By Gary Owen Caris and Lesley Anne Hawes
Equity receiverships often involve the administration of real estate assets. While real estate cannot “walk away,” unlike tangible personal property assets and intangible assets not yet frozen in financial institutions, identifying, taking control of and administering real property that is properly considered part of the receivership estate can present unique challenges and a number of issues that need to be considered by a receiver. This article will highlight some of those challenges and issues.
Assessment of Estate’s Real Property Rights and Interests at Case Inception
The first step in any receivership is for the receiver to assess the property rights and interests held by the estate. The receiver’s initial interview with a reasonably cooperative defendant and its initial forensic analysis of accounting and legal records, physical or electronic invoices and paid bills (such as mortgage or real property tax payments) generally yield immediate information to help the receiver identify real property assets that are likely property of the estate. Those records alone though are not definitive and are only the first pieces of the asset puzzle. To complete the picture, the receiver should investigate the identified real properties through title and lien searches and potentially title histories to determine when the current title holder of the real property acquired the property and from whom. Whether title to the real estate is in the name of a named, known receivership entity will not necessarily be determinative of whether the property is receivership property, and the receiver needs to explore through a forensic accounting any financial connection of the receivership estate to real property even if title to that property is held by an individual or entity not named explicitly as a receivership party. The receiver may be able to assert an interest in real property held in the name of another depending on that financial connection, and will have to determine the most effective and appropriate litigation strategy to gain possession and control of that property expeditiously.
One of the first issues the receiver will need to consider is whether protecting the estate’s interests in its real estate assets may warrant recording lis pendenses against those assets. Prior to recording any lis pendens, the receiver will need to investigate the local law of the state in which the real property is located, the grounds available for recording a lis pendens under that law and the applicable procedures and recording requirements of the local county recorder. In some states, such as Massachusetts, it may be necessary to obtain a court order to record a lis pendens. In other states, such as Florida, a lis pendens may have an automatic termination date. In all states, it is important for the receiver to fit its claim to title and/or possession of the real property into the grounds for recording a lis pendens authorized by law in that state so that the lis pendens gives valid notice of the pending action and its impact on the property. Receivers also need to be aware of the risks under state law of wrongfully recording a lis pendens against real property, such as in California where a party who successfully moves to expunge a lis pendens can in some circumstances recover the attorneys’ fees and costs the party incurs in moving to have the lis pendens removed.
The receiver must also immediately assess the extent to which any real property in which the estate claims an interest is located outside the district in which the receivership case is pending. To extend the receivership court’s jurisdiction to real property outside the district in which the case is pending, the receiver will need to file copies of the complaint and appointment order within 10 days in those other districts pursuant to 28 U.S.C. section 754.
The receiver also needs to review the status of title and liens against each real property as soon as possible. The receiver in particular should check the property for any tax lien sale as often real property taxes may be delinquent for multiple years.
A. Physical Inspection and Security
Whether the estate leases the real property or owns it, the first and most important step is the receiver’s physical, visual inspection of the premises. If personnel from the receiver’s office or from the receivership defendant’s business need to remain on the premises to review or copy records, secure property or perform other administrative tasks, it is important for the receiver to look for any signs of potential hazards at the property that could pose a risk to those personnel. Are there any maintenance or repair issues, such as a leaky roof, damage to doors, walls or floors that may result in further deterioration through weather or other forces or make the property vulnerable to security risks? Are there hazardous materials on the property that may require special handling and removal? In recent years with the value of copper skyrocketing, it is common for properties to be vandalized for their copper materials, including pipes and other systems. The visual inspection will also reveal potential points of entry or security issues that should be addressed immediately to protect the premises and preserve the records and assets present there, including alarm codes that may need to be changed and alarm service that needs to be paid for to help maintain the integrity of the premises and the records. Additional fencing or other physical security measures may be necessary to adequately secure the premises. Merely changing locks on the property may not deter the copper thieves, however, so additional physical security and patrols may need to be considered. In certain circumstances, where the property contains valuable assets and it is difficult to adequately secure it by other means, engaging a guard service may be justified for some period of time. See generally Vander Vorste v. Northwestern Nat’l Bank, 81 S. D. 566, 138 N.W. 2d 411 (1965) (receiver personally liable for taking possession of receivership personal property and not properly caring for them resulting in loss or diminution in value of items).
