Under the gun Featured

8:00pm EDT October 26, 2008

If you and your fellow corporate managers cannot agree on critical elements of doing business or if an outsider thinks that mismanagement is limiting your ability to pay bills — look out. There may be a court-ordered receivership in your future.

“The receiver’s job is to literally operate the business,” says John Mark Jennings, a partner in the law firm of Shulman Hodges & Bastian LLP. “A receivership is an action brought against your company because it is being operated to the detriment of shareholders or creditors.”

After a receiver is appointed, maintaining the continuity of running the business may not necessarily be his or her first objective.

“If the right thing is to keep the business open, the receiver will do that,” Jennings says. “If a business cannot pay its debts and is a dying proposition, the receiver is more apt to wind down his operations, rather than spending his time attempting to resurrect the company.”

Smart Business talked to Jennings about how managers should react to possible receiverships.

How common are court-ordered receiver-ships?

They are becoming more common. With the current state of the economy, there is distrust in the marketplace. In the business world, when consumer confidence is down, so is the confidence in others being able to repay debts. That lack of confidence sometimes requires a neutral third party to help make decisions, to enforce existing agreements or to comply with the law.

Under what circumstances is a receivership a good thing?

Often, members of company management are divided into factions. Their personalities might not mesh, and their overall business judgment may be clouded by infighting. In that case, one of the parties can initiate litigation and ask the court to insert a receiver to oversee the business. That action establishes an internal decision-making mechanism to conduct business while owners or top-level managers iron out their disputes.

Very often, a creditor will ask the court to appoint a receiver over a company that owes it money. Even if no internal strife exists, the company may not be paying its debts as they become due. In that case, the receiver is charged with the task of making sure that money flows where it should.

Tactically, it may be beneficial to be the first person to request a receivership, because courts are often inclined to follow a party’s nomination for the receiver — assuming he or she has proper credentials.

What impact does a receiver have?

A receiver, certainly, costs money, and charges by the hour. If the company cannot withstand that cost coupled with pre-existing financial troubles, the receivership process can be disrupted.

There is also the chance that the receiver will be talking to top managers about the company’s future direction. Very often, one of the parties can lose what control he or she had, which can lead to a true intellectual/financial rift among company leaders.

The receiver’s job is to get past the acrimony and animosity and do what’s in the company’s best interests.

In some cases, managers may agree that they will never reach a decision or compromise. In that event, the receiver also can provide a dispute resolution process.

What are a manager’s obligations under a receivership?

The very threat of being placed in receivership is a mission-critical turning point. You have to immediately focus on the problem, because you could be approaching the last decision you ever make as a corporate leader.

If my company were threatened with a receivership, I would first turn to my in-house counsel or an experienced attorney. You never want to go into a receivership process without having someone protecting your rights and those of the company.

Once you have been sued and a receiver has been appointed, you face a very large uphill battle. At that point, there is a good chance the court will keep the receiver in place until either the litigation runs its course or some kind of settlement is reached.

Under a receivership, a temporary restraining order is generally issued. Your obligations are to (1) make sure that you do not interfere with the receiver’s operation in any way and (2) help the receiver make decisions that are right for the company.

Initially, you have to determine whether or not you are going to oppose a receiver-ship, but after one is appointed, do everything you can to make sure the receiver’s job is easy and that you are not interfering.

What are the penalties for interfering with a receiver’s actions?

The consequences for those who choose to interfere with a receiver’s duties are predictable. Early orders and injunctions restrain corporate officers from doing something negative against the receiver’s actions. They also give the court contempt power over violations of its orders. Contempt penalties include sanctions and fines, which eventually can develop into criminal contempt charges. Bottom line — never interfere with a receiver’s duties.

JOHN MARK JENNINGS is a partner with Shulman Hodges & Bastian LLP. Reach him at jjennings@shbllp.com or (949) 340-3400.