Commercial real estate foreclosures present a number of significant challenges to lenders, special servicers and their counsel that residential foreclosures do not. But residential foreclosures make up the vast majority of state courts’ foreclosure dockets, so the court system – including Judges and Master Commissioners – is often unfamiliar of the challenges associated with commercial foreclosures. This can result in delays, unnecessary expense and the associated frustration that invariably follows when a commercial real estate asset is tied up in Court.
Because of these characteristics of the state court system, lenders and special servicers should always consider whether federal court is a viable alternative forum for their commercial foreclosure matters. If it is – almost always because diversity of citizenship among the parties exists – then lenders should also consider whether to seek the appointment of a Receiver to manage and ultimately sell the property at issue. Just as foreclosure in federal court offers an alternative to the state court system, the appointment of a Receiver to conduct a public sale of commercial real estate offers an alternative to the potentially significant fees and delays associated with sales conducted by the U.S. Marshal.
Foreclosure claims arise under state law, so federal court jurisdiction of commercial foreclosure matters is generally proper only when there is diversity of citizenship among the parties. If a lender and a borrower are diverse (i.e., citizens of different states for purposes of determining jurisdiction), then litigation in federal court is possible. In the commercial mortgage backed securitization (“CMBS”) context, this analysis is slightly more complex. In that scenario, foreclosure actions are filed in the name of the trustee of the CMBS trust, but those trustees generally utilize special servicers to conduct the litigation. At least one court has recently held that the special servicer is not a real party in interest in the litigation and that, therefore, its citizenship is irrelevant for purposes of determining whether diversity jurisdiction exists.
Assuming diversity of citizenship exists such that litigation of the commercial foreclosure in federal court is appropriate, the appointment of a Receiver is governed by federal law. See, e.g., Chase Manhattan Bank, N.A. v. Turabo Shopping Center, Inc., 683 F.2d 25, 26 (1st Cir. 1982); 12 Charles Alan Wright et al., Federal Practice and Procedure § 2983, at 33-35 (2d ed. 1997). Whether the appointment of a Receiver is appropriate requires the analysis of a number of factors:
Under federal law, appointing a “receiver is an extraordinary equitable remedy,” which should be applied with caution. [Aviation Supply Corp. v. R.S.B.I. Aerospace, Inc., 999 F.2d 314, 316 (8th Cir. 1993)]; 12 Wright, Miller & Marcus § 2983, at 24. However, there is “no precise formula for determining when a receiver may be appointed.” Aviation Supply Corp., 999 F.2d at 316. Rather, federal courts consider a variety of factors in making this determination, including, for example: (1) “whether [the party] seeking the appointment has a valid claim”; (2) “whether there is fraudulent conduct or the probability of fraudulent conduct,” by the defendant; (3) whether the property is in imminent danger of “being lost, concealed, injured, diminished in value, or squandered”; (4) whether legal remedies are inadequate; (5) whether the harm to plaintiff by denial of the appointment would outweigh injury to the party opposing appointment; (6) “the plaintiff's probable success in the action and the possibility of irreparable injury to plaintiff's interest in the property”; and, (7) “whether [the] plaintiff's interests sought to be protected will in fact be well-served by receivership.” Moore's, § 66.04[b]; New York Life Ins. Co. v. Watt West Inv. Corp., 755 F.Supp. 287, 291 (E.D. Cal. 1991) (citing 12 Wright, Miller & Marcus § 2983).
Canada Life Assur. Co. v. LaPeter, 563 F.3d 837, 844 (9th Cir. 2009).
Commercial properties that serve as security for loans in default are prime candidates for the appointment of a Receiver. Whether they are office complexes, hotels or apartment buildings, they require management and upkeep, both of which may suffer during the pendency of the litigation. As such, lenders seeking to foreclose in federal court are often successful in obtaining the appointment of a Receiver to manage the property that is the subject of the foreclosure action.
But in addition to managing the property during the litigation, Receivers in federal court can also conduct the public sale through which the property is disposed. See 28 U.S.C. §§ 2001, 2002 and 2004. Public sales of property by a federal Receiver must be conducted “upon such terms and conditions as the court directs.” 28 U.S.C. § 2001(a). Similar to many states’ requirements, federal receivers are required to give notice of the public sale to be conducted in advance of the sale. 28 U.S.C. § 2002. Because of the simplicity of this structure, lenders have flexibility to ensure that the relevant property is managed, marketed and sold in a way that maximizes value in the most expedient way possible. And assuming the Receiver who is appointed is knowledgeable of commercial real estate and the local market, a sale conducted by a Receiver can be more effectively marketed.
Finally, in addition to the efficiency associated with sales of property by federal court Receivers, the fees for conducting the sale can be negotiated, whereas the fees charged by the U.S. Marshal can be substantial – the lesser of 1.5% of the sale price or $50,000 in the Western District of Kentucky. These advantages, coupled with the avoidance of delays caused by any docket backlog, make public sales by federal Receivers an attractive alternative to those conducted by the U.S. Marshal.