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Receivership – Definition and Impact on Investors

What Is Receivership?

Receivership

Receivership is a court-appointed condition placed on a company to protect property controlled by a person sued in court. It is a legal remedy available to secured creditors to recover outstanding amounts in the event the company defaults on its loan payments.  Receivership and bankruptcy are not synonymous, nor are they mutually exclusive. They can occur concurrently, or a receivership can occur without a corporation going bankrupt.

A receivership is a court-appointed mechanism that can help creditors recover overdue funds.  At the same time, it can help distressed businesses avoid bankruptcy. If a borrower fails on a loan, a receivership in place makes it easier for a lender to recover outstanding funds. A receivership may also occur as a step in the restructuring process of a corporation.  This procedure is launched in an attempt to return a company to profitability. A receivership may also be imposed as a result of a shareholder disagreement.  For example, in order to complete a project, liquidate assets, or sell a corporation.

Receivership – A Closer Look

In general, a receivership is a process used to protect a firm. A receivership phase can be viewed as a safety net for a distressed corporation. During this period, a court-appointed receiver, or trustee, takes over the management of the entire firm.  The receiver controls the firm’s assets, as well as all financial and operational decisions. The company’s principals remain in position as substantial contributors while the receivership is in effect.  However, their authority is limited.

Traditionally, a receivership was meant to assist creditors in recovering sums owed under a secured loan.  It was utilized in the event that a borrower defaulted on its loan payments. Receiverships are still one of the most effective measures for protecting creditors. However, companies in financial hardship may also utilize receivership protection. A court can order a receivership as part of a firm’s restructuring process when a firm is under financial strain.  This allows the firm to make significant changes to its financial or operational structure. In this capacity, a receivership is an intermediary step in an effort to avoid bankruptcy.

A receivership is not a legal process in and of itself.  However, it is often ordered in conjunction with legal proceedings.  Either the secured creditor (lender) or a court of law appoints a receiver to act as trustee of a business. Privately appointed receivers usually only act on behalf of the secured creditor who appointed them.  Whereas, court-appointed receivers work on behalf of all creditors. The receiver must be an independent person with no past business relationship with either the borrower or the lender.  Further, he must carry out his obligations in an unbiased manner.  This means the receiver can never act in favor of one party at the expense of the other.

What Are the Responsibilities of a Receiver?

In the event of a restructuring, the appointed receiver usually has the last word regarding the company’s assets.  This includes management decisions and the authority to discontinue paying dividends or any interest payments. In addition, the receiver ensures that all past corporate operations adhere to government laws and standards.  All the while, ensuring efforts are made to keep the enterprise functioning and still maximizing profits.

Sometimes, the receiver works with the company to avoid bankruptcy while completing the liquidation of all assets. Other times, the receiver may choose to sell off certain assets in order to pay secured creditors.  The remaining efforts are then devoted to putting the company back on track as a going concern. However, if these attempts fail or are insufficient, the court may order the entire liquidation of a company’s assets. A liquidator would then manage the sale of assets and collect the proceeds to repay creditors. In that case, the corporation will cease to exist after all of its assets have been sold.

  • Privately Appointed Receivers – will often only function on behalf of the secured creditor who appointed them.  They will only attempt to recover assets covered by the loan agreement of the particular creditor who appointed them.
  • Court Appointed Receivers – are officers of the Court who work on behalf of all creditors. Court Appointed Receivers’ powers and rights are outlined in the Court order that appoints them.

Federal Court-appointed Receivership – To Protect Investors

Federal courts have special authorities, known as “equitable” authority.  The receiver’s authority is governed by the court’s order, which is based on the court’s authority. They can award relief in order to further the purposes of federal securities laws, safeguard investor funds, and guarantee that wrongdoers do not profit from their unlawful actions. Federal courts often grant receivers considerable authority.

The court’s order governs the authority of the receiver and is based on the court’s authority.  Federal courts have specific powers, known as “equitable” authority, to order relief to advance the purposes of the federal securities laws, preserve investor funds, and ensure that wrongdoers do not profit from their unlawful conduct.  Courts typically grant broad powers to receivers, including the authority to sue on behalf of the receivership and to gather, manage and liquidate receivership assets on behalf of potential creditors and harmed investors.  Special legal requirements apply to receivers.  A receiver must act in “good faith” and perform his or her duties with “reasonable diligence.”  A receiver is generally required to account to the court periodically for the property entrusted to him or her. (Source: sec.gov)

Receivership vs Bankruptcy

The phrases receivership and bankruptcy are sometimes used interchangeably.  However, the underlying differences are straightforward.

Bankruptcy

Bankruptcy is typically used to insulate a debtor from collection actions by creditors. Courts and rules are designed to protect the borrower, not the lender. A corporation may declare Chapter 11 bankruptcy if it needs more time to overcome its financial problems while continuing to operate.  When a firm files for Chapter 7 bankruptcy, it is typically for the purpose of liquidating and closing a business.  Other types of bankruptcies exist, but these two are the most common.

Receivership

A receivership, unlike bankruptcy, is not a legal action, but rather an alternative remedy. A receivership is used to protect the assets of a secured lender during an interim period.  For example, while a foreclosure action is proceeding. In this scenario, the secured creditor requests that the court maintain its security or collateral. This might be in the form of land, buildings, company income, cash, and other assets—until the foreclosure is completed. The assets are received by an independent party on behalf of the court.  The receiver remains in control and management of those assets until discharged by the court.

Up Next: Prop Trading – What is Proprietary Trading?

Prop TradingProp trading is the proprietary trading activity that occurs when a bank or firm trades stocks, derivatives, bonds, commodities, or other financial securities on its own behalf for its own economic gain. A financial firm or commercial bank that invests for direct market advantage rather than generating commission dollars by trading on behalf of clients is said to engage in prop trading. This sort of trading activity occurs when a financial business chooses to profit from market activities on its own behalf rather than by thin-margin commissions collected from client trading activity. Proprietary trading may include the purchase and sale of stocks, bonds, commodities, currencies, or other financial products.

Financial firms or commercial banks that participate in proprietary trading believe they have a competitive advantage.  As a result, they believe it allows them to outperform index investing, bond yield appreciation, or other investment methods.

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