The physical inspection of the property also allows the receiver to ask important questions about the assets located in or on the property, including trying to identify who owns those assets. If the assets located in or on the property are receivership assets, then there are a number of follow up issues for the receiver to consider regarding those personal property assets including:
a. What is their value?
b. Are they perishable or subject to diminishment in value through use, time, market forces, or other factors?
c. Do the assets require special treatment or care? Do they need to be relocated in order for them to receive that treatment or care?
d. Do the assets include hazardous materials or otherwise pose potential health or safety risks?
e. Do the assets require insurance separate from the real property insurance?
f. Are any of the personal property assets subject to leases, and should they be returned to the lessors?
The receiver must also take steps to investigate and confirm insurance coverage for the real property and determine that the insurance coverage is adequate to protect the estate’s interests. See FTC v. Think Achievement Corp., 2007 WL 3286802, at *7 (N.D. Ind. 2007) (question of fact for jury as to whether receiver who failed to obtain insurance for asset damaged post-receivership was negligent) but see Reading Co. v. Brown 391 U.S. 471 (1968) (receiver not liable for property destroyed by fire when receiver could not procure insurance). Most receivers have a blanket insurance policy covering the assets subject to their administration, but that policy may not be enough either in dollar amount or type and scope of coverage to fully protect the receiver, the specific real property asset and the estate. The physical inspection might also reveal damage to the property as to which an insurance claim may exist that requires investigation to determine if (a) a claim has been made that may be an asset for the estate to be administered, or (b) a claim has not been made but should be made as soon as possible to avoid any assertion by the carrier that the claim is untimely.
In addition, the receiver will want to be added to any existing insurance policies of the receivership entities as a “Named Insured” on the policies. Post-receivership, policy premiums are paid by the receiver from funds of the receivership estate. Having the receiver as a named insured facilitates future claims payments and communications with the insurer.
The receiver should also try to obtain complete records from the insurance company regarding the insurance policy, any claims made under the insurance policy and the disposition of those claims. The claims history may disclose valuable information regarding repairs and other work performed on the property or alert the receiver to prior risks or problems associated with the property. See NAFER’s Model Receivership Order, Sections VII.A.26 and IX.F.
C. Zoning/Use Restrictions
Zoning conditions and restrictions or any other legal restrictions or rules applicable to the operation, occupancy or use of the property should also be evaluated. The receiver should not assume the property is in compliance with zoning laws based on its existing use. Though not typical, commercial or residential property may be designated as “historic” and may be subject to extensive restrictions on its use, modification and maintenance.
D. Operation of the Property or the Business and Liability Issues
Section 959(b) of title 28 requires receivers to comply with applicable law in operating a business, including operating real property, on behalf of the estate. While there are a series of decisions that hold a receiver or trustee is not operating a property for purposes of section 959 if the trustee or receiver is liquidating the property, receivers need to be aware of the obligations imposed by this statute and the risks they may be facing if they are operating the property or a business on the property because of the provisions of 28 U.S.C. section 959(a) which obligate the receiver to manage property in accordance with applicable law. When the receiver is “carrying on business” in connection with the receivership property, the receiver may be sued without prior leave of court under section 959(a). These risks should be considered in evaluating the nature and extent of insurance coverage the receivership estate may need, in determining whether the property is adequately secured or may need guards or other special security measures, in reviewing all applicable statutes, regulations, local ordinances and other legal requirements that must be met in order to operate the property or the business in compliance with applicable law and in weighing whether the benefits of operating the business or property are outweighed by the expense of these protective measures and the risks of violation of the law.
