Lenders are finding that taking properties back is the easy part. As the number of real estate-owned (REO) properties in California mount, a challenge for lenders is identifying purchasers with access to acquisition financing and an appetite to take on bank-owned properties.

As an alternative to non-judicial foreclosure, the use of court-appointed receivers to manage, market and ultimately sell distressed properties is gaining momentum in the state.

Advantages abound

For lenders and CMBS loan servicers, there are a number of benefits — both economic and legal — to having a receiver appointed to sell non-performing real estate assets.

For many assets, opting for the appointment of a receiver to operate and ultimately sell a property can save the lender considerable time and money. With a cooperative borrower, the lender’s counsel can seek an expedited “ex parte” motion, which allows the lender to proceed to a hearing without the requirement of giving notice to all parties. These hearings can take place within a couple of days.

Though requirements and timing vary by county in California, an ex parte application for the appointment of a receiver requires a showing that there will be imminent and irreparable harm unless the receiver is appointed on an expedited basis.

Such a showing generally must be fairly clear if the ex parte application is opposed. But if unopposed, many courts will treat a stipulation in the loan documents allowing for the appointment of a receiver “without notice” as sufficient evidence of such a showing.

Even where a showing of imminent and irreparable harm cannot be made, however, a motion for a receiver can be heard on regular notice given at least 16 court days before the hearing, such that a hearing on a noticed motion can generally be accomplished in 25 to 30 days.

Compared with a minimum of 110 days from start to finish for a non-judicial foreclosure sale, the time saved in opting for the appointment of a receiver can be substantial. Even in the case of a borrower bankruptcy filing, in certain circumstances a bankruptcy court may permit a state-court appointed receiver to remain in place during the bankruptcy proceedings.

Once a receiver is appointed, provided the order contains authorization to do so, many state courts will permit it to market the property for sale, which can now be done in a more orderly fashion, untainted by the stigma of a foreclosure sale. With the rents stabilized and a new management team in place, this approach can yield a significantly higher disposition price for the lender.

Care should be taken, however, to ensure that the language of the appointment order provides express authority for the receiver to market the property for sale and, subject to court approval, ultimately sell the property. In the case of a securitized loan, it is also advisable to include provisions relating to the authority of the receiver to assign the existing loan documents to a purchaser on behalf of the borrower, subject to the lender’s consent to such a loan assumption.

As for cost savings, with a non-judicial foreclosure involving a large asset securing a $100 million loan, for example, trustee fees, the cost of the trustee sale guarantee (“TSG”) and other fees and costs could run anywhere between $90,000 and $120,000.

By comparison, legal fees and costs incurred in having a receiver appointed in uncontested proceedings would be, in most cases, just a fraction of this amount. Because the calculation of trustee fees and the cost of the trust sale guarantee are based on the size of the loan, costs savings will vary from asset to asset.

Shelter from lender liability

The legal advantages to a lender in using a court-appointed receiver to shield it from liability are well established. Because the receiver is an officer of the court and not the lender’s agent, provided the receiver does not deviate from the terms of the order of appointment, it and the lender are protected from “mortgagee-in-possession” and other lender liability claims that may arise if the lender were to take control of the property or collect the rents itself.

Moreover, unlike a trustee sale where the lender or a special purpose entity controlled by the lender makes a credit bid to acquire the property with the goal of disposing of it as REO, this arrangement allows a lender to avoid stepping into the chain of title to the property.

In this way, a lender is shielded from potential direct liability for environmental conditions on the property, construction defects in the case of a partially completed project, building code and life/safety violations, and other matters that, while they may not be known at the time the lender forecloses, can surface long after the lender has disposed of the property.

REMIC benefits

Finally, for securitized mortgage loans there are unique advantages to conducting the sale of a distressed property through a receiver. Securitized loans exist, in large part, because the Internal Revenue Code allows income from these loans to pass through the real estate mortgage investment conduit (REMIC) to certificate holders without paying tax at the REMIC trust level.

Although significant modifications to a securitized loan in the loan pool can jeopardize this tax-free status, loan modifications caused by a borrower’s default do not. Once a defaulted securitized mortgage loan is foreclosed on, however, the REMIC is not permitted to originate new loans to assist in a purchaser’s acquisition of the REO. The loan servicer must sell the property for cash only.

Given the lack of availability of acquisition financing and limited number of qualified purchasers, this restriction has contributed to an oversupply of REO properties, further depressing purchase prices. Because there is no adverse effect on the REMIC associated with either a modification of the existing defaulted mortgage loan, or the assumption of the loan, as modified, by a prospective purchaser, loan servicers can offer seller financing to purchasers through a receiver sale.

This would not be available through the foreclosure process, where the existing mortgage debt is extinguished by the trustee sale. Servicers are then in a better position to dispose of distressed assets at the maximum possible price, thereby minimizing losses to the REMIC’s bondholders.

J. David Larsen is a partner in the Los Angeles office of McKenna, Long & Aldridge LLP, where his practice focuses on loan workouts, real estate finance, real property acquisition and disposition, commercial lending, and commercial leasing. He can be reached at dlarsen@mckennalong.com.