Real Estate Mortgage Foreclosure Receiverships: Procedural Issues and Practical ObservationsSeptember 2013 – Nassau Lawyer: The Journal of the Nassau County Bar Association
Although it appears that the worst of the foreclosure crisis is now in the "rear view mirror," some experts believe that a new phase of residential and commercial foreclosures may be triggered by increased interest rates that will follow the federal government's eventual termination of its current quantitative easing monetary policy.
Another reason why foreclosure actions are not "disappearing," is that because of the general economic recession, many tenants are still in the process of filing for bankruptcy reorganization or liquidation.
Given the expectation that there will be a continuing need for real estate receiverships, this article will focus on certain procedural and practical aspects of receiverships.
Notwithstanding that a mortgage document provides that the mortgagee-plaintiff is entitled to the appointment of a receiver without notice and the mortgagee consents thereto, some judges require that notice be given to the mortgagor-defendants, relying on Section 202.7(f) of the Uniform Rules.
Where a bond is posted that is more than adequate to protect the plaintiff's interest in the property, a motion for a temporary receiver may be denied. Moreover, a motion for receiver will be granted only where legal or other remedies are "inadequate, ineffective, or had been exhausted." In determining receivership motions, courts will generally consider, inter alia,
(a) alternative remedies available to the creditor,
(b) the extent to which receivership will enhance the likelihood of satisfaction,
(c) the risk of fraud or insolvency if a receiver is not appointed.
"Thus, even where a mortgage or other contract provides that appointment of a receiver is a matter of right, courts have discretion whether to appoint a receiver."1 There must be an action pending, before a receiver may be appointed and if the complaint only seeks, as relief, the appointment of a receiver, the motion will be defective.
Generally, a movant must demonstrate a reasonable probability that it will prevail and the chances of recovery will be lost or materially impaired, absent appointment of the receiver. Notwithstanding a debtor's contractual consent, some judges are reluctant to appoint receivers on an ex parte application, given that it is a drastic remedy.
On the motion by any party or on the court's own initiative, a receiver may be removed for, inter alia, incompetency or lack of integrity and a receiver may, with reasonable cause, seek to resign.
Receivers' Rights and Responsibilities
Although there at one time had been some confusion as to whether receivers could receive a percentage of both the monies disbursed and the monies received, the law is now clear that receivers may receive a percentage of the total amount collected up to 5%.2 Sums collected do not include tenants' security deposits which are held in trust for tenants, but they could include a co-op's reserve fund.3
Compensation may be denied if a receiver grossly mismanaged the property, commingled receivership funds with personal funds or otherwise committed a serious breach of the receiver's fiduciary duties.
Additionally, if there are insufficient funds to pay the receiver, the court may direct that the party who had moved for appointment of the receiver must pay the receiver's compensation.4
A receiver has the right, but not the obligation, to pay bills for work done prior to the receivership. The salient issue is whether payment is beneficial to the estate. Upon a receiver being appointed and filing of his oath and bond, receivers are often bombarded with past due bills from a vast array of vendors.
With certain exceptions, receivers are bound by pre-existing leases. Courts may set aside fraudulent or collusive leases because of inadequate rental amounts or rent payments in anticipation of foreclosure.
Generally, a receiver is not obligated to adopt contracts or step into the shoes of owners if the receiver believes it would be unprofitable or undesirable to do so. A receiver is accorded a reasonable time todecide whether to adopt or disavow contracts. If the receiver has neither signed nor ratified such agreements, they are generally not enforceable against the receiver.
If a receiver is sued successfully, the claimant will have a claim as an existing indebtedness of the receivership which may be allowed in distribution of the estate if there is a distribution. It cannot be enforced against the assets within the control of the receiver and the mortgagor may still be sued for previous receivership debts and obligations.
A receiver is not empowered to act until a sufficient bond has been executed, filed and approved. Once a bond has been approved, the receiver's rights relate back to the date when the order of appointment was granted and entered, so that the receiver's rights prevail over third parties who have intervened in the meantime. An action on the bond may not be brought until the receiver's accounts have been settled so as to determine the amount and nature of the receiver's liability.
Secondary Appointments Accounts and Taxation
A receiver may not employ counsel unless authorized by the court. However, under exceptional circumstances, a court may ratify the unauthorized engagement of counsel by a receiver.5 Thus, although a receiver's counsel is selected by the receiver, the court must authorize the hiring.
If a receiver is an attorney, the receiver will generally be expected to do his or her legal work and will not be entitled to additional compensation for such legal services. If a receiver believes it appropriate, under the circumstances, to retain his or her law firm to provide legal services, such retention requires court approval.
Although a receiver should generally not employ attorneys for any of the parties to assist the receiver, if it is done on consent and approved by the court, it may be permissible. Similarly, a receiver may retain a property manager and other ancillary appointees, but such retention must also be with the approval of the court.
