Effectiveness of Contractual Receivership Clauses for Operating Companies

6 Min Read By: Aaron Walden, Sheryl Toby, Matt Ochs

IN BRIEF

  • Contractual provisions permitting a creditor to have a receiver appointed upon a default is likely to be applied differently for operating companies compared to single asset real estate cases.
  • In a recent Michigan federal case, the court granted a receiver for an operating company through consideration of both equitable factors and the contractual provision and determined that some of the traditionally applied equitable factors held little weight in light of the contractual receiver default provision.
  • The conclusion is that existence of a contractual receivership provision may be a strong factor considered by courts and tip the scale in favor of the appointment when weighing other factors.

A receivership occurs when a court appoints a third party to exercise independent oversight on specific assets. Although receiverships are commonly involved in real estate transactions, they can also arise when commercial borrowers are in distress, in cases of corporate deadlock, and in the event of litigation where the rights of the parties cannot otherwise be fully protected. In some cases, even for large operating companies, courts have appointed receivers and granted the receivers authority to take complete control of defendant’s business operations, including determining whether to sell or wind-down business affairs.

Contracts, particularly lending agreements, often contain clauses authorizing appointment of a receiver upon default. The question is: how effective are these provisions for operating companies (versus single asset real estate matters in which receivers are often appointed on an ex parte basis[1])? This issue often arises in the context of a contentious relationship in which the borrower refuses to file a bankruptcy case, and commencing an involuntary case is unavailable to the lender. The answer appears to be that although the receivership provision alone is not likely to be determinative as to whether to appoint the receiver, it may be considered by courts as a strong factor in the lender’s favor.

The issue over the effectiveness of a receivership provision was recently tested in The Huntington National Bank v. Sakthi Automotive Group USA, Inc., et al.[2] In Sakthi, Sakthi Automotive Group (Sakthi Automotive), a critical component supplier of automotive parts, defaulted on its loan obligations to Huntington National Bank (the Bank). The Bank sought a preliminary injunction prohibiting Sakthi Automotive from destroying, selling, transferring, or performing other similar acts with respect to the collateral. The Bank also sought the appointment of a receiver with broad powers, including to operate and sell the company pursuant to the terms of the parties’ credit agreement:

Upon the occurrence of an Event of Default and at all times thereafter, the Lender shall be entitled to the immediate appointment of a receiver for all or any part of the Collateral, whether such receivership is incidental to the proposed sale of the Collateral, pursuant to the Uniform Commercial Code or otherwise. Each Loan Party hereby consents to the appointment of such a receiver without notice or bond, to the full extent permitted by applicable statute or law; and waives any and all notices of and defenses to such appointment and agrees not to oppose any application therefor by the Lender, but nothing herein is to be construed to deprive the lender of any other right, remedy, or privilege the Lender may have under law to have a receiver appointed, provided, however, that, the appointment of such receiver shall not impair or in any manner prejudice the rights of the Lender to receive any payments provided for herein. Such receivership shall at the option of the Lender, continue until full payment of all the Obligations.

The court denied the motion for a preliminary injunction, finding, among other things, that the Bank could not establish irreparable harm because its injury could be fully compensated by money damages. However, irreparable harm was not a necessary factor for the court to consider in appointing a receiver; therefore, the Bank’s request to protect its collateral could be accomplished through appointment of a receiver.

In addition to recognizing Sakthi Automotive’s express contractual consent to the appointment of a receiver, the court also considered several factors traditionally applied in federal cases appointing receivers:

1) the existence of a valid claim by the moving party
2) alleged fraudulent conduct
3) imminent devaluation, concealment, or loss of the property
4) inadequate alternative legal remedies (such as money damages)
5) lack of a less drastic equitable remedy
6) whether appointment of a receiver will do more harm than good

As an equitable remedy, case law regarding the appointment of receivers generally suggests the weight of each factor is within the court’s discretion.

In initially considering the contractual provision, the court determined that there was no dispute that at least one default existed under valid contracts. The court found the unambiguous receivership provision to weigh in favor of appointing a receiver but continued to consider the factors referenced above. In so doing, the court determined that the Bank met the first three factors. As to the sixth factor, Sakthi Automotive failed to establish that the receiver will do more harm than good. That left the fourth and fifth factors, and as to these, the court placed great weight on the receivership provision and found that these factors had “little relevance” given the existence of the contractual provision. The fact the court gave “little relevance” to the fourth factor due to the contractual provision is particularly noteworthy in that the court previously determined the Bank could be fully compensated with money damages when denying the preliminary injunction request.

In its motion for reconsideration, Sakthi Automotive challenged only the fraudulent conduct, diminished value, and the “more harm than good” factors—not the factors given “little relevance” in light of the contractual provision. The court denied the reconsideration motion and noted that although there is disagreement about whether a contractual receiver provision is dispositive, in this matter both the contractual provision and the factors outlined in receivership case law favored a receivership in this case. The court entered an order granting the receiver broad operating power over the company assets.

In the end, for operating companies there are numerous reasons why a court may be reluctant to find that a receiver provision coupled with the existence of a default would indisputably lead to appointment of a receiver without proof of additional considerations. However, the existence of the contractual provision may be a strong factor considered and tip the scale in favor of the appointment when weighing the other factors. Indeed, a court may, as it did in Sakthi, determine that certain factors are met by the existence of a contractual provision.


[1] For real estate matters, see generally Uniform Commercial Real Estate Receivership Act, § 6, cmt. 2 (“there is significant recent authority supporting the view that a receivership clause alone provides a sufficient basis to appoint a receiver after the mortgagor’s default.”) (citations omitted). See also Britton v. Green, 325 F.2d 377, 382 (10th Cir. 1963) (holding that a contractual provision involving oil and gas leases was sufficient to appoint a receiver: “By the terms of the mortgage, the mortgagor expressly agreed that in the event of a foreclosure suit, the mortgagee is entitled, ‘as a matter of right,’ to the appointment of a Receiver to take possession and control of, operate, maintain and preserve the mortgaged property. . . .”).

[2] 2:19-cv-10890 (E.D. Mich. 2019). See also PNC Bank, Nat’l Ass'n v. Goyette Mech. Co., 15 F. Supp. 3d 754, 758 (E.D. Mich. 2014) (“the parties’ advance consent to the appointment of a receive (sic) is a strong factor weighing in favor of appointing one.”); Am. Bank & Tr. Co. v. Bond Int’l Ltd., No. 06-CV-0317-CVE-FMH, 2006 U.S. Dist. LEXIS 58361, at *21–*23 (N.D. Okla. Aug. 17, 2006) (unpublished) (appointing a receiver for an operating company’s collateral based on the Tenth Circuit’s approval of a security agreement’s receivership provision in Britton, supra note 1, and case law equitable factors).

ABOUT THE AUTHORS

Bloomfield Hills, MI

Sheryl Toby

Sheryl Toby (Member at Dykema) has substantial experience in two unrelated fields. First she regularly advises manufacturing entities (such as automotive clients)…

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