The presence of hazardous substances on, in or under real property poses special concerns for a receiver. While amendments to the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), title 42 section 9601 et seq., in 1996 limit the liability of fiduciaries as “potentially responsible parties,” neither that statute nor section 959(b) prevents liability from being imposed against the receivership estate for acts taken if the receiver actually operates the real property or the receivership entity’s business on the real property in a manner that violates applicable environmental laws. See In re Sundance Corp., 149 B.R. 641 (Bankr. E.D. Wash. 1993) (state court receiver in foreclosure action in which summary judgment was denied on claims against receiver for environmental clean up costs and claims dismissed where receiver was not negligent and did not act willfully and record was insufficient to determine if acts were outside receiver’s reasonable judgment). The NAFER Model Order proposes to expressly limit the receiver’s potential liability for properties contaminated with hazardous substances and confirm that the receiver is acting solely in its “fiduciary capacity” in in administering the property in receivership. See NAFER Model Order, Section XII.C. The receiver’s document review may disclose prior Phase I environmental reports for the property. Paints, cleaning solutions, fertilizers and other common materials may require special handling, removal and disposal in order for the receiver to properly comply with applicable environmental laws and for practical reasons, including in order to prepare the property for sale or transfer to a third party.
E. Interest in Entity that Owns the Property
Sometimes the interest held by the estate is not a direct interest in the property itself but instead an interest in the entity that owns the property. Such a personal property interest in the entity may nevertheless require the receiver to assess the underlying real property assets held by that entity, whether the estate’s interest is a majority interest, such that the receiver may potentially control the entity and its assets, or a minority interest, where the receiver may not be able to control management decisions regarding the underlying real estate assets. If the estate’s interest is a minority interest, the receiver should determine what rights the estate has to liquidate its interest. As a practical matter, the estate may be best served by a liquidation of the minority interest through a sale to the other owners.
Real Property Owned by the Receivership Estate
Once the receiver makes a preliminary assessment that the real property in question is or should be considered a receivership asset owned by the estate, the receiver has to evaluate whether that asset is worth administering. In general, that assessment means determining the amount of valid liens encumbering the property and getting at least one or more broker’s opinions of value to assess whether there is likely any equity in the property for the estate if the property were liquidated. The assessment also should include an evaluation of the physical condition of the property and repairs that may be needed to make the property saleable, whether unique characteristics of the property may impede or substantially delay a sale, the debt service and real property tax accruals and the availability of assets of the estate to service those expenses, and routine maintenance and preservation expenses. The receiver also needs to evaluate the administrative expenses for the receiver’s personnel in addressing issues regarding the property during the receivership.
A. Third Party Occupied Property
In some instances, the estate may have an ownership interest in real property that the receivership defendant is not using or occupying. In that case, the receiver must determine whether that property is occupied, and if so, by whom and under what authority (i.e., written lease agreement, month-to-month rental, or informal agreement for use of space). It is not unusual to discover that the receivership defendant’s principal has “lent” the use of the property to friends or colleagues that do not have a valid, contractual right to possession. In such circumstances, the receiver may first try to negotiate with the occupier to recover the property. Failing an agreement to vacate the premises, the receivership appointment order will likely allow the receiver to proceed in the receivership court to recover possession of the property for the estate based on the usual “exclusive possession” provision, avoiding the time and expense of state unlawful detainer proceedings. F.R.C.P. Rules 70 and 71 provide for issuance of writs of assistance and other orders to enforce the Court’s order directing the occupier to vacate the premises.
B. Commercial Property
If the property is commercial property occupied by a legitimate, third party tenant, then the receiver will need to examine the written lease or rental agreement, the rental rate compared to market, the term of the tenancy, the status of the tenant’s performance of both monetary and any non-monetary obligations under the lease or rental agreement and the tenancy’s net economic benefit to the estate. This evaluation is needed to determine the receiver’s strategies going forward, such as whether to seek to abandon the property or attempt to renegotiate with the tenant. As a practical matter, the receiver’s options may be limited when faced with a legitimate, third-party tenant. In any event, the receiver will need to give written notice to the tenant to make its payments to the receiver for the duration of the lease.
