90 Second Lesson: Are Secured Creditors Better Off With a Federal Court Receivership or Bankruptcy?

Question:

Do secured creditors benefit more from a debtor’s bankruptcy or federal court receivership?

Answer:

Firstly, what is the difference? Bankruptcy is often (but not always) a voluntary legal action that protects the debtor from collection actions as it creates a liquidation or reorganization plan that will allow it to repay outstanding debts. Meanwhile, a receivership is an involuntary action in which creditors seek a court order to recover debt owed under a secured loan that has defaulted. An independent receiver is appointed and acts as a trustee, making decisions on behalf of the company in selling or liquidating its assets.

The Benefits and Downsides of the Receivership Process

Bankruptcy and receiverships can be separate processes, or a receivership can take place within a bankruptcy, though it is usually a tool to avoid bankruptcy. What are the advantages and disadvantages of a receivership vs. bankruptcy?

Receivership vs Bankruptcy

In some situations, secured creditors would benefit more from a bankruptcy proceeding than a receivership, but a secured creditor should consider the benefits and detriments of each option before making a decision. Secured creditors should note, though, that if a bankruptcy case is filed after the appointment of a receiver, then the filing will trump the receiver’s appointment. The appointment of a receiver itself may constitute grounds for creditors to file an involuntary bankruptcy proceeding.

Receiverships tend to be more time and cost effective than formal bankruptcy proceedings. Additionally, a creditor who pursues a receivership can avoid the potential for liability associated with the filing of involuntary bankruptcy petitions.

Another difference in receiverships vs. bankruptcy is the appointment of a trustee. In formal bankruptcy proceedings, a court typically has the say in appointing a trustee. Receiverships, however, allow creditors to propose potential receivers.

Consider the Likelihood of a Court Appointed Receiver

Despite the advantages of a federal court receivership discussed above, secured creditors generally benefit more from the predictability of the established law under the Bankruptcy Code. In deciding which option is best, a secured creditor should consider the likelihood that a court would appoint a receiver, its likely choice for a receiver, the powers of that receiver, and whether bankruptcy would better serve the creditor’s goals.

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1. 90 Second Lesson: What is a state law receivership?
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3. Application for Receivership

[Editors’ Note: This is part of our irregular series in which we answer readers’ questions. If you have a question, submit it to [email protected], and we will try to answer it.

This 90 Second Lesson is based, in substantial part, on material reprinted from Commercial Bankruptcy Litigation 2d and Strategic Alternatives For and Against Distressed Businesses, with permission of Thomson Reuters. If you are a Westlaw subscriber, you can read more about this particular subject here.

To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can watch at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. State Court Receivership 101 series.
2. Federal Equity Receiverships: An Introduction- Why Investors, Lenders, Creditors, and Lawyers Should Care
3. Bad Debtor Owes Me Money!

This is an updated version of an article originally published on March 14, 2017 and previously updated May 22, 2020]

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