Contributed by Cristine Pirro

A state court appoints a receiver for the property and business of a limited liability company, and the receiver subsequently files the limited liability company – now the receivership estate – for chapter 11 protection.  Which governs the assets of the estate – the receivership order or the Bankruptcy Code?  Similarly, who administers the assets of the estate?  The Bankruptcy Court for the Northern District of Texas addressed these questions in In re Roxwell Performance Drilling, LLC, in which the receiver filed a chapter 11 petition (as authorized by the state court receivership order) along with a motion for authority to file that petition and to retain control of the estate.  The United States Trustee objected to the receiver remaining in control and filed a motion to appoint a chapter 11 trustee pursuant to section 1104(b)(1) of the Bankruptcy Code.  The bankruptcy court considered the motions jointly, weighing whether the Bankruptcy Code enables a receiver appointed by a prepetition state court receivership order to remain in control of estate assets postpetition.

In determining whether the state court receivership order or the Bankruptcy Code should govern the assets of the receivership, the court looked to 28 U.S.C. § 1334(a), which affords the district court exclusive jurisdiction over the bankruptcy estate.  Although property held by the receiver remains in possession of the receiver upon filing, authority to supervise the property in the receivership transfers from the state court to the bankruptcy court.  Control and decisions regarding receivership assets become the exclusive province of the bankruptcy court, and the receiver’s role is limited to that of a “federally superseded custodian of the bankruptcy estate.”

The Roxwell court also considered whether the receiver could remain in place under the receivership order without violating the provisions of the Bankruptcy Code and found that it could not.  In making this determination, the court cited to section 543 of the Bankruptcy Code, which requires a custodian appointed prepetition to account for and deliver to the trustee property in his or her possession, custody, or control, and prevents the custodian from making disbursements or taking any action related to the debtor’s property unless necessary to preserve that property.  Authority to manage the assets of the debtor in chapter 11 lies with the debtor as debtor in possession or with a chapter 11 trustee, not with a receiver.

The court further looked to the specific terms of the receivership order, which were inconsistent with the requirements and rules of the Bankruptcy Code for a trustee or debtor in possession.  For example, the receivership order specifically defined the standard of conduct that triggers liability of the receiver and professionals retained by the receiver, set compensation for the receiver and preemptively found such rates to be reasonable and necessary, and prevented any person with notice of the receivership order from disturbing the receiver’s assets without permission of the state court.  Although the bankruptcy court did not explicitly say so, the conflict between the state court order and the Bankruptcy Code seemed to bolster the court’s determination that the custodian (i.e., the receiver) could not simultaneously administer the bankruptcy case and the receivership proceeding.

Finally, the Roxwell court addressed the receiver’s argument that it could remain in possession under section 543(d) of the Bankruptcy Code, which allows the bankruptcy court to excuse compliance with subsections (a) and (b) if doing so is in the best interests of creditors.  The receiver argued that section 543(d) of the Bankruptcy Code should allow him to continue in possession of Roxwell’s assets and to continue managing Roxwell’s affairs because the “best chance for a successful reorganization under the Bankruptcy Code is to have the receiver, not a chapter 11 trustee, retain control of the Debtor.”  He also argued that retention of the receiver would be in creditors’ best interests, but did not provide sufficient factual support for his position.  Without evidence that allowing the receivership to continue indefinitely would be in the best interests of creditors, the court decided not to allow the receiver to continue managing the debtor’s affairs.  Because the receiver was not excused from the section 543(a) and (b) requirements, the receiver was required to deliver property of the estate to the debtor in possession or, in the alternative, the chapter 11 trustee.  However, the case had no trustee and, in light of the receivership, no “debtor in possession.”  The court thus decided “cause” existed to appoint a chapter 11 trustee under section 1104(b) of the Bankruptcy Code to avoid a “vacuum of authority going forward.”

As the court acknowledged, the United States Trustee could choose the receiver to act as chapter 11 trustee.  Because a receiver cannot guarantee it will be appointed as a chapter 11 trustee, however, Roxwell serves as a reminder that any receiver attempting to retain control of the debtor’s assets and remain in possession of the estate should be prepared to show it can administer the estate in the best interests of creditors as required by section 543(d) of the Bankruptcy Code, which governs the assets of the receivership once those assets enter into the domain of the bankruptcy court.