For many, the concept of bankruptcy is a familiar one. Conversely, people are less accustomed to the principle of state court receivership. Therefore, it is shocking for many to realize that state court receivership is basically a state substitute for federal bankruptcy. Receivership provides an orderly scheme to preserve assets, prevent preference, and to assure the equitable distribution of an insolvent debtor’s assets. A receiver may be appointed to preserve specific property that is the subject of litigation, to enforce a decree of a court of equity, and to tide an individual or corporation over temporary financial embarrassment. This article is an attempt to provide a guide to North Carolina receivership statutes and case law as they apply to insolvent debtors.
When a Receiver May Be Appointed
If an individual, partnership, or corporation is in serious financial distress, a receiver may be appointed upon application by one or more creditors. Although there is statutory authority for appointment of receivers, the court’s power to appoint a receiver is not limited to these provisions. Courts of equity have inherent power to appoint a receiver. In North Carolina, receivers may be appointed by both the district and superior courts. Any judge having authority to grant restraining orders and injunctions has jurisdiction to appoint receivers, though only superior court judges may appoint corporate receivers.
Statutes Governing Appointment
The principal statutes authorizing receiverships for distressed or insolvent debtors are N.C.G.S. 1-501 through 1-507.11. Although these provisions might appear to be limited to corporations, they apply equally to individuals and partnerships. Section 1-502 allows receivers to be appointed in five situations:
- Before a creditor obtains a judgment, if the creditor establishes that they have an apparent right to the property and that the property is in danger of being lost or materially injured;
- If judgment has already been rendered, a receiver may be appointed to effectuate the judgment;
- To preserve property pending appeal or to dispose of property when an execution is returned unsatisfied and the debtor refuses to satisfy the judgment;
- To preserve property within the state owned by foreign corporations; and
- If the creditor is seeking restitution for violation of the North Carolina Unfair Trade Act.
The Insolvency Test
The word insolvent is used in the receivership statutes as a criterion for the appointment of a receiver. North Carolina’s test for insolvency is “whether or not the entire assets of the person or entity in question equal or exceed in value the total indebtedness of such person or entity.” This is essentially the same definition used by the Federal Bankruptcy Reform Act.
Even if one is unable to establish that a debtor is actually insolvent, a receiver still may be appointed if the creditor can show that a danger of insolvency exists. Therefore, in North Carolina, one who seeks appointment of a receiver need not satisfy the test for insolvency so long as they can establish facts sufficient to indicate a danger of insolvency.
Procedure for Obtaining Appointment of a Receiver
A prerequisite to the appointment of a receiver is the filing of a principal action. This may be an action by a creditor who has an unsatisfied judgment or can produce the written admission of a corporation that it cannot pay its debts. It may also be an action in which one or more creditors seek to have the court take charge of the debtor’s property, ascertain the debts, and apply the funds to the payment of all creditors according to their rights. After the principal action has been commenced by issuing a summons and filing a complaint, the plaintiff may then apply to a judge for an order appointing a receiver.
The judge hears the application for receivership and may order appointment of the receiver after notice to the parties. If the judge determines that receivership is justified, he then decides whom to appoint as receiver. In addition to individuals, both corporations and banks may act as receivers. The courts will usually not appoint any person interested in the controversy, and the appointment of one involved in the action, such as an attorney for one party, is discouraged. In fact, the North Carolina State Bar has held that it is unethical for an attorney both to serve as a receiver and to represent the judgment creditor. This holding is a reflection that the receiver is an officer of the court and does not directly represent the interest of either party; the judgment creditor’s attorney must act as an advocate for his client. Finally, the judge is not limited to the appointment of a single receiver.
Powers and Duties of the Receiver
The receiver in North Carolina is given specific powers by statute and case law so that he may properly control, preserve, and settle the property and assets of the insolvent debtor. Before assuming these powers, however, the receiver must post a bond, conditioned upon the faithful discharge of their duties, in an amount fixed by the appointing judge. After posting bond, the receiver can take into possession all assets of the insolvent debtor. The receiver’s title, however, extends only to the property located within North Carolina. To reach assets located outside this state, creditors can seek attachment or obtain receivership there.
To aid in discovering and collecting the debtor’s assets, the receiver is empowered to send for and examine persons and papers, including creditors, claimants, officers, directors, and agents of the insolvent debtor. The receiver may examine these people to discover information concerning the debtor’s business transactions, operations, assets, and liabilities. Persons who fail to answer questions may be subject to punishment for contempt.
