Indiana Commercial Foreclosure Law

IndyStar: Receivers for Apartments

Today's Indianapolis Star has an insightful article about property manager Buckingham's recent involvement as a receiver in several lawsuits to foreclose on loans secured by apartment property.  Here's a link:  When apartments fail Buckingham Cos. gets a call.  The Star highlights some of the practical (and challenging) aspects associated with the job   

If Requested, Receiverships In Indiana Commercial Mortgage Foreclosure Actions Are Mandatory

There are many scenarios when a secured lender might want a receiver to take possession and control of commercial real estate loan collateral in order to preserve and protect the property during the pendency of a foreclosure suit.  The purpose of today’s post is to explain that, in Indiana, a motion for the appointment of a receiver should be granted every time.

What controls.  Indiana’s receivership statute, Ind. Code § 32-30-5, including specifically section 1(4), governs the appointment of a receiver:     

IC 32-30-5-1
 Appointment of receivers; cases
  Sec. 1. A receiver may be appointed by the court in the following cases:

    (4) In actions in which a mortgagee seeks to foreclose a mortgage.

However, upon motion by the mortgagee, the court shall appoint a receiver if, at the time the motion is filed, the property is not occupied by the owner as the owner’s principal residence and:

        (C) either the mortgagor or the owner of the property has agreed in the mortgage or in some other writing to the appointment of a receiver. . . .

Most loans secured by commercial real estate will have a loan document containing a receivership provision, which is a clause stating that the lender/mortgagee is entitled to the appointment of a receiver if the borrower/mortgagor is in default.  In such cases, Indiana’s legislature has left no doubt that lenders are entitled to a receivership.

(Please note that subsection (B) provides another basis when “it appears that the property may not be sufficient to discharge the mortgaged debt” or, in other words, when the amount owed is greater than the value of the real estate.)

The essentials.  In order to have a receiver appointed in an Indiana commercial mortgage foreclosure action, mortgagees simply need to show:

 1.  the lender/mortgagee has filed a lawsuit seeking to foreclose a mortgage;
 2.  the property is not occupied by the owner as the owner’s principal
  residence; and
 3.  the borrower/mortgagor has agreed in a written loan document to the
  appointment of a receiver.

Not discretionary.  How do we know a receivership is mandatory in such cases?  Because the Indiana Court of Appeals has said so.  In Citizens Financial v. Innsbrook, 833 N.E.2d 1045 (Ind. Ct. App. 2005) (Innsbrook.pdf), the trial court refused to appoint a receiver in the plaintiff bank’s action to foreclose a mortgage on the real property of a country club.  On appeal, the Court examined the mortgage language, as well as I.C. § 32-30-5-1(4)(C): 

To meet the requirements of Ind. Code § 32-30-5-1(4)(C), Citizens must show:  (1) that it, as mortgagee, sought to foreclose the mortgage; (2) at the time the motion is filed, the property is not occupied by the owner as the owner’s principal residence; and (3) either the mortgagor or the owner of the property has agreed in the mortgage or in some other writing to the appointment of a receiver.

The evidence in Innsbrook established these requirements.  The Court of Appeals thus reversed the trial court and held that the court had abused its discretion by not appointing a receiver.  The Court of Appeals focused upon the “shall” language in the operative statute and noted  that the appointment of a receiver is mandatory if section 4, and any one of its conditions, which include subsection (C), are met. 

If you’re wondering whether your institution is entitled to the appointment of a receiver, or how difficult it may be to have one appointed, you can see that in Indiana it’s practically automatic.  If your loan is nonperforming and presents problems that call for the solutions provided by a receivership, then don’t hesitate to pursue a court-appointed receivership.  Should you need additional details about the process, or to discuss strategies surrounding whether or when to seek a receivership in the first place, stay tuned for future blog posts or, as always, feel free to contact me.

Potential Negligence Of An Indiana Receiver

Judge Theresa Springmann of the Northern District of Indiana issued an opinion on November 5, 2007 in the case FTC v. Think Achievement, 2007 U.S. Dist. LEXIS 82621 (N.D. Ind. 2007) (ThinkAchievementOpinion.pdf).  Think Achievement was a negligence case brought against a court-appointed receiver relating to the alleged failure to preserve and protect the assets of the receivership estate.  The opinion addresses some of the general rules in Indiana and the Seventh Circuit that apply to receivers.  Although the underlying case dealt with Federal Trade Commission Act violations, the opinion relates to secured lenders because of their interest in holding receivers accountable for the protection of the receivership estate. 

Why the suit?  The receiver failed to procure insurance for a valuable estate asset, specifically a private residence in Carmel, Indiana.  The residence was damaged by arson, and there was no insurance coverage for the fire-related losses.  The question was whether the receiver should pay for the damage. 

More background.  The court-appointed receiver was an attorney with no prior experience as a receiver.  Interestingly, he also acted as legal counsel for the receiver.  (In essence, he provided legal counsel to himself.)  The receiver understood he had a responsibility to protect the assets in the receivership estate, including keeping insurance on property.  He ultimately dropped the ball, however, despite a seemingly reasonable excuse.  (I won’t bore you with the relevant insurance law.) 