Receivers may incur reasonable expenditures necessary to preserve the property of the estate. Expenses are usually addressed in the order of appointment and if not, should be the subject of a subsequent application. A receiver must maintain written accounts of receivership transactions, itemizing receipts and expenditures and the account should be available for inspection by any person having an apparent interest in the property. Moreover, a receiver must account for payments made to himself or herself and to any attorney or other ancillary person without authorization of the court.
Where the purpose of the receivership has been accomplished and the accounts of the receiver have been settled, an order of the court is entered discharging the receiver. A temporary receivership normally would not continue after a final judgment unless otherwise directed by the court.
Additionally, a receivership may be terminated where there was fraud or collusion in obtaining the receivership even if the receiver was innocent of any wrongdoing or complicity. A receiver may also be discharged when the party who requested the receiver fails to advance sufficient funds to the receiver to manage the property and where the income generated from the property is insufficient to meet operating expenses.
Commercial Real Estate Issues
Receivers must be qualified and be on an approved list.6 (Also true with respect to residential properties.) The receiver should promptly notify all tenants that rents or other payments are to be paid to the receiver (Notice to Attorn). This provides a receiver with an opportunity to dialogue with tenants and instill a sense of stability. It also helps to identify problems.
If a tenant pays the rent to the owner, notwithstanding the receivership, the tenant remains liable to receiver. Failure to pay may subject a tenant to contempt of court. The practical approach is often to pursue an appropriate landlord-tenant court proceeding.
The order of appointment should authorize the receiver to promptly take control of assets, books and records. The receivership order should also authorize retention of counsel to commence summary proceedings or other lawsuits and also authorize retention of other entities necessary to operate the property. The order should also authorize the receiver to enter into leases that don't exceed a specified number of years. If the order lacks this provision, the receiver should seek court authorization. Routine legal services are expected to be performed as part of a receiver's services, without additional compensation, if the receiver is a lawyer. East Chatham Corp. v. Iacovone.7 (Most cases on this issue involve cases where a receiver had failed to obtain advance permission from the court to retain counsel).
A receiver may be a petitioner in a summary proceeding (RPAPL § 721) and for venue purposes, the county of residence of the receiver is the county of his or her appointment or the county in which the receiver actually resides.8 Security deposits must be maintained as required by RPAPL § 1325(2-1) and General Obligations Law, Article 7.
Multi-Family Residential Properties
In New York City, the receiver must register with the NYC Department of Housing Preservation and Development under the Multiple Dwelling Law (MDL).
A receiver should check for violations of record and correct any "immediately hazardous" and "hazardous violations" (as defined in the Housing Maintenance Law). See Section 304(6-a) of the MDL for penalties for noncompliance. The appointment order should authorize the receiver to correct immediately hazardous and hazardous violations.9
A receiver should also confirm the physical occupancy of the building and condition. The appointment order should authorize the receiver to spend money for repairs and maintenance. The order will often limit the amount of monies that may be spent absent court approval. A receiver is legally obligated to maintain the receivership property in good repair and may be held liable for any damage that results from failing to properly maintain the property. A receiver should be bonded and insured and anyone who wants to sue a receiver requires court permission.10
A receiver's right to collect rent will be jeopardized if the premises are not habitable. In Fourth Federal Savings Bank v. 32-22 Owners Corp.,11 the court held that the warranty of habitability defense could be interposed against a receiver in a foreclosure proceeding.12
Courts have noted that the order of appointment required the receiver to make repairs necessary to the preservation of the property and to correct hazardous violations, and that a lack of funds in the Receiver's hands would not vitiate the warranty of habitability, since the Court could order the party who applied for the appointment of the receiver to pay for the necessary repairs if the receiver lacked sufficient funds. Additionally, a receiver is considered an owner for the purpose of rent regulation13 and must comply with all applicable rent regulations.
Rent regulation laws provide certain immunities to receivers. The Emergency Tenant Protection Act relieves receivers of responsibility for maintaining certain records and for rent overcharges, under certain circumstances. There are analogous provisions in the Rent Stabilization Law.14
If a property is not properly maintained, tenant may sue for breach of contract and claim constructive eviction. However, such tenant must show that it actually vacated.
Practical Advice from Judges
I have discussed receiverships with several Justices of the New York State Supreme Court. Their observations include the following.
Certain parties will object to a receivership on frivolous grounds. Parties would usually benefit from participating in a constructive manner in the selection of the receiver and in the crafting of an appropriate order of appointment.
Although someone may be on an approved receiver list, it does not mean that the judge knows that he or she is truly the best person for the job. Judges want receivers who are not strangers and who will consult with the court and the parties. The technical legal skills and the receiver's personality cannot necessarily be divined from a list of approved receivers.
