Receivership: Definition & Overview
When a company defaults on its loans, a number of things can happen.
One of the options that can happen is for a company to go under a simple receivership. But what exactly is a receivership? Read on as we give you an in-depth definition and overview of everything you need to know about receiverships.
Table of Contents
- A receivership is a court-appointed tool that is used to help creditors to recover defaulted funds.
- It can also be used to help companies that are in financial trouble avoid going into bankruptcy.
- The main goal of a receivership is to return a company to being profitable.
- In a receivership, an independent receiver or trustee will be appointed by the court. They will effectively manage all of the troubled company’s business operations.
What Is a Receivership?
A receivership is a tool that is court-appointed. It helps to assist creditors with the process of recovering funds in default. It can also help companies that are in financial trouble to avoid bankruptcy. Having a receivership makes it far easier for lenders to recover any funds that they are owed. This is in the case that a borrower ends up defaulting on the agreed-upon loan agreement.
Another scenario where a receivership may occur is as a step in the restructuring process of a company. This would be initiated to return a company to profitability. You could also have a receivership during a shareholder dispute. This would be to complete a project, sell a business, or liquidate assets for example.
How Do Receiverships Work?
Receiverships are generally put in place in order to protect a company. They are often thought of as a protective umbrella for a company that is in troubled waters. During a troubled spell, a receiver or trustee comes in to take over the management of the entire company. They would also take over all of their assets and the operating and financial decisions of the company. While a receivership is taking place, the principles of the affected company remain in place. This is as material contributors. However, during this time their authority is somewhat limited.
A receivership was traditionally intended to help creditors to recover outstanding amounts under a secured loan. This was in the event that a borrower defaulted on their loan payments. A receivership is considered one of the more powerful and effective tools that are available to protect creditors.
They can also be used by a business or corporation that is in a state of financial distress. That could be during the restructuring process of a company, or when a company is heading in the direction of potential bankruptcy.
While a receivership in itself is not technically a legal process, it does tend to be invoked during legal proceedings. Either the secured creditor or a court of law would then appoint a receiver. This receiver will then act as a trustee of the business in question. A receiver that is appointed privately will tend to act on the behalf of the creditor that appointed them. But court-appointed receivers will act on behalf of all of the creditors.
A receiver has to be an independent party. They must have no prior relationship, both in a business sense or a personal sense, with the borrower or the lender. They also can never act for the benefit of one side to the detriment of the other side.
What Is a Receiver?
A receiver is a person that is appointed as the custodian of an entity or a person. They will be in charge of their property, general assets, finances, and the operations of the business. These are extensive powers that can change the course of a business.
A receiver can be appointed by a number of entities. This includes government regulators, bankruptcy courts, or private entities.
The main aim of a receiver is to realize and secure assets. They also manage any affairs with the aim of paying any debts that the entity owes. In the case of being the receiver for a business, they will still seek to maximize profits where possible. They also look to maximize individual asset value. They can achieve this by selling all or part of the company, or by terminating operations where necessary.
When a receiver is appointed, the company in question will be said to be in receivership.
What Is a Receiver Responsible For?
An appointed receiver will generally have the ultimate decision-making power. This is in the case of restructuring. They will be responsible for the company’s assets and management decisions. This includes having the authority to stop paying applicable interest payments, as well as stop paying dividends. The receiver will also ensure that all of the previous company operations are compliant with government regulations and standards. This will all be while trying to maintain the maximization of the company’s profits.
A receiver will tend to work alongside the company to avoid the complete liquidation of all assets, meaning a complete bankruptcy. But a receiver may also choose to get rid of select assets. This is for the purpose of paying a portion of their creditors with the aim of bringing the company into a recovery period.
Should the efforts of the receiver fail, then a court may order the liquidation of the company’s assets. In this case, the sale of assets would be overseen by a liquidator. The funds would then be collected from the liquidation to repay all of the company’s creditors. At the point where all of the assets have been sold and the debts repaid, the company would cease to exist.
What Is the Difference Between Receivership and Bankruptcy?
Receiverships and bankruptcy are often confused. However, they are very much not the same thing, but they also aren’t mutually exclusive. Bankruptcy and receivership can occur at the same time as each other. Or a company could be under a receivership without being actually bankrupt.
So while the two terms can often be confused, the general differences are simple enough. Let’s take a closer look at both of these terms.
A receivership is not a legal action. Instead, it is more of an adjunct solution. When there is a secured lender, a receivership is put in place to protect the assets of the lender. This is during an interim period, such as when a foreclosure is pending.
In the case of a foreclosure action, the secured creditor is essentially asking the court to protect its collateral. This is until the foreclosure is resolved. Collateral can include things such as:
- Real estate
- Business income
An independent party will receive the protected assets on behalf of the court. They will then remain in the possession and control of the chosen party until the court discharges them.
Unlike a receivership, bankruptcy is a legal action. It tends to be taken in order to protect a debtor from an action of collection by creditors. The courts of bankruptcy and the rules associated with them are mainly aimed at protecting the borrower. This is in direct contract to a receivership which protects the lender.
A company can file for Chapter 11 bankruptcy. This is when it needs time in order to solve its financial problems, all whilst maintaining business operations. A company can also file for Chapter 7 bankruptcy. This is with the purpose of closing and liquidating a business.
The Two Main Forms of Bankruptcy
Chapter 11 Bankruptcy
Chapter 11 bankruptcy is a form of bankruptcy that involves a complete reorganization of a debtor’s debts, assets, and general business affairs. It is for this reason that it tends to be known as reorganization bankruptcy.
It is generally considered to be the most complex form of bankruptcy proceedings. It is also the most expensive form of bankruptcy proceedings. It allows a company to stay in business while they restructure their obligations.
Because of the complexity and expense of a Chapter 11 bankruptcy, it tends to only be undertaken when a company has undergone significant analysis and a thorough exploration of all other possible alternatives.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy controls the process of liquidating a business’ assets. In this case, a trustee is appointed with the aim of liquidating any nonexempt assets. This is in order to fully pay back the company’s creditors. After the proceeds of this are exhausted, any debt that is remaining is discharged.
During Chapter 7 bankruptcy, unsecured priority debt is prioritized and paid first. After this has been paid off the next priority is any secured debt. Once all of these debts have been paid and there are no amounts outstanding, they will then pay off any nonpriority unsecured debt. None of these realizations will be given to unsecured creditors.
In order to be eligible for Chapter 7 bankruptcy, the company must pass a means test. It must also have had no Chapter 7 bankruptcy discharged in the previous eight years.
Chapter 7 bankruptcy is also known as straight or liquidation bankruptcy.
For troubled companies, drastic action sometimes has to be taken. This drastic action isn’t always a negative thing, and can actually help many companies to recover. A receivership is a drastic action that can end up benefiting the company in the long run.
FAQs on Receiverships
The process of a receivership occurs when a debtor fails to make the agreed-upon payments to a creditor. This creditor must hold a fixed legal charge. Once they are in arrears, the creditor can then commence the receivership process.
A company that is in receivership will have a receiver appointed to them. This receiver must be a licensed insolvency practitioner. The receiver will assess the company’s assets and then liquidate them in order to recoup the debt that is owed.
The main differences between receivership and bankruptcy are twofold. Firstly a receivership is not a legal action, whereas bankruptcy is. Secondly, a receivership’s main aim is to protect the lender’s assets. Whereas bankruptcy’s main aim is to protect the borrower.
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