Orderly Takeovers of Special Properties A Court Order Checklist

Orderly Takeovers of Special Properties A Court Order Checklist

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Attorneys and others involved in the turnaround of troubled properties should be aware that there is a vast difference between traditional real estate entities, such as office buildings, and "special assets," which run the gamut from amusement parks to restaurants. When drafting court orders for these special properties, it is critical to view them first as businesses and only secondarily as real estate assets.

Unlike traditional or "passive" income properties—such as office buildings, shopping centers and multi-family housing—special assets feature a retail component that typically represents a significant portion of the value. Examples include hotels, restaurants, convenience stores, gas stations, truck stops, senior care facilities and recreational or theme parks. These assets typically involve a host of complex business issues, and require specific knowledge of the business itself, not merely general real estate management skills.

Having served as a receiver, trustee, custodian and/or manager for hundreds of retail properties, our task is always affected by the court orders that empower us. Court orders are critical to any takeover; careful drafting not only saves time and helps curtail potential problems, but can significantly affect the cost to the receivership or bankruptcy estate, and ultimately the amount recovered on the loan.

Not surprisingly, the impact on speed, cost and effectiveness is magnified when the asset is not a simple income property, but involves the operation of a business as well. Indeed, special assets such as hotels, gas stations and theme parks can add several levels of complication for any receiver or trustee, as well as the operator.

Problems and needs encountered by attorneys when dealing with these properties range from taking stock of inventories to examining franchise agreements to dealing with environmental claims. The following are just a small sampling of the problems that can be encountered when working with these properties, and how they can be dealt with in the court orders. These scenarios can apply to a receiver in a pending foreclosure action, to bankruptcy trustees or to third-party operators placed through stipulations among parties. By covering all of these anticipated hurdles in advance, a return visit to court for additional orders can be avoided, and assets can be protected more effectively.

Bank Accounts. A complex property such as a hotel may have multiple bank accounts—one for ordinary operating expenses, one for processing credit card transactions, another for reservation deposits and yet another for capital reserves. In addition, there will be many different cash banks for personnel such as desk clerks and bartenders or accounts used by the owner under a different name. With this in mind, the court order should specifically allow the receiver to seize all related accounts and specify other entity names, if known. The receiver should be allowed to keep the accounts open in order to receive additional deposits or transfers, but be able to freeze all funds so no further checks can clear.


[S]pecial assets such as hotels, gas stations and theme parks can add several levels of complication for any receiver or trustee, as well as the operator...

Inventories. The inventory of a major high-rise office building is quite simple when compared to a hotel or even a modestly-sized restaurant. For that reason, the court order for a special asset should allow ample time for the filing of an inventory. An "inventory" may also include accounts receivable, which can be very substantial and complex for an entity such as a truck stop or convention hotel. In addition, reporting these accounts may create false hopes about collectability.

Most receivership statutes—when they even exist—refer to "receipts and disbursements," not profits and losses, thus implying that accounting should be done on a cash rather than accrual basis. That being the case, it is usually advisable not to include accounts receivable as inventories or assets, but instead to simply note the apparent amount and then reflect any payments as income when actually received. Dollar values should not be assigned to most inventories, since such valuations are highly subjective and can open the door to arguments later on.

Books and Records. While rent rolls and security deposit information are fairly straightforward in traditional real estate, much more detailed and critical business records are involved when dealing with special assets. For example, lengthy lists of major corporate accounts, travel agents, previous guests, daily reports and reservations are vital for hotels, while fuel supply data and store sales records are critical bits of information for gas stations and convenience stores. For a property such as a theme park, it might be necessary to contact all previous season passholders before re-opening for the season. The bottom line? Past business records are critical in retail assets.

Franchise Agreements. A hotel, restaurant or gas station is often branded through a franchise agreement. Most often, when an owner defaults on debt service, there are already other defaults with vendors, taxes and franchises. In addition, most franchise agreements include receivership or bankruptcy as a default. The particular franchise (or "flag") can be a very substantial benefit to such an asset. Yet if badly chosen, the "flag" can also be a detriment. Receivers, trustees and turnaround managers experienced with such projects can not only quickly assess the flag's value and successfully maintain the desirable identity, but can often improve on the terms of such agreements. The court order should always allow the receiver to negotiate such agreements.

Liquor and Gaming Licenses, Lottery Tickets. This category may seem insignificant, but is actually an extremely important source of income for many special assets. The survival of a gas station may be dependent on the sale of lottery tickets or liquor sales to attract customers to its gas pumps. A convention hotel that cannot operate its cocktail lounge or serve wine to a banquet could lose all its future bookings. For these reasons, the receiver needs authority to continue using existing licenses and/or to transfer or acquire licenses. A new license rarely allows for continued operation, and often takes months of processing, whereas assignment, transfer or merely "use" of the existing license allows for continued operation.

The administrative agencies that control these privileges are not governed by court orders involving other parties, but an order that specifically mentions these licenses may still be of great help. The order may simply direct the debtor not to surrender or terminate the licenses, or to cooperate in transferring the license to the receiver. While the legal merits of such an order are unclear, if the agency bureaucrat believes the order to be valid and complies, the asset (and arguably all parties) will benefit. The debtor is certainly free to object, but in hundreds of cases, this has only happened to our firm once, and we still managed to obtain the license.

