The courts in Illinois can increasingly include equity management


This article was originally published on Law360.

The COVID-19 pandemic has caused massive humanitarian and economic turmoil and continues to cause them with no clear end in sight. Borrowers are already striving to increase the liquidity of their banks. Some will continue to act openly, honestly, and in the best interests of the company and its stakeholders. Others won’t.

Notwithstanding that lenders and governments seek to mitigate the effects of the crisis,[1] Credit defaults are expected to increase and, accordingly, credit enforcement procedures will increase.

In legal proceedings related to the COVID-19 crisis, where the default is not only due to a lack of money – fraud, mismanagement, neglect, waste, misconduct – litigants and courts can increasingly turn to equity recipients to protect collateral and troubled companies to manage.

Equity Receivership Framework in Illinois

Illinois already has a framework for bankruptcy administration. At the beginning, however, there are two distinctions to be made.

First, an equity recipient is not the same as a recipient of real estate. A real estate manager manages real estate that is the subject of litigation (often a foreclosure), is often pre-arranged in loan documents, and has legal powers under the Illinois Mortgage Foreclosure Law.

Second, the fact that a commercial loan is not drawn does not mean that an equity taker can be appointed. Other attenuating circumstances (see below) are required as the appointment of an equity recipient is viewed as a drastic remedy.

The Illinois courts of law have the discretion to appoint liquidators. Early case law stated that this can allow the court to establish justice between the parties by preserving property or assets that are the subject of litigation for the benefit of all parties involved. A plaintiff seeking the appointment of an equity manager must demonstrate a right to the property that the liquidator will dispose of and that the property has generally been obtained through fraud or is in danger of being lost through negligence, waste, misconduct or bankruptcy .

Equity recipients are not just channels through which a lender can get their way. Bankruptcy administrators appointed by the court are officials of the court and represent all interested parties. The recipient is bound by court orders and cannot exercise their discretion on a whim.

The purpose of an equity recipient is to protect, maintain, and maximize the value of the company. This can be done in a number of ways, including taking on the running of a distressed company, selling certain assets, and analyzing operations.

It is at the discretion of the court to make appropriate arrangements that will guide the conduct of a liquidator and hopefully lead to more favorable outcomes for all parties. In addition, if appointed early, an equity recipient can quickly replace existing poor management, analyze internal and often opaque operational and management problems that harm the debtor, and hopefully provide guidance that will save operations, money and jobs.

The equity argument

While equity recipients are historically rare in Illinois, the COVID-19 crisis coupled with the ability of equity courts to produce fair and equitable results could change that. Courts acting in equity should probably appoint fair recipients more often. They can help manage a troubled business, protect lenders’ collateral, and ensure the business operates accurately, completely, and honestly – all of which have the potential to produce better long-term results for lenders, borrowers, other stakeholders, and the economy to be achieved by and large.

Courts could be persuaded to view equity recipients as an integral part of resolving the financial hardship caused by the COVID-19 crisis, especially given the immediate demand for efficient and available alternative solutions to emergency situations.

Judges can help parties adapt the administration of the bankruptcy to the case before them. Specifically, with the assistance of the lender’s attorney (and likely through the objection of the borrower’s attorney), judges can establish reporting procedures, rules, mechanisms, controls and countermeasures, and other requirements that will help the court manage the debtor and the parties in the interest of that the business will continue and / or that collateral will be retained.

Do you need help? Look at your neighbor

If courts and litigants need advice, they can turn to the Federal Code of Civil Procedure 66. Additionally, courts and litigants can turn to other jurisdictions to see how equity managers are appointed, how they work, and how they can help the parties outperform a zero sum litigation or bankruptcy.

Federal courts can appoint equity administrators under the Federal Code of Civil Procedure 66, and have done so for some time. Other states allow equity recipients to be appointed[2] (1) to assist in post-court proceedings in which the identified property is the subject of the judgment; (2) to assist in the sale of trust assets; (3) to help in badly managed or distressed business situations; and (4) as an alternative to bankruptcy (Illinois courts can use this analog when property or assets are degraded due to bankruptcy).

To name a few, Minnesota, Wisconsin, Michigan, Texas, Colorado, and California all have legal frameworks that at least provide that equity recipients are an available tool for litigants and litigation.[3] Even if the circumstances do not fit into a legal schedule of when a bankruptcy trustee can be appointed, some states – for example, California – allow the appointment of stock trustees if this has been done by the equity courts in the past. As you can imagine, this gives the courts considerable discretion.

While Illinois doesn’t have a law that specifically governs general wealth management, states that often have the equity capital have allowed the judicial process to have extensive discretion in appointment and oversight. The analogy is strong, and Illinois courts can use it to aid the appointment.

Potential challenges

Unlike the bankruptcy court, a non-bankruptcy case where a bankruptcy trustee is appointed does not have an automatic suspension of claims by creditors. However, this potential harm is mitigated by the fact that a bankruptcy trustee can be appointed and operate more efficiently, and it is often the case that no large creditor organization storms the castle that would increase the need for residency.

In addition, there may be major concerns about succession liability due to non-bankruptcy proceedings. However, under certain circumstances (and under certain state laws), liquidators may be entitled to sell assets free and free of liens, claims and encumbrances if the termination requirements are met, which gives buyers who are buying assets out of non-bankruptcy at least one Insolvency proceedings offer certain convenience in order to avoid successor liability. In addition, in the event of a sale of property, the court of first instance may issue an order specifying the procedure for the sale and, in all likelihood, must approve the sale once it has been carried out. An aggrieved creditor, buyer or interested party can intervene to a limited extent in the legal dispute if he deems it necessary.

Ultimately, appointing an equity manager cannot prevent a distressed borrower from filing for bankruptcy. Even if an insolvency administrator threatens or even after the appointment of an insolvency administrator, a debtor can apply for bankruptcy protection. In this case, however, creditors may seek to (1) keep the current equity recipient in place rather than allowing the debtor to be in possession; or (2) in extreme cases, appoint a Chapter 11 trustee. However, the cost of bankruptcy to a debtor (and the potential inability to use a lender’s cash collateral against the lender’s objection) can deter a debtor from filing for bankruptcy and lead them to take their risk with an equity taker.

Conclusion

Debtors and creditors will be hard hit by the COVID-19 crisis and the rapidly evolving and changing financial landscape that has and will continue to cause it. Courts, especially trial courts that sit by equity law, are uniquely positioned to partly dictate the narrative of how businesses recover. Stock administrators are not a panacea, but they can help everyone involved.

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