Recent headlines regarding conservatorships, highlighting their negative consequences which can include overbearing administrators flexing too much power over long periods of time at high expense, can unjustifiably cloud the public perception of a similar process – receiverships. But such a rush to judgment would be a misstep when a receivership is tactfully deployed, in circumstances such as insolvency or other mismanagement. Here are six reasons why establishing a Rule 66 receivership can be a creative tool to achieve a best-case goal.
1. Attain More Claims
This requires an example, which we will call the “Three Party Case.” In a recent case in Colorado, the problem confronting a real estate developer was that while its insolvent and near defunct client was cooperative and suffered damages due to the acts of a breaching third party, the developer did not have privity of contract directly with the breaching third party, that privity being necessary to support contract-based claims such as breach of contract. With the client’s poor state of affairs, the client did not have the will or means to pursue the breaching third party either. In essence, the third party unlawfully breached a critical contract with the client, causing the client to fold and terminate the real estate development, leaving the real estate developer to sort out a plan to pursue relief.
For the real estate developer to increase its chances of recovery against the breaching third party, the real estate developer needed a breach of contract claim directly against the breaching third party, which meant the real estate developer had to strategically find a way to “stand in the shoes” of the client, who no longer had officers or employees, had no other known creditors, and was effectively dissolved. Since the client was friendly and accepting of its insolvent circumstances, pursuing a default judgment against the client with an order installing a receivership over the client, for the receiver to then pursue the client’s claims against the breaching third party became the answer. The endgame was to have the client win or settle its breach of contract claim, the client bringing in money that the receiver would then distribute to the developer. The developer de facto attained more claims, all because of a strategically placed receiver.
2. Cost Effective Alternative
In the Three Party Case, placing the client into federal bankruptcy was not the answer, because a bankruptcy stood to take too long, cost too much, have too many costly and regular reporting requirements, and have too many parties involved (e.g., a trustee, an actively involved judiciary). Further, the client was a non-profit, which per 11 U.S.C. § 303(a) cannot generally be placed into involuntary bankruptcy. This is where the receivership, with no costly monthly operating report requirement, no regular fee application requirement, and more manageable receivership fees versus U.S. Trustee fees, presented a significant financial advantage. The real estate developer could prearrange fees and reporting requirements, with the court’s blessing, creating a budgeted, efficient process.
Another notable positive attribute of a Colorado state court receivership of a business, versus pursuing federal bankruptcy, is more flexibility in dictating the scope and process of the receivership, which contributes to the additional advantage of control over cost. Additionally, narrowing and refining the scope of the receivership orders artfully reigns in the control and power of the receiver and interested parties. Still, to the outside observer, even an efficiently run receivership can appear to be a broadly extending hydra, with its reach into every aspect and issue of the business, which can seem administratively cumbersome.
That does not have to be the case, though. To the contrary, and by the open design of Rule 66, a strategically planned receivership with narrowly tailored orders intended for specific tasks, can add a relatively inexpensive tool to a creditor’s belt. Using the Three Party Case, to further create value-added efficiency, having the receiver share counsel with the real estate developer was important, because then the receiver could prosecute the subsequent suit against the breaching third party with counsel loaded with ready-to-go institutional knowledge. But conflicts could arise if other creditors sought relief against the receivership, because the receiver and the developer’s counsel could not “split” duties, seeking a pot of money that could ultimately be divided then amongst multiple parties with conflicting interests.
The answer to this involved a thorough front-end investigation to determine that there very likely were no other creditors, obtaining affidavits from former client officers that there were no other creditors, and designing a portion of the receivership orders that allowed the receiver to first investigate this, and then hire the developer’s counsel if the receiver reasonably determined there were no other creditors, while also having orders that extended privilege among the collective of the receiver, the developer, and the counsel for then the developer and the receiver. This well-crafted plan set the stage to cost-effectively pursue the at-fault breaching third party, now further armed with a breach of contract claim alleged by the receivership/defunct client against the wrongdoing third party. Tools of this nature are highly unlikely to be found in the Bankruptcy Code or pass muster with the U.S. Trustee or a Federal bankruptcy judge, both of which are bound to adhere to the Bankruptcy Code.
4. You Cannot Force or File Federal Bankruptcy
We are in Colorado, so we are familiar with the fact there is and has been an industry here that our federal laws do not allow. As we learned from In re Way to Grow, Inc.1, industries with even indirect business relationships to cannabis companies cannot file federal bankruptcy. But the holding of Way to Grow does not preclude creditors of cannabis-related companies or cannabis-related companies themselves from filing Rule 66 receiverships to administer assets and debts, distributing value in the order of priority, and obtaining something akin to discharge orders.
5. Discharge Orders
Finality, by way of ordered releases and discharge orders, is a key sought after component that one can obtain in a receivership, generally the same as in a bankruptcy. The one caveat to this is there can be challenges to a Colorado state court discharge order, or any other order in the receivership, extending to bind out-of-state parties and courts. That said, doctrines and legal concepts such as the Barton doctrine, full faith and credit, and comity may allow orders to apply broadly to parties, or receivers to seek assets in other states.2 For example, in Wright v. Philips3, a case decided by the
California Court of Appeals, the court stated that:
“Receivers appointed under a jurisdiction other than that of the state forum may be permitted to sue in a stranger state as a matter of comity only. That this privilege of comity will be extended, wherever the rights of local or domestic creditors are not prejudiced, is now the general rule in the United States.”
Colorado courts, similarly, have recognized such comity, and the limits of it.4 Ultimately, while there is law providing leverage against out-of-state creditors and parties, the best laid scheme is to investigate the existence, nature, and extent of any out-of-state creditors, assets, and claims before electing to proceed with a Rule 66 receivership, to weigh the advantages/disadvantages, and perhaps more appropriate venue.
6. Adding Value and Preventing Loss
Just as in the Three Party Case, where the client had neither the means nor drive to prosecute the client’s claims, letting those claims potentially melt away, a receivership can allow a creditor to add value, where others do not care, do not see value, or are not protecting assets. Intangible or intellectual property do not stand out immediately to all as being valuable, but placed in the hands of a competent receiver with investment banker contacts and creditors angling to extract what they can, a receiver can obtain much more value beyond that seen by the debtor’s abandoning officers and owners. Akin to that, officers and owners of insolvent companies may seek to have value leave out the back door, and a creditor that uses evidence of threats of theft to obtain ex parte orders appointing a receiver can swiftly and tactfully protect collateral’s value.
The maxim that possession is nine-tenths of the law has its merits. Rule 66 receiverships allow creditors and claimants to possess, figuratively, a nimble, creative avenue to collect, assert claims, and close tumultuous matters, and possess, precisely, assets of a counterparty to achieve those goals. When the route to relief appears unclear, a state receivership may be the less traveled device to achieve the creditor client’s objectives.
- In re Way to Grow, Inc., 597 B.R. 111 (Bankr. D. Colo. 2018).
- Herstam v. Bd. of Directors of Silvercreek Water & Sanitation Dist., 895 P.2d 1131, 1134 (Colo. App. 1995) (citing U.S. Const. art. IV, § 1).
- Wright v. Phillips, 213 P. 288, 289 (Cal. Ct. App. 1923).
- McCague v. Dodge, 114 P. 648, 650 (Colo. 1911) (though denying the application of comity, finding the receiver failed to state a cause of action in using his NE court orders to control assets located in CO, of a CO corporation).