Receivers could be very expensive. Sometimes, the applicant must pay some money up front, to cover initial expenses. The receiver must act quickly and needs to incur expenses to get the receivership up and running. Judges sometimes encounter the need to appoint a receiver when the ability to pay the receiver is questionable. In such cases, they may need a receiver who is willing to defer or reduce his or her compensation.
Occasionally, a party may say a receiver's attorney's fee or other expense is too high. Occasionally, the party requesting the receivership may agree to fund the difference between what an objecting party would concede is a reasonable range and the price of hiring the entity or individual whom the receiver and the lender believe should be hired.
A receiver should select the appropriate managing agent, who will perform well and file all appropriate reports required by state and municipalities. A receiver must prevent a managing agent from giving below market leases to friends or using vendors who are friends, but not necessarily competent or cost effective.
A receiver must promptly focus on collection of rent and violations. If the property is in foreclosure, then the owner had money problems. That usually means there was deferred maintenance and a lack of important repairs. Courts may go back to the party that requested the receivership to fund the repairs.
Since there must be an accounting at the end of the receivership, a receiver should start, on day one to keep careful financial records. Some judges want periodic reports to minimize surprises.
A receiver must be vigilant with respect to potential conflicts with ancillary appointments and discuss such potential appointments with the judge before any motion for their appointment is made. Receivers should also timely address insurance coverage.
A receiver is not an ordinary litigant. A receiver is an agent of the court and can call the judge and discuss matters without the parties on the telephone line. Many judges want to be "kept in the loop" since they are the ones who made the decision to put the receiver in place and then selected the receiver. A receiver should discuss the preferred communication protocol with the judge.
Courts have lots of discretion as to scope of the appointment order. Judges will not look to get involved in "day to day" issues. But their doors will be open if there are complaints about the receiver or if the receiver needs guidance. Receivers may ask the lawyers for the parties for suggestions as to how to resolve the issues. Courts will sometimes ask the parties and/or their counsel if they have a recommendation for a particular receiver.
Selecting Attorneys and Agents Receivers should be transparent and communicative with the interested parties and especially the court. Receivers should welcome input from everyone and then they should make the decisions and seek court authorization if necessary.
With respect to lawyers, managing agents, and brokers, the receiver must thoroughly explore possible conflicts. Moreover, receivers should do their "homework" as to whether such retention is appropriate for the subject type of property.
Attorney for the Receiver: Should the attorney be a transaction lawyer or a litigator? If a litigator, what kind? Real estate litigation? Breach of contract? Specific performance? Title claims? Landlord-tenant?
Managing Agent: Does the managing agent have experience with buildings of the size and complexity of the subject property? Where are the other buildings managed by the agent? Any in Nassau County? Is the agent doing other work for the debtor? Is the price competitive? Are all necessary services included?
Leasing Agent: Many of the foregoing questions apply to leasing agents as well, plus: Is the agent leasing a competing building? Is that a plus or a minus? Does the managing or leasing agent have a possible business conflict because it wants to either purchase the building or the mortgage note or make a commission or fee or other economic benefit from a potential buyer?
Termination: Are there appropriate termination provisions to address the fact that the receivership will terminate or the receiver may be dissatisfied with the agent's performance?
The receiver is an officer of the court and a fiduciary, with the obligation to protect the estate. A receiver should not only protect herself or himself from professional public embarrassment and liability, but be mindful that the receiver's performance reflects upon the judge who made the appointment. If there is conflict, the judge may be embarrassed and will be burdened with additional work in the form of extensive motion practice and delay of pending litigations.
Scott E. Mollen is a partner at Herrick, Feinstein LLP, a weekly columnist on real estate litigation for the New York Law Journal and an adjunct professor at St. John's University School of Law.
1. Finch v. Ray, 208 A.D. 51 (3d Dept. 1924).
2. See CPLR 8004(a).
3. DeSantis v. White Rose Assocs., 152 Misc.2d 567 (Sup.Ct., N.Y. Co. 1991)
4. CPLR 8004(b).
5. CPLR 6401[b].
6. See Part 36 of the Rules of the Chief Judge (of the State of New York).
7. 26 A.D.2d 433 (1st Dept. 1966).
8. Weinstein-Korn-Miller, New York Practice, 6401.02.
9. RPAPL §1325.
10. Schwartz v. Kurlander, 279 A.D.2d 465 (2d Dept. 2001).
11. 236 A.D.2d 300 (1st Dept. 1997).
12. See Apple Bank for Savings v. One Arden Street Assocs., 165 Misc.2d 1011 (Sup.Ct., N.Y. Co. 1995)
13. Emergency Tenant Protection Act, §2500.2.
14. Emergency Tenant Protection Act §§ 2502.3(3), 2502.7(2), 2506.1(f)(2).