RE Basics: Receivership

Receivership is a tool used by mortgagees (lenders) to protect the value of collateral property prior to foreclosure and during a redemption period. As a general rule, when collateral property is in receivership, a duly appointed receiver takes over management of the collateral and the mortgagor loses most or all of its control.

This article provides a general overview of receivership—including mortgagee considerations, advantages and disadvantages, and its effects on leases and rents—and concludes with a discussion of the statutory requirements governing receivership in Minnesota.

General Overview of Receivership

Managing Risk, Protecting the Value of Collateral. If foreclosure appears likely following a default, there is the risk that a mortgagor may divert rent and income to parties other than the mortgagee (including into the mortgagor's own pockets). A mortgagor may also become derelict in the management and maintenance of the collateral following default. A mortgagor may even attempt to "milk" the property by accepting prepaid rent from tenants at a discount, or may otherwise strip value from the collateral.

Depending on the jurisdiction, significant time can elapse between the loan default and foreclosure (and the expiration of the redemption periods). Because of the risks associated with leaving a defaulted mortgagor in control of collateral property, a mortgagee may want to take steps to protect the collateral and its income.

Mortgagee Objectives Upon Default.  A mortgagee generally has the following short-term objectives following a material default by a mortgagor:

1. Ensure rents are applied to the mortgage debt
   
2. Continue favorable leases
   
3. Prevent milking of the collateral by borrower inviting and accepting rent prepayments
   
4. Ensure that taxes and insurance premiums are paid
   
5. Ensure the property is physically maintained and managed
   
6. Ensure the lender has priority as a secured creditor (for rents) if the borrower files for bankruptcy

To address cash management risks, a mortgagee will consider alternatives such as (a) entering into (or invoking pre-existing rights to) a cash management agreement with the mortgagor (e.g., a lockbox); (b) taking possession of the property (if allowed in the jurisdiction, or if agreed to by borrower); (c) invoking rights under an assignment of rents; or (d) seeking appointment of a receiver.

Advantages and Disadvantages of Receivership.  Receivership is attractive to mortgagees partly due to the limited effectiveness of other alternatives. Implementing a cash management program often requires some cooperation from the mortgagor. Furthermore, this option does not provide maintenance oversight and does not remove physical control of the asset from mortgagor. Assignment of rents only addresses application of income—not expenses—and does not address maintenance and control of the asset. In addition, invoking the assignment of rents prior to foreclosure is limited or disallowed in some jurisdictions. Similarly, many jurisdictions do not allow a mortgagee to take possession of the collateral prior to foreclosure. Even if a mortgagee is able to take possession prior to foreclosure, it risks liability under a duty of prudent management and through interaction with third parties in connection with the asset.

However, there are disadvantages to receivership. The costs of the receiver must be paid, so this is an added expense to the foreclosure. There is also no assurance that the court will appoint a competent receiver.

Effects of Receivership.  Receivership has effects on leases and rents. Mortgagees should consider the following:

• Jurisdictions may have rules requiring a receiver to apply rents in a particular order.
  
• In some jurisdictions, a receiver may have the ability to disaffirm a lease entered into by the mortgagor when the mortgagor was in default under the loan.
  
• If mortgagor bankruptcy is a risk, receivership may help establish the perfection of the mortgagee's security interest in the rents.

Receivership Availability.  The ability to appoint a receiver varies among jurisdictions. The application is generally made in connection with an application for judicial foreclosure, or as a separate action if nonjudicial foreclosure is being pursued.

In many jurisdictions there is statutory governance. Absent statutory guidance to the contrary, courts will often require a showing of elements such as a risk that security is not adequate to cover the loan balance, danger of physical waste or borrower insolvency.

Receivership in Minnesota

Minnesota is a lien theory state. Consequently, a mortgagee generally does not have a right to possession of the collateral prior to foreclosure absent an agreement with the mortgagor following default. Minnesota statutes permit enforcement of an assignment of rents without receivership, but only if the assignment requires that rents must be applied as required by the receivership statutory guidelines.

Governing Statutes.  Receivership is governed by Minn Stat. § 576.01, subd. 2 and Minn. Stat. § 559.17. The statutes provide that a receiver shall be appointed upon a showing that events specified in an assignment of rents have occurred that provide for receivership, or upon application to the court after first publication of notice of sale for foreclosure or with commencement of action to foreclose—in both instances if the principal amount is $100,000 or more—and a residential or homestead exemption or agricultural exemption does not apply. In addition, the court is supposed to appoint a receiver upon a showing that the mortgagor has breached a covenant in the mortgage relating to any of the following:

1. Application of tenant security deposits (as required by Minn. Stat. § 504B.178)
   
2. Real estate taxes or special assessments
   
3. Payment of insurance premiums for insurance required by the mortgage
   
4. Keeping certain covenants required of a landlord or licensor

Receiver Requirements.  The receiver is supposed to be an experienced property manager. The receiver is required to collect the rents, profits and income; manage the mortgaged premises; execute leases approved by the court; pay expenses of normal maintenance; and perform the terms of the assignment of rents (in compliance with a statute). The receiver is also required to apply property income in the order required by the statute (see 1–4 above), after payment of receiver fees approved by the court.

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Further details are necessary for complete understanding of the subjects covered by this article. For that reason, the specific advice of legal counsel is recommended before acting on any matter discussed in these pages.