Q: I am a Chapter 7 bankruptcy trustee. One of the assets of the bankruptcy estate is a note, which is secured by an apartment building, owned by the debtor’s brother. The note is in default and I have learned there are health and safety issues at the building. Another asset is the debtor’s interest in a partnership, where the brother is the managing partner. The brother is selling off interests in real property owned by the partnership, but not remitting any of the proceeds to me. I intend to file adversary proceedings to judicially foreclose on the note and to recover the estate’s interest in the partnership assets and for an accounting. Can I have the bankruptcy court appoint a receiver to collect the rents at the apartment building, pending foreclosure, and deal with the health and safety issues and can a receiver be appointed to conserve the partnership assets and perform the accounting?

A: Whether the bankruptcy court will appoint a receiver depends on where the bankruptcy court is and who the bankruptcy judge is. If the court is in the Seventh or Eighth Circuits, it has been the law for over thirty (30) years that bankruptcy courts can appoint receivers in adversary proceedings. In the Ninth Circuit, it also appeared that bankruptcy courts could appoint receivers in adversary proceedings. That has now been called into question by Judge Mark Wallace in In re Halvorson, 607 B.R. 680 (Bankr. C.D. Cal. 2019). In the case, a Chapter 7 trustee filed a complaint for turnover, to avoid fraudulent transfers, for an accounting and other relief related to interests in various LLCs and real property. The trustee contended the property was marital community property of the debtor [and hence property of the estate – 11 U.S.C. § 541(a)(2)], but was being held by debtor’s wife and other family members. The trustee moved to have a receiver appointed to take possession of, maintain, and manage the property. Judge Wallace denied the trustee’s motion, finding the bankruptcy court does not have the power to appoint a receiver.

Section 105 of the Bankruptcy Code, titled “Power of Court”, under subsection (a), gives the court broad, wide-ranging authority. But Section 105(b) states: “Notwithstanding subsection (a) of this section, a court may not appoint a receiver in a case under this title.” Relying on the statute’s “plain language” Judge Wallace held the court was prohibited from appointing a receiver. In doing so, however, he acknowledged many other courts have held otherwise.

In In re Memorial Estates, Inc., 797 F.2d 516 (7th Cir. 1986), a bank held a note secured by real property, a cemetery. The note was in default and the bank learned a third-party was operating the cemetery, selling plots, and keeping the proceeds. It filed suit in state court to foreclose and moved to have a receiver appointed. Prior to the hearing on the motion, the debtor filed Chapter 7. The bank removed its action to the bankruptcy court and asked it to appoint a receiver to prevent waste and maintain and operate the cemetery. [Judge Wallace wrongly states the bankruptcy trustee moved to have the receiver appointed. Halvorson, 607 at 683. In fact, it was the bank. The trustee just did not object. Memorial Estates, 797 F.2d at 518]. The Seventh Circuit explained the prohibition in § 105(b) was on appointing a receiver for the entire bankruptcy estate, in order to prevent the circumvention of the appointment of a trustee. It concluded: “Section 105(b) is not addressed to the power of the bankruptcy court to appoint a receiver in a separate controversy between a creditor and the debtor or another creditor.” Id. at 520.

The Eighth Circuit in In re Cassidy Land and Cattle Co., Inc., 836 F.2d 1130 (8th Cir. 1987), followed the Seventh Circuit’s lead. In the case, the Chapter 7 trustee brought an adversary proceeding to foreclose on mortgages held by the estate and moved to have a receiver appointed, pending foreclosure, to manage the property. The Eight Circuit agreed with the Seventh Circuit that the power “precluded by Section 105(b)... is the power to appoint a receiver for the estate in lieu of a trustee... Section 105(b) is not addressed to the power of the bankruptcy court to appoint a receiver at the request of the trustee for the limited purpose of administering the mortgaged property pending disposition of the foreclosure proceeding.” 836 F.2d at 1133.