If the property is not occupied, the receiver must consider whether it is best to have the property remain vacant or whether the receiver should try to rent or lease the property post-receivership. If the receiver rents the property, the receiver will be considered to be operating the property post-receivership and may be subject to liability for claims arising out of the operation of the property under 28 U.S.C. section 959. Slip and fall accidents or other incidents arising from its operation make it imperative to have sufficient general liability insurance coverage to protect the estate. See Becknell v. McConnell, 142 Ga. App. 567, 236 S. E. 2d 546 (1977) (receiver not personally liable for personal injury claim from injured party’s fall at premises of receivership property, but estate could be liable if steps were negligently maintained). If there is a secured creditor with a lien on the property, before the receiver enters into a new lease for all or a portion of the property, the receiver will likely need to address the new lease with the lender and potentially try to obtain a subordination and attornment agreement with the lender to allow the lease to remain in effect if the lender forecloses on the property in the future. The proposed lessee is likely to insist on such an agreement. The receiver also needs to consider whether the prospective lease is a sufficiently significant event in the receivership based on the duration of the lease, whether there is any likely dispute with interested parties over the sufficiency of the rent or other similar concerns so as to warrant seeking explicit court approval of the lease. But see Chicago Deposit Vault Co. v. McNulta, 153 U.S. 554 (1894) (no sanction imposed on receiver for entering into a lease not expressly approved by court order where the lease was for a reasonable rental rate and had reasonable terms and would likely have been approved if presented to the court). The receiver will also want to confirm that all tenants at the property have appropriate insurance coverage for their activities and use of the property.
Whether or not the property is occupied, a federal equity receiver with commercial real property needs to engage in the same property analysis that a rents and profits receiver would engage in regarding commercial income producing property, including determining if there are risks to the estate in leasing the property, such as environmental hazards or other health and safety concerns. The receiver will have to evaluate whether those concerns could be remedied, the cost of remediation, and the net value the asset may have to the estate given any expenses of administration to be incurred. The receiver should also consider the likely time frame for potential sale of the property for the benefit of the estate, assuming that the receiver has been granted sale authority or believes the Court would grant such authority. The receiver will also need to evaluate the panoply of existing maintenance contracts for the property for their terms and relationship to market rates for the many services required to operate a commercial property. Accordingly, the receiver should consider employing a real estate professional that can advise the estate on issues relevant to the management and operation of the property if any special expertise may be needed to properly administer the property, including expertise in compliance with local regulations affecting the property.
Special issues arise in the administration of estate property that may be an investment property of the receivership defendants, such as hotel properties. Those properties may have a host of additional administrative concerns for the receiver to address, including brand issues, management contracts, and whether to continue to operate such a facility post-receivership based on an analysis of its profitability and the scope of administrative activities required to operate the facility.
C. Residential Property
If the receivership order does not prevent the receiver from taking possession of the residence, then the receiver has a number of issues to consider. If the residential property is part of a common community, the receiver should investigate any homeowner’s association dues that may be required to be paid and the Covenants, Conditions & Restrictions (“CC&Rs”) that may impact the ability to rent the property to third parties, the ability to make changes to the exterior of the property, and other restrictions. The CC&Rs should also be evaluated to determine what rights the receiver may have to attend and comment at meetings, to vote, and to elect board members, rights which may be meaningful based on the specific circumstances of the case and the property. If unoccupied, security concerns may exist at the property, such as the risk of vandalism and liability if the property has a pool and could be an attractive nuisance to children or others.
If the property is a multi-unit residential property, the receiver will need to determine if a management company is in place and assess that company’s performance, rates and services. The disruption in changing property management can also sometimes disrupt rent payments to the detriment of the estate. Whether the receiver keeps the existing management company in place, changes to a different management company or manages the property himself, appropriate notice that rent payments need to be directed to the receiver should be given as soon as possible. The receiver also needs to investigate the status of tenant security deposits and to gain control of those deposits and an accounting of the funds held for the different tenants. Applicable local law may also require notice to be given to the tenants of any transfer of the security deposits to the receiver.
If the defendants are allowed to remain in the property, the receiver should conduct regular inspections of the property to ensure the property is not being damaged and is being properly maintained. Even if the receiver cannot gain access to the interior of the premises, regular drive-by inspections should be conducted. Ideally, periodic access to the entire property with reasonable notice to the defendants would be allowed to avoid the risk of serious damage to the premises occurring during the receiver’s administration though there may be privacy issues and the receivership order typically does not authorize access to the residence by the receiver if the defendants are allowed to remain in their home. See, e.g., Securities and Exchange Commission v. Kowalewski and SJK Investment Management, LLC, U.S.D.C., N.D. Ga. Case No. 1:11-cv-0056 (serious damage caused to residence including removal of fixtures).
