Biting The Hand That Feeds You – A Case Study In Receivership

If your client is in default on a loan and lender’s counsel suggests stipulating to the appointment of a receiver, be aware of the potential pitfalls of doing so. You may be exposing the company’s owners and management to a lawsuit for breach of fiduciary brought by the receiver. The following recent Court of Appeals decision illustrates the perils of such a decision.

In Coppola v. Manning, 2015 Mich App LEXIS 2152 (November 17, 2015), the plaintiff was a court-appointed receiver for a debt-ridden failed corporation and the defendants were its former officers and directors. Most of the debt arose from two multi-million dollar loans which were in default. The corporation eventually entered into an agreement with the lenders and a stipulated court order was entered appointing the plaintiff as receiver of the corporation’s property.

After digging into the corporation’s records, the receiver determined that the defendants had caused the company to take on excessive debt to support what he regarded as an imprudent plan of expansion and that they had also taken excessive compensation. In addition, the plaintiff determined that the defendants had failed to keep adequate corporate records, which contributed to the inability to sell the company and pay off the creditors. Concluding the defendants had grossly mismanaged the company, the receiver retained legal counsel to bring suit against the defendants for breaching the fiduciary duties owed to the corporation under MCL 450.1541a.

The defendants moved to dismiss the lawsuit, arguing the receiver lacked standing to bring the suit as he was not a shareholder and was attempting to bring the equivalent of a derivative action. They also argued that there was no authority showing that officers and directors could be sued for breach of authority by the company, a receiver or creditors. The trial court agreed with the defendants’ arguments and dismissed the complaint.

The Court of Appeals reversed the trial court’s dismissal and reinstated the receiver’s suit. Citing MCL 450.1541a, other provisions of the Business Corporation Act and Estes v. Idea Engineering & Fabrications, Inc, 250 Mich App 270, 285 (2002), the Court first ruled that a corporation may file suit against its directors and officers for breach of their fiduciary duties in violation of MCL 450.1541a. After reviewing the case law regarding the powers of a receiver, the Court further found that a receiver stands in the shoes of the person or entity for which they are appointed receiver and has the power to pursue any claims they could pursue, including the claims at issue.

In addition to the standing issue, the defendants also argued that the receiver’s claims were barred by a release entered into with the lenders, which released any claims the lenders had against the corporation’s officers and directors. The Court of Appeals held that as the receiver was not an agent of the lenders the release did not bar his separate claims against the defendants. In light of these rulings, the Court of Appeals reversed and remanded the matter to allow the receiver to pursue his claims.

Not every court-appointed receiver will decide that a company’s officers and directors breached their fiduciary duties and seek to sue them on behalf of the corporation. However, as there is always the risk the receiver could do so, counsel for debtors should think twice before opening that door by stipulating to the appointment of a receiver.

For more information about receivership, please contact Stephen McKenney at smckenney@neumananderson.com.