Courts Consider Both Contractual Agreements and Common Law Factors When Appointing a Receiver

A state or federal court receivership can be a viable and effective alternative to a federal bankruptcy proceeding, which often costs more, takes longer, and involves more oversight than a receivership.

A receivership involves the court appointment of a receiver to oversee and, in most cases, operate and/or liquidate a business. A receiver is a neutral and independent third party appointed to act on behalf, and for the benefit, of all interested parties.

Secured lenders typically include clauses in loan agreements that authorize the appointment of a receiver in the event of a loan default. It’s often assumed that, because a borrower consents to the appointment of a receiver by contract, that a court’s appointment of a receiver is a mere formality. It’s not—at least it’s not a foregone conclusion.

The issue of the enforceability of a contractual provision for the appointment of a receiver was at issue in a case, The Huntington National Bank v. Sakthi Automotive Group USA, Inc., before the United States District Court for the Eastern District of Michigan. The court ultimately appointed a receiver in the case, but in doing so did not rely on contractual language alone. As discussed below, it considered common law factors as well in making its decision.

(Editor’s Note: The Dragich Law Firm serves as legal counsel to the court-appointed receiver of Sakthi Automotive Group USA, Inc.’s assets, but was not counsel to the company in the litigation described in this article.)

The Court’s Analysis Regarding the Appointment of a Receiver

As a starting point, the court considered the contractual basis for the appointment of a receiver, including section 11.5 of the Credit Agreement between Sakthi Automotive Group USA, Inc. (“Sakthi”) and The Huntington National Bank (“Huntington”), which entitled Huntington to the appointment a receiver in the event of Sakthi’s default, and provides:

Upon the occurrence of an Event of Default and at all times thereafter, the Lender shall be entitled to the immediate appointment of a receiver for all or any part of the Collateral, whether such receivership is incidental to the proposed sale of the Collateral, pursuant to the Uniform Commercial Code or otherwise. Each Loan Party hereby consents to the appointment of such a receiver without notice or bond, to the full extent permitted by applicable statute or law; and waives any and all notices of and defenses to such appointment and agrees not to oppose any application therefor by the Lender, but nothing herein is to be construed to deprive the lender of any other right, remedy, or privilege the Lender may have under law to have a receiver appointed, provided, however, that, the appointment of such receiver shall not impair or in any manner prejudice the rights of the Lender to receive any payments provided for herein. Such receivership shall at the option of the Lender, continue until full payment of all the Obligations.

A similar provision was included in the mortgage agreement between the parties.

While the court recognized that the appointment of a receiver was a remedy that Sakthi agreed to in the loan documents, its analysis did not stop there. The court explained, in its order denying Sakthi’s motion to delay the appointment of a receiver, that courts “disagree about whether a party’s advanced contractual consent to the appointment of a receiver is dispositive of the issue of appointment or simply a factor that favors appointment.”  There are additional factors, found in the common law, that can weigh on the decision.

The common law factors were articulated in the case of Meyer Jewelry Co. v. Meyer Holdings, Inc., 906 F. Supp 428 (E.D. Mich. 1995), and include:

1. The existence of a valid claim by the moving party;

2. The probability that fraudulent conduct has occurred or will occur to frustrate the claim;

3. Imminent danger that property will be lost, concealed, or diminished in value;

4. Inadequacy of legal remedies;

5. Lack of a less drastic equitable remedy; and

6. The likelihood that appointment of a receiver will do more harm than good.

After analyzing these factors, the court found that most, if not all, weighed in favor of the appointment of a receiver. Beyond the existence of a contractual agreement, the court noted that: “Courts contemplating the appointment of a receiver have considered a number of factors but have found the adequacy of the security and the financial position of the [defendant] to be most important.”

Finally, the court considered the balance of harms between the parties should a receiver be appointed. Here again, the court referred back to the contractual agreement in ruling in favor of Huntington Bank, explaining that when a party contractually agrees to not to contest the appointment of a receiver, “[T]here is little harm in enforcing the terms of the parties’ bargain.”

Contractual Agreements Weigh Heavily, But are not Dispositive

A receivership provision in a loan agreement will weigh heavily, but will likely not be dispositive, in a dispute as to whether to appoint a receiver. A lender seeking appointment of a receiver should also be prepared to make a showing that the common law factors outlined above support the appointment of a receiver.

If you have any questions about these issues, please contact David Dragich or Amanda Vinthevoghel at [email protected], [email protected], or 313.886.4550.