NY Federal Court Permits Appointment of Receiver for Hotels Without Lender Having Commenced Foreclosure Action
Recently in U.S. Bank National Association v. Nesbitt Bellevue Property LLC, et al., the US District Court for the Southern District of New York, granted a lender’s motion to appoint a receiver for eight hotels that secured a loan, even though the lender had not commenced a foreclosure with, or prior to, its motion for the appointment of a receiver. Petitions for property receivers are customarily brought in pending foreclosure actions which in many states, such as New York and New Jersey, can often take up to two years to complete. Exercising its broad equity powers, the federal court in Nesbitt allowed the receivership finding that the lender intended to foreclose or liquidate the hotels and that the receivership was necessary to preserve the value of the hotels which were risking the loss of their Embassy Suites franchises.
In Nesbitt, plaintiff was the trustee for a $187.5M securitized loan which was indisputably in default as a result of the owner’s failure to make debt service payments for six months. The primary collateral for the loan consisted of eight hotels operated as Embassy Suites franchises located in six different states. Most importantly, Embassy Suites had threatened to terminate borrower’s franchise, in response to unsatisfactory quality assurance evaluations. As the hotels were not generating sufficient cash flow, borrower requested that the trust provide the funding to upgrade the hotels in order to prevent the revocation of the franchise. The loss of the Embassy Suites’ franchises would have substantially reduced the value of the hotels. However, the lender was unwilling to advance the funds without having control over the hotels. Lender, therefore, brought an action in federal court seeking the appointment of a receiver to whom the lender presumably intended to loan funds for the hotel upgrades. Inexplicably, however, no foreclosure or relief, other than the appointment of a receiver for the hotels, was sought by the lender in its suit.
Borrower moved to dismiss the receivership action, arguing that the Court could not appoint a receiver because the “receivership [was] not ancillary to some other final relief.” As in many states, New York law generally requires that a motion to appoint a receiver be ancillary to some other action. (i.e. a foreclosure action). Section 6401 (a) of the New York CPLR provides in part that the appointment of a receiver must be incident to some other proceeding, when there is danger that the property may materially lose its value. Similarly, when a receiver is sought in a diversity case in federal court, Rule 66 of the Federal Rules of Civil Procedure provides that “the appointment of a receiver in equity is not a substantive right but is a remedy that is ancillary to the primary relief prayed for in the suit.”
While acknowledging that the law requires that an action for receivership be accompanied by request for a primary form of relief (i.e. foreclosure), the Court in Nesbitt examined whether the lender intended to ultimately seek to foreclosure and the equities of appointing a receiver to protect lender’s interest in the hotels. The Court held an evidentiary hearing where the lender’s representative testified that while the lender had not commenced a foreclosure action against any of the hotels, it was the lender’s intent (emphasis added) to foreclosure on the properties.
The Court then examined the equities of appointing a receiver, the effect that the receivership would have on lender and borrower, and the imminent danger of the properties being lost, injured, diminished in value, or irreparably damaged. Lender argued that a new manager should be appointed since under the current manager, the hotels ended up in default of its loan and franchise agreement. Borrower argued that if a receiver was appointed, the receiver would most likely hire a new management company, depriving the hotels of the prior manager’s experience. The Court disagreed with borrower and stated that the appointment of a receiver “would be a far more effective protection for the properties than a continuation of the current management."
With respect to the whether the properties were in imminent and irreparable danger of being destroyed or damaged, the Court stated that there is no dispute that if the hotels lose their license to operate under the Embassy Suites brand that it would substantially diminish their value. In order to preserve its franchise, borrower estimated that it would need an additional $4.4M from lender to preserve the Embassy Suites franchise. The Court relied upon testimony that the trust was reluctant to advance an additional $4.4M to borrower, without the appointment of a receiver. Based upon the borrower’s poor management of the hotels, the Court stated that lender has every reason to avoid loaning additional money to borrower, without control over the property. The Court concluded that receivership was the most practical way to preserve the hotels and to avoid a substantial and preventable decline in their value.
While lender’s may take comfort from the Court’s decision in Nesbitt, it is not clear whether state or federal courts in New York or elsewhere would allow the appointment of a receiver without the commencement of a foreclosure action and give greater consideration to the equities of appointing a receiver for the preservation of the value of the collateral. The less risky course of action for lenders, would be to file a foreclosure proceeding and immediately apply for the appointment of a temporary receiver in the foreclosure based on a loan default and some combination of the following grounds warranting a property receiver: fraud, gross mismanagement, failure to pay real estate taxes, waste, diversion of rents and lack of equity in collateral.
White and Williams regularly represents lenders as well as court appointed receivers in foreclosures of multi-family properties, shopping centers, office buildings and other types of collateral. For questions regarding the Nesbitt decision or property receiverships, please contact Steve Ostrow (firstname.lastname@example.org; 212.714.3068) or member of the Real Estate and Finance Groups.