After locating the debtor’s property, the receiver must eliminate any property in the debtor’s possession that is not subject to claims of any kind. This would include property that is held in bailment and that is not subject to creditors’ claims. The receiver then may exercise his powers over the property that is subject to the receivership. As a result of these powers, the receiver may foreclose mortgages executed to the insolvent debtor, sue to recover property, sell any assets, appoint agents, and borrow money. Additionally, they can do all acts that could have been done by the debtor if necessary for the final settlement.
In exercising these powers, the receiver is acting under the authority and supervision of the court. Therefore, he is required to inform the court about the property within the receivership. Within thirty days after his appointment, the receiver must submit a full and complete inventory of all of the debtor’s assets, indicating their nature and probable value, and obtain a court order prior to selling specific property. The receiver ordinarily will not be permitted to dispose of a substantial part of the debtor’s assets without court authorization.
Procedure for Determining Validity of Claims
The court supervising the receivership fixes a time period during which all claims must be presented to the receiver. The court then notifies creditors of the time limitation. Creditors must present their claims in writing to the receiver, and those who fail to file claims within the designated time period may be barred from participation in the distribution of the debtor’s assets. All claims must be brought in the original action in which the receiver is appointed, absent court authorization to bring an independent action against the receiver.
After the claims are filed, the receiver determines their validity and priority. To aid the receiver in making this determination, N.C.G.S. 1-507.6 allows the receiver to examine claimants and witnesses and to require production of relevant books and papers. The receiver then evaluates the claims; they may allow or disallow part or all of any claims.
Upon reaching a decision on a claim, the receiver must notify the claimant and the court of their findings. Within ten days after notice of the receiver’s findings, interested persons may file exceptions to the receiver’s determination and contest the findings in the original action without leave of court. The judge has discretion to extend the period for filing exceptions.
Priority of Claims
One of the major problems in receiverships is determining the priority of various claims asserted against the insolvent debtor’s assets. Priority is affected both by the type of claim involved and by relevant statutes. Frequently, these assets are insufficient not only to pay anything to the general creditors, but also to pay fully the claims of creditors having priority.
Priority for payment of claims against the insolvent debtor’s assets in receivership is determined by state statute unless federal law prevails. Distribution usually occurs in the following order:
- Liens perfected prior to appointment of the receiver, ranking according to the date when they were perfected;
- Claims of the federal government for debts, including unperfected tax liens;
- Unperfected tax liens of the State of North Carolina;
- Funds may be distributed to the insolvent debtor’s employees who claim wages for services rendered;
- Any remaining assets are paid to those claiming as general creditors.
Court Order to Distribute Assets
After the debtor’s assets have been collected, and the status and priority of all claims have been determined, the receiver obtains a court order allowing distribution. The order of distribution will not be issued “until the receiver has proved to the satisfaction of the court that written notice has been mailed to the last know address of every claimant who has properly filed claims with the receiver.” The receiver then pays all claims if the funds in receivership are sufficient. If the funds are insufficient, they are distributed pro rata among all the creditors who have established claims.
Discharge of Receiver
Discharge usually occurs after distribution of assets. A court may, however, discharge a receiver prior to distribution. A receiver in charge of a corporation’s assets may be discharged if it appears that the corporation’s debts have been paid or provided for, and sufficient capital remains for the corporation to resume business. The corporation’s property, rights, and franchises then revert to the corporation as though the receiver had never been appointed. If the receiver is not discharged prior to the distribution, the court may provide for his discharge in the distribution order or may issue a separate order of discharge.
Once the order of discharge is entered, the receiver’s official existence terminates. The receiver may not, for example, take control of additional assets of the debtor that existed during the receivership but were not discovered until after the discharge. Instead, a new receiver may be appointed to administer those assets.
Although receiverships primarily have been a state substitute for federal bankruptcy proceedings, that role may be changing. There are numerous grounds in addition to bankruptcy that justify appointment of a receiver. Receivership may be used as a valuable tool to ensure the satisfaction of creditors’ claims. A creditor may seek receivership when he fears a debtor may become insolvent or as a safeguard to protect property subject to litigation prior to receiving judgment. For whatever purpose a creditor seeks appointment of a receiver, he must carefully comply with applicable statutory procedures in order to obtain payment of a claim.
Co-Contributed by Kathryn C. Setzer, Summer Intern