Commercial Restructuring & Bankruptcy Alert - October, 2009 - Part 2

Ninth Circuit Joins Eleventh, Holds There Is Federal Common Law Of Receivership By Mike C. Buckley

The U.S. Court of Appeals for the Ninth Circuit has held that there is a federal common law of receivership in the context of real property security interest, joining the Eleventh Circuit. Can. Life Assurance Co. v. LaPeter, 557 F.3d 1103 (9th Cir. 2009).

While most states have their own receivership statutes, federal law does not have a parallel statutory scheme. Federal Rule Civil Procedure 66 recognizes historical federal receivership practice but does not define the circumstances under which a receiver should be appointed. LaPeter, an appeal from a decision by the federal District Court of Idaho, clearly establishes for the first time in the Ninth Circuit that a receiver can be appointed in a diversity action to aid in the enforcement of a real property security interest.

LaPeter (a family trust) purchased a shopping center in Boise, Idaho, with financing from Canada Life. After several years, LaPeter approached Canada Life with a request to refinance the loan at a lower rate of interest. During the negotiations, LaPeter made representations about the shopping center's projected income and the status of negotiations over renewal of several of the tenants' leases. After committing to the loan, Canada Life discovered that the representations were false and cancelled its refinancing agreement.

LaPeter failed to find alternative financing and defaulted. Canada Life initiated a nonjudicial foreclosure against the property and filed an action in Idaho state court, seeking the appointment of a receiver to manage the shopping center and collect the rents pending foreclosure. LaPeter removed the case to federal court on diversity grounds.

Receiver Appointed The federal district court appointed a receiver with responsibilities typical of those appointed in the shopping center context: to manage and rent the property, collect the rents, provide insurance, provide maintenance and upkeep, and account for the income and disbursements. The district court made findings that tracked the requisites of the Idaho state receivership statute. Even so, the district court did not articulate whether it was relying on the federal common law or state statutory law to justify the appointment.

LaPeter appealed, and the Ninth Circuit affirmed.

The question as to what standards should be applied to justify the appointment of a federal receiver in a diversity action has not been fully addressed by the circuit courts. The Eleventh Circuit's decision in Nat'l P'ship Inv. Corp. v. Nat'l Hous. Dev. Corp., 153 F.3d 1289 (11th Cir. 1998) concluded that federal common law governed the appointment of federal receivers in a diversity case. The Ninth Circuit in LaPeter followed suit and went on to articulate the legal standards governing the appointment.

The court acknowledged that no single factor determined whether a receiver should be appointed. Instead, a number of factors need to be considered to make a decision.

The factors articulated by the court should come as no surprise to receivership lawyers. The court listed these circumstances to be considered, no one of which is dispositive:

Is there a substantial probability that the plaintiff has a valid claim? Has there been fraudulent conduct and how certain is the proof of that conduct? Is the property at risk of being concealed or damaged, or is it declining in value pending the foreclosure? Are the legal remedies available to the plaintiff inadequate to protect its security interest in the property? Where does the balance of equities point – does the injury to the secured creditor from allowing debtor uncontrolled use of the property outweigh the injury to the debtor as a result of the appointment of the receiver? Is the receiver the best remedy for the evils being considered – would a writ of attachment or some other procedure be more effective or fair? Managing Real Property In a 1960 opinion, the Ninth Circuit established additional factors that must be established in order to fully empower the receiver to manage real property collateral as opposed to just controlling the rents. In Viewcrest Garden Apartments, Inc. vs. U.S., 281 F.2d 844 (9th Cir. 1960), the court held that the plaintiff needed to show the doubtful financial standing of the defendant, the over-encumbered status of the property, and typically something in addition, such as the defendant's deliberate conduct to allow the property to deteriorate. LaPeter leaves these requirements in place.

Accordingly, the Ninth Circuit affirmed the district court's order appointing a receiver.

Finally, as in many federal common law contexts, the court had to grapple with the Erie Doctrine. Is a receivership in a diversity case a substantive or a procedural matter? If substantive, state law applies; if procedural, federal law does. In LaPeter, the Ninth Circuit determined that receivers were essentially procedural tools used to keep the status quo while the parties' substantive rights were determined under applicable state law.

Here, the claims over the alleged breach of contract claims by LaPeter against Canada Life were seen as substantive, but the court had no trouble concluding that Canada Life's foreclosure on its deed of trust and the associated receivership were procedural matters. So a federal common law of receivership did not violate the Erie Doctrine.

Going Forward The LaPeter decision may open up an additional opportunity for a party considering an application for a receivership. In some states, the state receivership law may be less favorable to the applicant than the nationwide federal common law of receivership articulated in LaPeter. If diversity jurisdiction is available over the defendant there, the federal court might be a better place to apply.

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