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§ 543 Turnover Requirements Amid The Receivership Renaissance

The Great Recession of recent years brought about a resurgence in popularity in the receivership, one of the oldest pre-judgment remedies available to creditors. A leading treatise on receiverships is Ralph Ewing Clark’s Treatise on the Law and Practice of Receivers 3d (“Clark on Receivers”), originally published in 1918 and last updated with its 1968-69 supplement. Ohio’s current receivership statute, O.R.C. § 2735.01, et seq., took effect on October 1, 1953, over 60 years ago, and courts in Ohio have been considering receiverships for over 100 years. See eg., Cincinnati, Sandusky & Cleveland RR. v. Sloan, 31 Ohio St. 1, 12 (1876).

Regardless, the receivership renaissance has touched Ohio, demonstrated by various court decisions statewide and the Ohio legislature’s recent efforts to revise the current receivership statute beginning in late 2012: Senate Bill No. 388, Substitute House Bill No. 610, and Substitute House Bill No. 9. Despite the rise in popularity, the body of law concerning receiverships is sparse in comparison to the body of federal bankruptcy law.

The appointment of a receiver is frequently sought by a secured creditor in the context of a foreclosure or similar proceeding. With creditors favoring receiverships to preserve property of a debtor during a pending controversy, many debtors are naturally invoking the relief afforded by the Bankruptcy Code to regain possession of their property.

Turnover Requirements of § 543

A receiver is a “custodian” within the meaning of § 101(11). 11 U.S.C. § 101(11); See Paren v. Noneman (In re Paren), 158 B.R. 447, 450 (Bankr. N.D. Ohio 1993); In re Synergy Properties, Inc., 130 Bankr. 700, 703 (Bankr. S.D.N.Y. 1991); Foundry of Barrington P’ship v. Barrett (In re Foundry of Barrington P’ship), 129 B.R. 550, 557 (Bankr. N.D.Ill. 1991). Under § 543 a “custodian” who has knowledge of the commencement of a bankruptcy case is generally barred from taking any further action in the administration of the debtor’s property and must turnover any assets of the estate in its possession. 11 U.S.C. § 543(a) and (b); In re Lizeric Realty Corp., 188 B.R. 499, 506-507 (Bankr. S.D.N.Y. 1995). A custodian must deliver to the debtor in possession or trustee any property that is in its possession, custody or control when the custodian acquires knowledge of the commencement of the case. In re South Side House, LLC, 474 B.R. 391, 405 (Bankr. E.D.N.Y. 2012).

Excusing Compliance with the Turnover Requirements of § 543

Despite § 543(a) and (b), under § 543(d) the creditor can seek to excuse the receiver from compliance with the turnover requirements. Pursuant to § 543(d)(1), the court must consider whether the interest of creditors is better served by the receiver remaining in possession of the debtor’s assets. Courts typically consider some of the following non-exhaustive factors: likelihood of reorganization; probability that funds required for reorganization will be available; whether there are instances of mismanagement by the debtor; whether the debtor will use the turnover property for the benefit of creditors; and the existence of avoidance claims. See In re Poplar Springs Apartments of Atlanta, Ltd., 103 B.R. 146, 150 (Bankr. S.D. Ohio 1989); In re Falconridge LLC, 2007 Bankr. LEXIS 3755, *21, 22 (Bankr. N.D. Ill. 2007) (citations omitted); Dill v. Dime Sav. Bank, FSB (In re Dill), 163 B.R. 221, 225 (E.D.N.Y. 1994) (citations omitted). Even if these factors are resolved in favor of the debtor, the court may still excuse compliance if turnover would be injurious to creditors. In re Poplar Springs Apartments of Atlanta, Ltd., 103 B.R. at 150.

Essentially, § 543(d) is a modified abstention principle that echoes the abstention doctrine of § 305. See In re Constable Plaza Assocs, L.P., 125 B.R. 98, 103 (Bankr. S.D.N.Y. 1991) (citing In re Pine Lake Village Apt. Co., 17 B.R. 829, 833 (Bankr S.D.N.Y. 1982)); see also Matter of WPAS, Inc., 6 B.R. 40, 43 (Bankr. M.D. Fla. 1980). § 305(a) authorizes dismissal or suspension of proceedings only in the interest of both the creditors and the debtor. Foundry of Barrington P’ship v. Barrett, 129 B.R. at 555. Unlike § 305, with § 543(d) the sole concern is the interests of all creditors. In re Poplar Springs Apartments of Atlanta, Ltd., 103 B.R. at 150. The interests of the debtor are not to be considered in the court’s decision. Id. (citing Dill, 163 B.R. at 226; Foundry of Barrington P’ship, 129 B.R. at 557).

§ 543(d) provides that a custodian may be excused from the turnover requirements “after notice and hearing.” § 102(1)(A) defines notice and a hearing to mean such notice and opportunity for a hearing as is appropriate in the particular circumstances; however, nothing in the statute necessarily requires an evidentiary hearing be held. Dill, 163 B.R. at 224.

