. That can occur in several ways, including taking over management of a distressed business, selling certain assets and analyzing operations.
The court has the discretion to enter appropriate orders that guide a receiver's conduct and hopefully dictate more favorable results for all parties. Moreover, if appointed early, an equity receiver can quickly replace existing poor management, analyze internal and often opaque operating and management issues that are harming the debtor, and hopefully provide guidance that saves operations, money and jobs.
The Equity Argument
Even though equity receivers are historically rare in Illinois, the COVID-19 crisis coupled with equity courts' ability to craft fair, just and equitable results may start to change that. Courts acting in equity arguably should appoint equity receivers with more frequency. They can help manage a distressed company, protect lenders' collateral, and help ensure accurate, complete, and honest operation of the company — all of which have the potential to yield better long-term results for lenders, borrowers, other stakeholders and the economy at large.
Courts might be persuaded to see equity receivers as an integral part of the solution to the financial distress caused by the COVID-19 crisis, especially in the face of an immediate demand for efficient and available alternative solutions to distressed situations.
Judges can help parties tailor equity receiverships to suit the case before them. Specifically, with the assistance of guidance from lender's counsel (and likely over the objection of borrower's counsel), judges can set out reporting procedures, rules, mechanisms, checks and balances, and other requirements that will help the court manage the receivership and allow the parties in interest comfort that the business continues to function and/or that collateral is preserved.
Need Help? Look to Your Neighbor
When courts and litigants need guidance, they can look no further than Federal Rule of Civil Procedure 66. In addition, courts and litigants can look to other jurisdictions to see how equity receivers are appointed, how they function, and how they can help the parties achieve better litigation outcomes than a zero-sum trial or a bankruptcy.
Federal courts can appoint equity receivers under Federal Rule of Civil Procedure 66 and have been doing so for quite some time. Other states allow equity receiver appointments[2] (1) to aid in post-judgment proceedings where the property identified is subject to the judgment; (2) to assist in the disposition of trust assets; (3) to assist in mismanaged or distressed business situations; and (4) as an alternative to bankruptcy (Illinois courts can use this analog where property or assets are dissipating due to insolvency).
To name a few, Minnesota, Wisconsin, Michigan, Texas, Colorado and California all have statutory frameworks providing, at a minimum, that equity receivers are an available tool for litigants and trial courts.[3] What's more, even where circumstances do not fit a statutory list that says when a receiver can be appointed, some states — California for example — allow for the appointment of equity receivers where doing so has historically been done by courts sitting in equity. As you can imagine, this provides trial courts a significant amount of discretion.
Even though Illinois does not have a statute that specifically governs general equity receiverships, states that do often have the equity catch-all that allows wide trial court discretion in appointment and oversight. The analogy is strong and Illinois courts can use it to support appointment.
Potential Challenges
Unlike in bankruptcy court, in a nonbankruptcy matter where a receiver is appointed, no automatic stay is imposed against creditor actions. However, this potential harm is mitigated by the fact that an equity receiver can be appointed and can function more efficiently, and often it is the case that there is no large creditor body storming the castle that would increase the need for a stay.
Additionally, there may be greater successor liability concerns resulting from nonbankruptcy proceedings. However, under certain circumstances (and under certain state laws), if notice provisions are observed, receivers may be authorized to sell assets free and clear of liens, claims, and encumbrances — giving at least some comfort to purchasers buying assets out of a nonbankruptcy insolvency proceeding that they may be able to avoid successor liability. Moreover, if an asset sale is to take place, the trial court can set forth an order outlining procedures for the sale, and in all likelihood, will have to approve the sale after it takes place. An aggrieved creditor, purchaser, or interested party can intervene in the litigation on a limited basis if it feels the need.
Ultimately, the appointment of an equity receiver might not stave off a bankruptcy filing by a distressed borrower. With the threat of an equity receivership looming, or even after a receiver is appointed, a debtor can still seek bankruptcy protection. If this happens, however, creditors can seek to (1) keep the current equity receiver in place rather than allow the debtor to be in possession; or (2) in extreme cases, appoint a Chapter 11 trustee. However, the expense of a bankruptcy to a debtor (and the potential inability to use a lender's cash collateral over the lender's objection) may dissuade a debtor from filing bankruptcy and prompt it to take its chances with an equity receiver.
Conclusion
Debtors and creditors are going to be deeply affected by the COVID-19 crisis and the rapidly evolving and changing financial landscape it has and will continue to cause. Courts, specifically trial courts sitting in equity, are uniquely positioned to partly dictate the narrative of how businesses recover. Equity receiverships are not a silver bullet, but they can help all stakeholders.
Steven Mroczkowski is senior counsel, and Mark Silverman, Jonathan Aberman and Edward Weil are members at Dykema Gossett PLLC.
Gary Segal, Katie Welch and Dawn Peacock contributed to this article.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] Lenders are being encouraged, and in some cases may be mandated, to enter into 60 or 90-day forbearance agreements with commercial borrowers. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), provides additional temporary relief to small business borrowers in the form of forgivable SBA loans, payroll tax relief, and (relevant here) opens the door to allow more businesses to benefit from relaxed plan confirmation requirements in a Chapter 11 reorganization.
[2] This list is for illustrative purposes and is by no means exhaustive.
[3] Minn. Stat. § 576.25, Subd. 4 and § 576.25, Subd. 6; Wis. Stat. Ann. §128.08 and §128.001; MCR 2.622; Tex. Civ. Prac. & Rem. Code § 64.01; C.R.C.P 66(a)(3); Cal. Civ. Proc. Code § 564(b)(6), § 564(b)(9).
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