Legal theories.  The case was a negligence action asserting that the receiver breached his duty, owed to the receivership estate, “to exercise reasonable care to protect and preserve the assets of the receivership estate.”  Id. at 8.  Here are a couple important points cited in the opinion:

• Standard:  In carrying out the duties of a receiver, the receiver “must exercise ordinary care and prudence, that is, the same care and diligence that an ordinary prudent person would exercise in handling his or her own estate, or under like circumstances.”  Id.

• Help:  “If a receiver is uncertain how to preserve property, he should petition the court for instructions.”  Id.

In this particular case, the plaintiff argued that the scope of the duty included, specifically, a duty to obtain insurance for the protection of the estate assets and that the receiver breached that duty. 

Outcome.  The dispute did not center upon whether a duty existed.  Indeed, the defendant did not deny that he had a duty of care to the receivership estate requiring him to obtain insurance on insurable assets.  Id.  Instead, the issue was whether and to what extent he appropriately carried out that duty, and the Court held there was evidence from which a jury could conclude either way.  Although Judge Springmann pointed to facts unfavorable to the defendant, in the final analysis she held that the facts concerning whether the receiver breached (violated/failed to comply with) his duty did not “lend of themselves to only a single inference.”  Id. at 12.  In other words, whether the receiver conformed his conduct to the applicable standard of care was a triable issue of fact that must be reserved for the jury.   

The upshot for receivers.  There are a handful of points receivers can take away from the Think Achievement opinion.  First, a court-appointed receiver may be exposed to liability for damages if it acts unreasonably with regard to its duty to protect the assets of the receivership estate.  Second, if the receiver is faced with an issue and is unsure as to what to do, the receiver can and should petition the court for direction.  Finally, as suggested by Judge Springmann, it may be prudent to seek the assistance of outside legal counsel. 

Neither receivers, nor parties involved in a receivership, want to see unnecessary or avoidable expenses incurred.  Hiring lawyers and filing motions with courts can become expensive and can, indirectly, dissipate the assets of the receivership estate.  However, reasonable measures need to be undertaken to prevent damage to the property, such as the fire-related losses addressed in the Think Achievement case.  Receivers are well advised to consider the retention of legal counsel when confronted with a tricky issue. 

Lender applicability.  From the perspective of a secured lender, the Think Achievement case is important because it is a reminder that, not only is a receiver’s purpose to protect loan collateral, but an unreasonable failure to do so may expose the receiver to a damages claim.  Secured lenders might be able to seek recourse against receivers that negligently cause losses to the receivership estate.

Indiana Receivers Can Sue For Damages Suffered By The Receivership Entity

What happens if, as a secured lender, you file a foreclosure suit and have a receiver appointed, and during that process you learn of circumstances in which your borrower (a/k/a the receivership entity) has a claim for damages against a third party?  Because the financial wellbeing of a borrower usually inures to the benefit of the lender, it may be in the mutual best interests of the secured lender and the borrower to pursue a lawsuit against that third party.  Judge Hamilton of the USDC for the Southern District of Indiana addressed some general principles surrounding this issue in his September 5, 2007 opinion, Marwil v. Kluff, 2007 U.S. Dist. LEXIS 65996 (MarwilOpinion.pdf).  Marwil illustrates how a receivership might help a secured creditor get paid.   

Not a foreclosure, but applicable nonetheless.  The backdrop to the Marwil case was a civil enforcement action brought by the SEC.  The Court had appointed a receiver for the Church Extension of the Church of God, Inc. (CEG), an Indiana non-profit corporation founded to raise funds for an Indiana-based church with more than 230,000 members nation-wide.  CEG, the receivership entity, allegedly had been mixed up in multiple fraudulent conveyances associated with a highly complicated loan and real estate transaction scheme.  The specific issue in the Marwil opinion was the validity of the receiver’s suit against third parties based upon Indiana’s fraudulent transfer statute, Indiana Code §§ 32-18-2-14 and 15. 

Receivership rules and analysis.  The third parties (the defendants in Marwil) that allegedly participated in the fraud filed a motion to dismiss.  They argued that the receiver did not have standing to bring suit because the suit, in reality, was for the benefit CEG’s creditors, not CEG itself.  Judge Hamilton held, however, that the Complaint asserted CEG, the receivership entity (not the creditors), suffered actionable injuries.  Based upon those assertions in the Complaint, he denied the motion to dismiss.  Here are some of the general receivership rules that applied:

 The role of the receiver is to promote orderly and efficient management of property involved in a dispute for the benefit of the creditors.  Id. at 10.

 The benefit to creditors contemplated by receivership law, however, is only a derivative one.  The general rule is that a receiver may pursue only the rights and claims that belong to the receivership entity itself.  Id.

 For a receivership entity to possess claims, the entity itself must have suffered a cognizable, redressable injury reasonably traceable to the challenged action of the defendants.  Id. at 11.

 Fraud on the receivership entity that operates to its damage is for the receiver to pursue (and to the extent that investors as the holders of equity interests in the entity may ultimately benefit from such pursuit, that does not alter the proposition that the receiver is the proper party to enforce the claim).