D. Undeveloped Land
While raw land does not pose some of the risks that other real estate assets may hold, raw land nevertheless needs to be visually inspected and supervised during the receivership as well as investigated from an economic standpoint to determine if it should be administered. The property may need to be physically secured by fencing or other physical barriers to protect the property from trespassers. Though vacant, raw land can attract squatters and trespassers who need to be removed, or may have personal property located there that needs to be removed. The receiver may need to also place visible signage on the property to deter trespassers if there are no signs prohibiting trespassing.
Raw land can also be subject to physical deterioration that must be monitored and addressed during the receivership, including flooding and erosion. There may be local ordinances and requirements for addressing brush clearance and other issues regarding the maintenance of the property that the receiver should investigate in order to assess the costs of administration of the property and the net value of the property for the estate, and to ensure the receivership estate’s compliance with law. The receiver will also need to investigate any zoning issues and restrictions regarding the property that may affect the use of the property and the marketability of the property. The receiver may need to analyze whether the raw land can be subdivided or whether it is already in a condition where it can be sold legally, and any restrictions that may exist on doing so, including minimum lot size requirements.
Leasehold Interests Where the Estate Is Lessee: The Clock Ticks
If the estate does not have an ownership interest in the property but has a leasehold interest, the receiver has a number of issues to address promptly. The receiver will first need to determine who the landlord is and whether the landlord is an independent third party or an affiliate of the receivership defendants. Assuming the landlord is an independent party, the receiver will need to read the written lease and any modifications that may have been made to the lease to determine the scope of the leased premises, the rent obligation, the duration of the tenancy and any other monetary or non-monetary obligations of the receivership defendant/tenant and rights such as any purchase option, under the lease. Landlords will assert that the receivership is liable to pay post-petition rent accruing and other financial obligations to the landlord on an administrative priority basis so long as the receivership estate continues to use and occupy the premises, making time of the essence in evaluating the lease and whatever rights the receivership entity may have under it.
If the receivership entity is the lessee of real property, it likely paid the landlord a pre-receivership security deposit. That deposit is likely equal to at least one month’s rent or more. The receiver may seek to negotiate with the landlord to have the deposit applied to any post-receivership rent accruing for the limited time the receivership estate may be occupying the premises. The receiver is typically not deemed to have “assumed” the lease by occupation of the premises for a limited time after the commencement of the receivership, and the receiver may want to explicitly advise the landlord that the receiver is reserving the right to reject the lease, vacate the premises and limit the landlord to a claim against the receivership estate for any unpaid rent or other monetary obligations due under the lease beyond the limited rent payment for the estate’s post-receivership use and occupancy of the premises.
The receiver needs to quickly determine (a) whether the lease has an option to purchase, a right to assign the lease or a right to sublease that could have value for the receivership estate; (b) the estate’s need to continue to occupy the premises and for how long; (c) the status of the receivership defendant’s performance under the lease, including whether rent is current, whether there are any ongoing violations of the lease regarding the use of the premises that need to be addressed and corrected, what obligations the receivership defendant may be facing in the near future that the estate might have to perform to maintain the lease, and the amount of pre-paid rent and security deposit in the landlord’s possession; (d) what the market rent for the leased premises is; and (e) available alternatives and the cost of alternatives if the estate needs a place to maintain records or personal property pending a sale or other disposition of those assets.
1. Gary Owen Caris is a Partner and Lesley Anne Hawes is Senior Counsel at Diamond McCarthy LLP. The authors would like to thank Greg Hays of Hays Financial Consulting LLC for contributions to this article through his thoughtful comments and reference to his informative article, “Fiduciaries Gone Wild” and the authorities cited therein.
2. See, e.g. Muratore v. Darr, 375 F. 3d 140 (1st Cir. 2004); In re Delorean Motor Co., 991 F. 2d 1236 (6th Cir. 1993); In re Nathurst, 207 B.R. 755 (Bankr. M.D. Fla. 1997).