By Alexandra S. Jackiw, CPM®, CAPS, C3P
When a commercial property owner defaults on their loan agreement, the lender has the legal right and obligation to protect the underlying collateral that secures the loan – the mortgaged property. In Part, I of this series the role of the receiver was discussed. Let’s dive deeper into how an experienced receiver can benefit both the lender and borrower of a mortgaged commercial asset.
Typically, financially distressed assets are assigned to an asset manager or “special servicer,” who will make every attempt to hammer out a “workout” plan to restructure the debt and get the asset back on a stable financial footing. In the event that a workout cannot be achieved, the asset manager will set the legal wheels in motion to gain control of the mortgaged property and protect it from deteriorating in value.
Assembling the Team
The asset manager begins the value recovery efforts by identifying a team that will work to protect the mortgaged property and the rights of the lender.
- A local broker is selected and asked to prepare a Broker Opinion of Value (BOV) that will provide a fair estimate of the range of values for the mortgaged property.
- Legal counsel is retained to identify the legal steps necessary to take control of the asset. Because commercial loan documents contain specific language giving the lender the authority to ask for the appointment of a receiver, legal counsel will typically initiate foreclosure proceedings and simultaneously work towards having a receiver appointed.
- A receiver is identified who has the ability and knowledge to immediately step in and take over management of the asset. The receiver has the option to manage the property themselves or hire a management firm to operate the property under the receiver’s direction. The receiver is charged with the responsibility of preserving the property on behalf of both the borrower and the lender.
The Actions of the Receiver Prior to Appointment
Once a receiver is identified legal counsel will begin the process of “qualifying” the receiver to ensure that both parties will find the individual selected acceptable. Ideally, both parties will agree to the person selected by the lender in advance of any court proceedings, but that is not always the case. In preparation for the court hearing the selected receiver candidate will complete the following actions:
- Submit a detailed resume outlining experience managing distressed assets and providing value recovery services.
- Complete an initial site visit to the property, whenever possible, to familiarize themselves with the asset and its condition.
- Submit a proposal outlining the fee structure for the assignment (subject to approval by all parties).
- Review and provide comments on the draft receiver order.
- Apply for the receiver bond, if required by the order.
- Attend court proceedings when the hearing to appoint the receiver is scheduled.
Actions of the Receiver Immediately After Court Approval
Once the receiver order is approved by the court, the oath of the receiver is filed, and the receiver bond posted, the receiver must move quickly to take control of the mortgaged asset and assess all aspects of operations and financial management. A series of carefully orchestrated steps must occur swiftly.
- The receiver must visit the property immediately with the stamped court order in hand and meet with the on-site staff to explain what has occurred and what will be expected of them. Sometimes the staff has been made aware in advance of the legal proceedings but frequently they are caught unaware by what has transpired. On rare occasions, an emergency receiver order may be approved by the court because of lender concerns about waste or fraud that can result in the borrower being surprised when a receiver shows up at the property.
- The receiver will make contact with the borrower expeditiously and request all of the documents and records that are specified in the receiver order. Usually, the borrower is given five business days to comply with providing the documents as stipulated in the receiver order. Additionally, all funds in the borrower’s possession related to the mortgaged property must be transferred immediately into the bank accounts set up by the receiver for those funds. Once the receiver order is approved by the court the borrower can no longer retain any monies that were generated from operating the property.
- The status of insurance coverage is determined. If insurance coverage is still in place, the borrower is precluded from canceling the policy, and the receiver’s name is added to that policy as an additional insured. If the policy has lapsed, the receiver will work with the lender to identify and place insurance on the property.
- Continuity of utility service is confirmed and contact is made with utility providers. Most receiver orders include language that precludes utility companies from interrupting service to the mortgaged property for non-payment.
- If the property is not adequately staffed or staff needs to be replaced, the receiver will take immediate steps to get personnel in place to operate the property.
Completing a Thorough Due Diligence of the Asset
The receiver is required to submit detailed reports to the court regularly throughout the term of the receivership. The reports will outline property operations, value recovery strategies and provide detailed financial information for all parties and stakeholders. The most important functions that must be completed within the first thirty to sixty days include:
- Conducting detailed due diligence of the property operations – lease file audit, physical inspection, unit walk-throughs, personal property inventory, maintenance overview, leasing and marketing initiatives, financial management.
- Reviewing property payables and making a determination of how invoices will be paid. The receiver is not required to pay any invoices for services or supplies purchased by the borrower prior to the receiver order. However, the receiver is given wide discretion to selectively pay those vendors that are determined to be critical to the continued operations of the property.
- Preparing an operating budget, marketing plan, and business plan for the property.
- Conducting a “forensic” accounting audit to determine how property funds were handled by the borrower prior to the receivership, if necessary.
- Submitting the first comprehensive report to the court that will include the results of the due diligence and any major findings that may be cause for further investigation.
Receiverships are a fascinating and challenging aspect of property management that requires acumen and focus on the part of the real estate professional charged with the responsibility for overseeing an asset that is placed in the receiver’s care. Understanding the legal framework, keeping all stakeholder interests aligned, and providing objective, well-reasoned direction to recover asset value can lead to optimal outcomes when the right receiver is selected.
During the receivership process, a number of issues can arise that require creativity and hard work to resolve. There can be any number of “surprises” and unique situations in operating a property in receivership that will need to be addressed. In the last installment in this series, the unique issues that may need to be confronted by the receiver will be discussed, along with the process of closing out the receivership and the final disposition of the asset.