If the bankruptcy court excuses a receiver from turnover, the receiver remains subject to the terms of the prepetition order appointing receiver, but the bankruptcy court may enter further orders to supervise the receiver. In re 400 Madison Ave. Ltd. Pa’ship, 213 B.R. 888, 898-899 (Bankr. S.D.N.Y. 1997).

Payment of the Receiver’s Outstanding Fees Upon Turnover

In the event a receiver is not excused from turnover, the receiver is required to deliver to the debtor in possession any property of the debtor that is in the receiver’s possession, custody or control on the date it acquires knowledge. 11 U.S.C. § 543(b)(1); In re South Side House, LLC, 474 B.R. at 405. Generally, in addition to possessing a debtor’s property, a receiver maintains deposit accounts wherein prepetition profits from the receivership property are deposited, often consisting of prepetition rents. Whether a prepetition receivership account constitutes property of the estate is determined by state law. See In re Buttermilk Towne Ctr., LLC, 442 B.R. 558, 562 (B.A.P. 6 th Cir. 2010) (citing Butner v. United States, 440 U.S. 48, 54, 99 S.Ct. 914, 915, 59 L. Ed.2d 136 (1979)); Oakland Gin Co. v. Marlow (In re Julien Co.), 44 F.3d 426, 428 (6 th Cir. 1995) (citing In re White, 851 F.2d 170, 173 (6 th Cir. 1988)).

Upon a specific pledge of the rents, either in a mortgage or an assignment of rents, Ohio state law dictates that prepetition rents and profits held by a receiver in receivership accounts are not property of the estate. A mortgagee is entitled to the rents and profits of real property if the mortgage or assignment of rents expressly includes a specific pledge of the rents and profits, and the mortgagee takes possession of the premises, or takes some action, such as the appointment of a receiver, to reduce the rents and profits to possession. In re Sam A. Tisci, Inc., 133 B.R. 857, 859 (N.D. Ohio 1991); In re Pfleiderer, 123 B.R. 768, 769 (Bankr. N.D. Ohio 1987) (citing 69 O.Jur.3d Mortgages, § 151 (1986)). A mortgagee is entitled to the rents and profits of the mortgaged premises when it takes actual possession of the premises, when possession is taken on its behalf by a receiver, or when it demands such possession. Perin v. N-Ren Corp., 1988 Ohio App. LEXIS 2089, *10 (12 th App. Dist. 1988). Moreover, the state appellate court in Banks v. Heritage Prop. Group, LLC, 2014-Ohio-991, 2014 Ohio App. LEXIS 943 (12 th App. Dist. 2014), recently opined that the ownership interest in rents transfers from a mortgagor to a mortgagee upon the appointment of a receiver. Banks v. Heritage Prop. Group, LLC, 2014-Ohio-, at *P24, 2014 Ohio App. LEXIS 943, at **20.

Futhermore, the sixth circuit recognized that funds held in trust or in similar capacity are not property of the estate. See Stevenson v. J.C. Bradford & Co. (In re Cannon), 277 F.3d 838, 849-51 (6th Cir. 2002); FDIC v. AMFin Fin. Corp., 2014 U.S. App. LEXIS 12807, *15-*20; 2014 FED App. 0142P, **8-**10 (6 th Cir. 2014).

When a receiver is appointed prepetition upon a creditor’s request, the creditor took the necessary action to reduce rents and profits to possession. Consequently, under Ohio state law the funds held in a prepetition receivership account are not property of the estate and not subject to the turnover of § 543 or the automatic stay of § 362. Therefore, typically the outstanding fees of the receiver should be paid from the prepetition funds collected by the receiver, subject to the terms of the prepetition order appointing receiver, with any remaining balance being disbursed to the secured creditor in partial satisfaction of its claim.

Notwithstanding, some courts have reached the opposite outcome, such as the In re South Side House court which determined that prepetition rents are property of the estate even when the debtor has lost possession of the rents to a receiver, albeit the court applied New York state law. In re South Side House, LLC, 474 B.R. at 406. (citations omitted).

If the prepetition receivership funds are insufficient to pay the outstanding fees of the receiver, or are determined to be property of the estate and subject to turnover, then § 543(c) provides the receiver is entitled to be paid reasonable compensation related to the performance of its obligations. Those fees are entitled to administrative expense priority pursuant to § 503(b)(3)(E) and (b)(4).

Deep Thoughts (In Closing)

§ 543 and the appointment of receivers pursuant to non-bankruptcy law will remain in tension. The turnover requirements of § 543(a) and (b) are the rule, and excuse from compliance with those requirements under § 543(d) is the exception. Receivers must be familiar with the requirements of § 543, and secured creditors seeking to continue a receivership must be prepared to demonstrate that the interests of creditors are better served by doing so.