Question: When discussing a defaulted borrower with the other creditors, there seems to be a lot of confusion between receivership and bankruptcy. What are the differences as they pertain to a creditor, specifically?
Answer: Confusion between the two is very common, and the differences are often confused by even experienced lenders and attorneys, particularly those who don’t deal with both on a regular basis. The fundamental differences are fairly simple. A bankruptcy is an action usually filed to protect a borrower/debtor from collection actions by creditors. Bankruptcy courts and rules are primarily aimed at protecting the borrower, not the lender.
A “Chapter 11” bankruptcy is filed when a debtor wants time to solve its financial problems while maintaining business operations. A “Chapter 7” is filed for purposes of liquidating and winding up a business. There are other forms of bankruptcies, but these two are most commonly encountered by commercial lenders. A receivership is not a legal “action,” but rather an “ancillary remedy.” A motion to appoint a receiver is only filed after a suit is already in progress. A receivership is designed to protect the lender’s assets during an interim period, for example, while a foreclosure action is pending. In this case, the secured creditor (lender) is asking the court to protect its security (land, buildings, business income, cash, etc.) until the foreclosure is resolved. In appointing a receiver, the court is agreeing to the lender’s argument that the debtor may not act in the interest of maintaining the asset’s value, since that debtor will likely not own it after the foreclosure, which could be many months away. The court may appoint an independent person, not connected to either the plaintiff (lender) or defendant (borrower) in the foreclosure action. That independent party “receives” the assets on behalf of the court and remains in possession and control of those assets until discharged by the court.
Question: So a Receivership works to the Lender’s benefit?
Answer: It can because the receiver’s role is to protect the value of assets which are subject to the underlying legal action. However, the Receiver can never act for the benefit of one party and the detriment of the other.
The receiver must be an independent party, with no prior business relationship to either the borrower or lender. The misconception of a receiver “working for the bank” often arises because the receiver may have been nominated by that same bank many times previously. Fortunately, judges understand that such past history is not a “business relationship” that acts as a disqualification.
Ancillary Remedy: (ancillary adj.) Supplementary; subordinate (remedy n.) means of enforcing a right or preventing or redressing a wrong; legal or equitable relief. Black’s Law Dictionary (8th ed. 2004)
Bankruptcy: A statutory procedure by which a (usu. insolvent) debtor obtains financial relief and undergoes a judicially supervised reorganization or liquidation of the debtor’s assets for the benefit of creditors; a case under the Bankruptcy Code (Title 11 of the United States Code). Black’s Law Dictionary (8th ed. 2004)
Receiver: A disinterested person appointed by a court, or by a corporation or other person, for the protection or collection of property that is the subject of diverse claims.