Considerations for Municipal Bondholders in Pursuing a Receivership

A neutral party takes possession of and administers assets subject to court oversight and for the benefit of all stakeholders. In certain circumstances, a court-ordered receivership may be preferable to a bankruptcy filing because it is less expensive and therefore beneficial for creditor recoveries. In others, a receivership is the only practicable avenue to any creditor recovery. This client alert discusses key issues for municipal bondholders considering the pursuit of a receivership.

Nature of Receiverships

A receivership is a type of insolvency proceeding directed by a state or federal court, but it is not a bankruptcy proceeding. A receiver is a representative (sometimes considered an officer) of the court that appoints it. Although a creditor may bring an action in court seeking the appointment of a receiver, that receiver is neither an agent for the creditor nor a trustee who acts for the benefit of all creditors. Rather, a receiver’s role is like an administrator of assets with duties owed toward all persons of interest in the assets. Regardless, receivers are subject to the court’s directions. Critically, a receiver’s duties, obligations, and powers are prescribed and defined by an order signed by the court.

When a Receivership Becomes the Preferable Remedy

There are several reasons why municipal bondholders would prefer a receivership to a bankruptcy or other remedial actions:

• A borrower that is a municipality must be permitted to file for bankruptcy by state law to be eligible for Chapter 9 bankruptcy protection under federal law. If state law does not permit it, bankruptcy will not be an option, and a receivership could be the best option.

• A borrower that is a utility may be prohibited by law from pledging a security interest or mortgage in its physical assets, like power lines and water pipes, to creditors. Thus, foreclosure is not an option. Instead, utilities will pledge a stream of revenues to their bondholders. Bondholders of a distressed utility are left with limited options for remedial action in a default scenario besides the appointment of a receiver to ensure that the pledged revenues are safeguarded.

• A borrower that is obligated on municipal bonds but not otherwise prohibited from filing for bankruptcy or pledging its assets as collateral may nevertheless prefer receivership because the benefits of a receivership outweigh the costs.

Benefits of Receivership

There are several benefits of a receivership, mainly by delivering control — through a tightly drafted receivership order — and cost-efficiency. The receiver steps into operational control and possession of assets, with fees typically negotiated up front with the stakeholders driving the appointment. Courts can authorize continued operations, impose or recognize litigation stays to prevent value-destructive creditor races, and approve sales of assets free and clear of claims. Compared to bankruptcy, the process usually involves fewer constituencies, no US Trustee Program oversight, and less procedural friction, often translating into lower burn and better net recoveries.

Consensual vs. Non-Consensual Receiverships

A receivership can be sought consensually or over objection of the borrower. A consensual appointment with the borrower accelerates transition, reduces motion practice, and preserves liquidity. Contested appointments remain viable through a lawsuit and motion practice in the appointing court, but expect higher costs, more evidentiary work, and greater interim risk.

The Receivership Order: Your Recovery Engine

The receivership order is the operating manual and the guardrails for the receivership. Results depend on careful drafting. Bondholders and the proposed receiver should negotiate it line-by-line before filing, ensuring the court grants the powers needed to stabilize operations, protect revenues, and execute the turnaround without serial returns to court.

Grounds for Appointment

Careful thought to the grounds for receivership must be given before filing an action for receivership in court. Receivership is an ancient equitable remedy. Nevertheless, states have enacted statutes pertaining to receiver’s appointment and the powers of receivers. Receivership is also available as a remedy in federal court, and federal receiverships are governed by the substantive law of the federal courts, which may be different from the receivership law in the state where the borrower is located.

Bond documents often give the bond trustee a “strict right” to appoint a receiver in an event of default. Nevertheless, because receivership historically has been an equitable remedy and subject to its own body of statutory and judge-made law, a court may not appoint a receiver solely due to a technical default under the bond documents.

For these reasons, the motion to appoint a receiver should detail all the facts warranting appointment of a receiver. For example, to the extent a borrower has been mismanaging their finances or operations, or incurring economic losses, the motion is more likely to be granted. A court may also require, before appointing a receiver, a finding that all other remedial actions would be ineffective. The motion should explain why other approaches to resolving the controversy would not work and why a receivership is the only appropriate course of action.

Conclusion

For distressed municipal and utility credits, especially where Chapter 9 is unavailable or asset liens are constrained, a receivership can be the most direct path to protecting revenues and maximizing bondholder recoveries. Outcomes are driven by forum selection, evidentiary rigor, and, above all, the precision and scope of the appointment order.