Judge Wallace rejected both the Seventh and Eighth Circuits rulings, contending they fail to cite any authority supporting their conclusion. Halvorson, 607 B.R. at 683. The Seventh Circuit in Memorial Estate, however, cited the legislative history that the new Bankruptcy Code has provisions for the appointment of a trustee and, therefore, “[a]ppointment of a receiver would simply circumvent the established procedures.” 797 F.2d 519. It concluded the prohibition relates to a receiver for the whole case, in place of a trustee, not in an adversary. Id. Judge Wallace ignored this, instead citing another part of the legislative history which states: “. . .the bankruptcy judge is prohibited from appointing a receiver in a case under Title 11 under any circumstances. . . Appointment of a receiver would simply circumvent the established procedures.” Halvorson, 607, B.R. at 684 (emphasis added by Judge Wallace).

While Judge Wallace relies on some of the language of the legislative history from the adoption of the Code, he ignores the history of bankruptcy courts appointing receivers under the prior Bankruptcy Act and the reason for change; which explains the new prohibition. Under the Act: “Between the filing of a bankruptcy proceeding, either voluntary or involuntary, and the appointment and qualification of the trustee a considerable time often passes. During that time the property of the bankrupt for one reason or another may need protection and preservation by the court. The bankruptcy court should appoint a receiver thereof when the court is satisfied that the appointment or authorization is necessary to preserve the estate or to prevent loss thereto.” 4 Clark on Receivers § 1016 (3rd Ed. 1959) See also, Clark at § 1035 [“The purpose of the appointment of a receiver in bankruptcy is to preserve the property temporarily until a trustee may be elected or appointed or until the property may be disposed of by some order of court.”]. Section 11(a)(3) of the Bankruptcy Act provided the court could: “Appoint, upon the application of parties in interest, receivers or the marshals to take charge of the property of bankrupts and to protect the interests of creditors after the filing of the petition and until it is dismissed or the trustee is qualified...”

The procedures adopted by the Bankruptcy Code changed this, as alluded to in the legislative history city by the Seventh Circuit in Memorial Estates. Under the Code, a trustee is automatically appointed when a Chapter 7 case is filed and, unlike under the prior Act, in Chapter 11 debtors remain in possession of their assets unless the court appoints a trustee (11 U.S.C. § 1101). Given these new procedures, there was no longer a need to appoint a receiver for the case and the prohibition was put into § 105(b) to prevent, as the Seventh Circuit states, circumventing the new procedure.

As indicated, the prohibition in § 105(b) is on appointing a receiver “in a case under this title.” One could argue, using the “plain language” that “case” refers to the bankruptcy case and not lawsuits related to a case, which are called adversary proceedings. See Federal Rules of Bankruptcy Procedure, 7001 and 7003. To avoid this conclusion, Judge Wallace argues adversary proceedings are included in “case,” because 11 U.S.C. § 324(b) provides that when a court removes a trustee for cause from a case, the trustee is also removed “in all other cases under this title in which such trustee . . . is then serving.” He concludes, if a trustee is removed from all the cases in which he serves, he could not possibly continue to serve as trustee in adversary proceedings in those cases, so the term “case” has to include adversary proceedings.

Whether one accepts Judge Wallace’s strained logic, it is clear, at least in his court, receivers cannot be appointed, even if requested by a trustee. Judge Wallace acknowledges not only that the Seventh and Eighth Circuits disagree, but so do lower court cases throughout the country, including not only other cases in the Ninth Circuit, but also in the Central District of California where he sits. See In re Kellogg-Taxe, 2014 WL 1329822 (Bankr. C.D. Cal. 2014). While he cites three Ninth Circuit cases holding otherwise, there are more. See e.g., In re Ledstrom, 2017 WL 1239144 (D. Nev. 2017); and In re Cuzco Development USA, LLC, 585 B.R. 870 (Bankr. Hawaii 2018).

Judge Wallace also concedes Collier on Bankruptcy also disagrees, but argues it and the other contrary cases simply rely on Memorial Estates and Cassidy Land. Halvorson, 607 B.R. at 680. Therefore, until the Ninth Circuit rules on the issue, whether the bankruptcy court can appoint a receiver will depend on which bankruptcy judge you are before. If the Ninth Circuit ever hears the issue, and agrees with Judge Wallace, it may take the Supreme Court to resolve the possible split in the Circuits.

*Peter A. Davidson is a Partner of Ervin Cohen & Jessup LLP a Beverly Hills Law Firm. His practice includes representing Receivers and acting as a Receiver in State and Federal Court.