Unusual Vendor Relationships. A special asset's relationship with vendors is often less than straightforward. For example, when a customer pays at the pump at a local gas station, often the credit card proceeds do not go to the owner or operator of the station, but are deposited directly into the account of a fuel supplier or "jobber." These receipts can represent the majority of sales, so cash flow at the property may be limited. Jobbers also typically require substantial deposits before delivering fuel. If the tanks need filling every day to meet demand, the receiver may need to borrow cash immediately to stay open, and additional debt requires prior court approval, which leads to the following discussion about receiver's certificates.

Receiver's Certificates. Special assets often depend on going-concern value as much as, if not more than, real estate or improvements value. A closed hotel is worth only a fraction of an operating one, even one that loses money. Some hotels take years to become established and stabilize, so closure can be fatal. The lender may be prepared—particularly if forewarned—to fund operating losses of the business in order to maintain or enhance the ultimate sale value of the asset. If this can be anticipated, the order appointing receiver should also grant permission for the receiver to borrow money. The loans can be added to the underlying indebtedness as additional advances, or receiver's certificates can be issued as a separate debt. Most judges are reluctant to agree in advance to such borrowing, so it will be important to be prepared to explain a critical need. Some receivers and trustees are also experienced as expert witnesses in their field, and should be able to assist your legal counsel in drafting such requests. This is merely one example of why it is important to have a receiver who is knowledgeable about both receivership law and the specific business or industry.

Accounts Payable. Generally, a receiver has no obligation (or even right) to pay pre-receivership debts. The court may allow exceptions when the receiver feels they are necessary to protect or benefit the estate. When such expenditures can be anticipated—i.e., for unpaid wages—the initial order should allow either for the specific payment, or for discretion of the receiver.

Management Companies. Because of the cost savings and easy transition upon foreclosure, many lenders and servicers prefer to use a receiver who is connected to a management company (although this is harder to find with retail properties). The court's order should not only grant authority to hire a management company, but include a company in which the receiver is a principal, employee, etc. Naturally, the relationship should be disclosed, and management fees should be competitive.

Intercepting Mail. When dealing with retail businesses rather than traditional commercial income properties, it is typical for owner/operators to have many unique or personal methods of conducting their business. It is not uncommon for payments from major accounts, for example, to be directed to a location other than the subject property. For that reason, the receiver should have authority to intercept mail and to have the postmaster redirect business mail to the receiver's offices.

Environmental Audits. It is frequently vital for the lender (plaintiff) to request an assessment of any environmental issues. Since it is also of importance to the receiver, along with health and safety issues, the order should specifically provide for access to conduct such inspections and audits.

Retaining Legal Counsel. Aside from routine evictions or collection matters, most judges do not like receivers to automatically retain legal counsel. If the need for separate legal counsel for the receiver is expected, the purpose should be carefully detailed to facilitate the court's approval. An experienced receiver should not need to consult with legal counsel for most matters.

Personal property. With special assets such as restaurants, hotels, convenience stores and other businesses, very often the personal property may be leased. The receiver will need to determine who the actual owner is, and whether or not to continue honoring such leases. It may be beneficial to have the court "order" other parties not to remove leased equipment. However, in the case of a foreclosure action, third-party lessors are not necessarily subject to that court's jurisdiction.

Restraining Orders. Orders appointing receivers commonly also include temporary restraining orders, which prevent the debtor from canceling insurance policies, removing property or interfering with the receiver's responsibilities and duties.

Bonds. Every court seems to have its own method for determining what size bond the receiver should post. Some judges, in dealing with traditional commercial real estate, feel that one month's rent receipts is an appropriate amount. This is based on the theory that once a month, when rents are collected, the receiver will have that much money on hand. However, the receiver of a hotel or restaurant will rarely if ever have such an amount at one time, and a bond in that amount could be more than $1 million. Counsel should be prepared to suggest a reasonable amount to the court, with supporting reasons, since the cost of the bond is also an expense to the receivership estate.

Ex Parte or Noticed Motion? The typical hearing on a motion for appointment of a receiver is scheduled after appropriate notice to all parties, and may be set for a date days or weeks in the future. In some cases, counsel may seek an ex parte motion on an expedited basis. The hearing can be held as quickly as the following day, with the notice to the other party sometimes being a simple phone call. Courts are naturally reluctant to grant a motion that removes an owner from his/her property on such short notice, so it is important to have a compelling reason. A gas station that is being forced to close because it can't pay for fuel delivery or a hotel that is about to lose its franchise would be good arguments for an ex parte motion.

Conclusion

Careful drafting is naturally important in all legal documents. However, the order appointing a receiver or directing a trustee becomes even more critical when an operating business comprises a substantial part of a real estate asset's value. Because of the unique nature of these properties, the lender and its legal counsel should be extremely prudent when drafting the court order and take careful note of all the issues addressed.

While there are dozens of other "standard" items that should be included in every court order—as well as many more special issues to be addressed for different types of assets—this article should provide a checklist for such special properties. If possible, input from the proposed receiver and/or management company should be solicited at the earliest opportunity. A return visit to the courtroom for supplemental instructions and orders is expensive and time-consuming, and a delay of even a day or two can sometimes be fatal to the financial health of a business.


Footnotes

1 An attorney, licensed real estate broker, Certified Hotel Administrator and court-appointed receiver, William J. Hoffman is president of Trigild, a property management firm that has handled hundreds of special assets from hotels to amusement parks. Return to article

Journal Date: 
Sunday, September 1, 2002