Money and Dirt: A blog on legal issues impacting California real estate investment, development, and secured lending

The Uniform Commercial Real Estate Receivership Act (Part 1) — Pathway to “Receiver Sales” of Real Estate Security?

“Uniform” laws seem to be all the rage these days.

A group called the Uniform Law Commission (aka National Conference of Commissioners on Uniform State Laws) does the drafting, and the goal is to come up with a comprehensive and standardized statutory scheme that all states can “opt into” (or slightly tweak for their own variation) in order to give court cases better clarity and predictability.  Examples include the Uniform Trade Secrets Act, the Uniform Fraudulent Transfer Act (now called the Uniform Voidable Transactions Act), and the Uniform Commercial Code.

The Uniform Commercial Real Estate Receivership Act

A new proposed uniform law — the Uniform Commercial Real Estate Receivership Act (UCRERA) — was recently approved by the Uniform Law Commission and the American Bar Association and recommended for enactment in all states.  The UCRERA tackles the often thorny topic of commercial real estate receiverships.

Some states have already started considering adopting the UCRERA, and California legislators will probably take up the issue soon.

The most interesting — and likely controversial — aspect of the UCRERA is its authorization of “receiver sales” of real estate used as security for a loan.  In order to digest the impact of this new proposed law, it helps to understand how California law currently operates.

The Shortcomings of Lien Rights

In California, lenders obtain a lien on real property used as security for a loan.  A lien is useful, but it is not the same thing as an ownership interest.  Thus, when the borrower defaults, the lien itself does not give the lender the right to take immediate possession of the property and sequester the rents generated by the property.  The lien simply provides the basis for an eventual foreclosure sale.

But foreclosures take some time to complete, and during that delay several bad things can happen:  the property might fall into disrepair or “waste” (causing its income-producing capacity to suffer), taxes and insurance premiums might go unpaid, half-built projects might become hazardous, or the borrower might pocket the rents generated by the property.

Assignment of Rents

To address those risks, most standard forms of deeds of trust contain an assignment of rents clause, which are typically enforced in court through the appointment of a receiver.

There are various grounds upon which a real estate receiver can be appointed — see Code of Civil Procedure section 564 for several — but enforcement of an assignment of rents clause upon the borrower’s default is probably the most common (and easiest in terms of standards for appointment).

To have a receiver appointed after the borrower defaults, a lender simply needs to file a lawsuit seeking specific performance of the assignment of rents clause from the deed of trust, and then make a motion for the court to appoint a receiver to assist with enforcement of the assignment of rents clause.  These motions are routinely granted.

Traditional Roles

A receiver acts as an independent agent of the court, not the lender.  In theory, this is good for both the borrower (who is more likely to be treated fairly) and the lender (who can avoid most liabilities associated with pre-foreclosure possession and control of the property).

Under existing California law, a rents and profits receiver’s purpose is generally to “protect, operate, or maintain” real property and collect rents until a foreclosure sale can be completed.

Lenders typically use receivers to:

  • collect rents and remove a defaulted borrower as the operator of an income-producing property
  • make payments on taxes, insurance, and senior liens
  • maintain and repair the property
  • reduce the risk of rent-skimming and waste
  • take over a project under construction and either complete the project or shut it down and secure the premises

One Action and Anti-Deficiency

Receiverships under current law rarely run afoul of California’s borrower-friendly One Action and anti-deficiency protections.

An action to enforce an assignment of rents clause through the appointment of a receiver is not an “action” for purposes of Code of Civil Procedure section 726 (the One Action rule), so a lender does not need to worry about incurring a One Action sanction (such as loss of security) merely by having a receiver appointed.

Likewise, collecting rents is a permissible pursuit of “additional security” rather than a form of deficiency.

Basics of Real Estate Receivership in California

Unlike some other states, California already has a fairly well-developed statutory scheme governing the appointment and conduct of receivers.  (See, e.g., Code of Civil Procedure sections 564-570; California Rules of Court, Rules 3.1175-3.1184.)  This scheme covers all of the basics, including:

  • grounds and procedure for appointment of receivers
  • qualifications and bonding requirements
  • general powers and duties of receivers
  • interim reporting requirements
  • final account and report

Against that existing statutory backdrop, the changes proposed by the UCRERA are not dramatic or controversial — with one exception….

Overview of the UCRERA’s “Receiver Sale” Provisions

The UCRERA sets forth its own detailed provisions regarding all of the items set forth above — appointment, qualifications, powers, reporting, etc.  Most do not vary wildly from existing California law, and this post will not explore all of the minor differences.

But the provisions authorizing “receiver sales” of property outside the ordinary course of business are noteworthy, and raise many questions surrounding California’s potential adoption of the UCRERA.

Section 16(c) of the UCRERA states:

With court approval, a receiver may transfer receivership property other than in the ordinary course of business by sale, lease, license, exchange, or other disposition.  Unless the agreement of sale provides otherwise, a sale under this section is free and clear of a lien of the person that obtained appointment of the receiver, any subordinate lien, and any right of redemption but is subject to a senior lien.

Section 16(e) adds that a receiver sale “may occur by means other than a public auction sale.”

Finally, Section 25 provides that a receiver’s application of receivership property or proceeds to the secured obligation is not an “action” under the One Action rule, and that after a receiver sale is completed the creditor’s ability to obtain a deficiency judgment is governed by existing state law.

These provisions are all foreign to California law, and as explored further in Part 2 (next week), could present serious conflicts and uncertainties.

Preview for Part 2

Our next post will explore these “receiver sale” provisions of the UCRERA in detail, including a look at the purposes and policy objectives behind receiver sales, and potential conflicts with the existing California anti-deficiency framework.

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