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Receivership reforms, part three: Creditors’ rights and priority of claims

David Warfield September 17, 2013

Note: This post is part of a four-part series on the Credit Report Blog. Click here to view all related posts.

In our previous post, we provided background on receiverships and detailed specific reforms that could provide much-needed updates to the process. Today we’re continuing to look at those possible reforms.

Conduct of case and notice to creditors

Most receivership cases are commenced by a single creditor against the distressed business. The receivership, however, can affect the rights of many others who are not parties to the litigation, such as employees, creditors, and business partners. Although some old cases, including Schneider v. Schneider, decided in 1940, recognize the ability of creditors to file claims against receiverships, there is no uniform procedure to account for the claims of creditors and otherwise protect the rights of non-parties. The statute should be reformed to require that the receiver submit to the court as soon as practicable after appointment a complete list of creditors and other persons and entities affected by the receivership so that they may receive notice of events that impact their rights.

If it appears that there may be funds available to pay creditors, all creditors should receive notice of the procedures to file a claim against the receivership. The statute should provide procedures to be followed to adjudicate disputed claims. Leave should be liberally granted to permit those who are affected by the receivership to be added as parties to the case. So long as appropriate notice and due process has been provided, a receivership order should be binding upon a person or entity affected by the receivership, whether they are parties to the litigation or not.

Priority of claims against the receivership

Since the assets subject to a receivership will rarely be sufficient to satisfy all claims against the receivership entity, it is necessary for the receivership court to rank the claims in accordance with some priority scheme. Even though there is little doubt that a secured creditor holding a validly existing lien on receivership assets will be entitled to receive its collateral or be paid the sale of its collateral, current law offers little guidance on prioritizing unsecured claims. The old cases are similarly unenlightening.

For example, one court observed, “to warrant the enforcement of the claim of one creditor over those of another, there must be something in the intrinsic nature of such claim conferring an equity superior to that of the creditors over whom he claims a preference.” It is not necessarily clear, however, whether a claim for unpaid taxes is intrinsically superior to a claim for unpaid wages, or whether a claim for unpaid federal taxes is superior to a claim for unpaid state taxes. Federal bankruptcy law, of course, has a very detailed priority structure for claims against an entity in bankruptcy. To avoid inconsistent results and discourage forum shopping, the receivership statute should be reformed to adopt (or at least very closely parallel) the claim priority structure contained in the Bankruptcy Code.

Automatic stay of actions against the receivership entity or assets

The filing of a bankruptcy case automatically stays creditors from suing the entity in bankruptcy or attempting to collect its assets. The automatic stay prohibits the bankrupt entity from being dismembered piecemeal by its creditors and promotes the policy of equal treatment for similarly situated creditors. The current receivership law does not contain an automatic stay, but some old Missouri cases have held that a judgment against an entity in receivership may be disregarded because the court entering the judgment lacked jurisdiction. (State ex rel. Bromschwig v. Hartman, 300 S.W. 1054 (Mo App. 1928); Miller v. International Fire Assur. Co. of America, 196 S.W. 452 (Mo. App. 1917).

To avoid any possible ambiguity, the receivership statute should be reformed to provide expressly that the receivership court has exclusive jurisdiction over any assets within the receivership and that all creditors and other parties are prohibited from suing the receivership entities or taking any action to collects its assets. Some states have limited the duration of the automatic stay in receivership cases to 60 to 90 days. A creditor or other interested party without knowledge of the receivership that violates the stay should not be punished, but the stay should apply to all claims against the receiver or receivership assets. The automatic stay of actions against the receiver or receivership assets should not apply to certain types of actions, most notably perhaps any action to exercise a governmental unit’s police or regulatory power. (The Bankruptcy Code presently recognizes no fewer than 27 exceptions to its automatic stay.  There is no need to incorporate most of these bankruptcy exceptions into a new receivership statute, however.)

Executory contracts and leases

Almost any business enterprise is going to be a party to many ongoing contracts or leases, and many of these contracts will contain a so-called “ipso facto” clause that provide the appointment of a receiver is a contractual default that entitles the counterparty to terminate the contract. The current Missouri receivership statute is silent about the enforceability of ipso facto clauses and the rights of a receiver to assume or reject an executory contract or unexpired lease. At a minimum, the statute should be reformed to provide clearly that receivers may reject a contract or lease that is burdensome to the receivership estate and that the counterparty to a rejected contract or lease may file a claim for damages incurred on account of the rejection.

In the fourth and final part of this receivership series, we will compare receivership to bankruptcy and look at how other states have revisited their receivership laws.

David Warfield is the co-chair of Thompson Coburn’s Financial Restructuring Group. You can reach David at (314) 552-6079 or dwarfield@thompsoncoburn.com.