Judge Hamilton concluded that “so long as the claims themselves seek redress for injuries suffered by CEG, [the receiver] can assert and pursue them against the defendants.”  Id. at 12. 

Indiana’s receivership statute.  Indiana Code § 32-30-5-7 states, in pertinent part:

The receiver may, under the control of the court or the judge: 
  (1) bring and defend actions;
  (2) take and keep possession of a property;
  (3) receive rents;
  (4) collect debts; and
  (5) sell property;
in the receiver’s own name, and generally do other acts respecting the property as the
court or judge may authorize.

For reasons unclear to me, Judge Hamilton did not cite to this statute in reaching his decision.  The Indiana statute may not have applied because the underlying action in Marwil dealt with SEC violations.  It is significant to note for purposes of this article, however, that the Indiana statute supports the proposition that receivers have the power to file lawsuits.

LENDER AND RECEIVER BOTH MAY PAY FOR MISMANAGED FORECLOSURE

If you deal with receiverships, this case will be of interest to you.  A lender, a borrower and a court-appointed receiver have been battling one another in an Indiana federal court in connection with a failed construction project.  Problems arose when a partially-constructed apartment complex deteriorated so much during a foreclosure suit that a judge condemned the property and ordered it to be demolished, resulting in damages alleged by the borrower of $4,167,881 (representing the purported value of the property pre-suit minus the value of the foundations of the buildings after demolition).  In Judge Philip P. Simon’s words, “assessing who is at fault for this mess is at the center of the action currently before the Court.”  In rulings filed September 18, 2006 and October 16, 2006, the Northern District’s Judge Simon brought some order to the chaos in case no. 2:02cv368, Four Winds v. American Express Tax and Consulting Services, et al.  The cite to the September Opinion, which relates to the borrower’s claims against the receiver, is 2006 U.S. Dist. LEXIS 71349.  The October Opinion, which addresses the receiver’s cause of action against the lender, can be found at 2006 U.S. Dist. LEXIS 75581.

Lender spanked.  The litigation began when the lender decided to foreclose.  The borrower filed a counterclaim asserting wrongful foreclosure because there had been no default.  The borrower convinced the court that no default occurred, so the court dismissed the foreclosure aspect of the case.  The lender then settled with the borrower for a “hefty amount” on the counterclaims.   

Receiver faces trial.  The borrower also is pursuing the receiver for negligently failing to protect and preserve the project.  An agreed order governed the receiver’s conduct, and the issue is whether the receiver was grossly negligent.  The receiver sought a dismissal of the claim by submitting evidence that it did not act with gross negligence.  In fact, the receiver undertook at least some measures to protect the property.  But Judge Simon ruled that the case must go to the jury to decide factual issues, including:  (1) how the project would have faired had the receiver not undertaken the protective measures that it did, (2) how much damage would more extensive protective measures have prevented, (3) why the receiver did not apply to the court for permission to complete the project or for funding to implement more extensive measures, (4) how many times should the receiver have visited the project and (5) whether the receiver was grossly negligent in fulfilling its duties as the receiver.  The case is set for a jury trial on February 20, 2007. 

Receiver v. lender dismissed.  The receiver, in turn, had its own negligence claim against the lender, which claim really was about seeking reimbursement for any damages the receiver might have to pay to the borrower.  The receiver pointed the finger at the lender, arguing that the lender controlled the receiver’s actions through the funding (or lack thereof) of the receivership.  Judge Simon held there was no legal basis for the receiver’s position, however, and dismissed the claim.  If any negligence-based duties flowed between the parties, they flowed from the receiver to the lender, not vice versa.  Thus the receiver, if found to be grossly negligent, cannot recoup any losses from the lender (although the receiver may be entitled to a credit/set-off for the money the lender paid to the borrower.)

Interestingly, the agreed order appointing the receiver required the receiver to preserve and protect the property with receivership funds, even though there were no “receivership funds” to do so because the property generated no income.  That catch-22 may have been the property’s downfall.  The receiver was responsible for directing the preservation of the property, but on whose dime?  Evidently there was an informal arrangement whereby the lender funded the receivership.  That went okay at the beginning, but the problems and costs later seemed to snowball out of control.  I gather that, if and to the extent the receiver was negligent, it was due in part to inadequate funding by the lender.  The confidential “substantial” settlement the lender paid to the borrower supports my speculation. 

Lessons.  Even though the lender won its legal battle with the receiver, the lender had already lost when the project failed and the borrower forced the lender to settle.  There are some lessons here for lenders (and receivers):

• Ensure there is a default before a foreclosure case is initiated
• Spell out in the receivership order exactly how the receivership will be funded
• Clarify in the order the duties of the receiver, and the borrower or lender as warranted
• If the lender agrees to fund the preservation of the property, it should take reasonable steps to do so and should not unreasonably permit a project to deteriorate substantially in value

But perhaps the greatest lesson is - in cases of construction loans where the collateral is being built - lenders should foreclose and appoint a receiver only as a last resort.