By Zac Kester, Executive Director
Few industries have been immune from economic troubles brought on by COVID-19, and nonprofit organizations were no exception. But unlike business corporations, nonprofits cannot be forced into bankruptcy by creditors.
So what are your options if your nonprofit organization is defaulting on payments?
Once in bankruptcy, very few companies emerge intact. The remaining corporations liquidate with creditors recovering pennies on the dollar. There are two main reasons corporations do not emerge successfully from bankruptcy: the time and expenses of a reorganization.
A less common but historically tried-and-true alternative to bankruptcy is a receivership. Receiverships are legislative-made creatures of state law.
A receiver is an “officer of the court” who gathers, markets, and sells all assets of a corporation. In a standard receivership, after marketing is done for a reasonable period, a purchase agreement is negotiated. Then the receivership court approves the sale and the sale is consummated. Once the sale is complete, the receiver distributes the cash generated by the sale in accordance with the state law priority scheme – administrative-priority creditors and transaction costs first, then secured creditors and then unsecured creditors – and the case is then closed.
Appointment of Receiver
Today, receiverships are typically sought by a creditor with liens against an organization’s assets. Receivership can also be requested by the Attorney General or the nonprofit itself in some cases. Typically, the secured creditor will sue the organization for repayment of the debt owed and seek the appointment of a receiver. Receivers are usually appointed early in a legal action. An appointed receiver will operate the nonprofit as well as possible but if it remains impractical or wasteful in its operation, then the receiver will assist with a merger or dissolution with sale of assets. Receiverships may provide a less expensive resolution for defaults while keeping the nonprofit intact and able to serve the community.
Benefits to Receivership for a Nonprofit
- Speed There are fewer roles in a receivership compared to a bankruptcy – no debtors’ counsel, no creditors’ committee – so the process often takes less time. And unlike bankruptcy, no plan, disclosure statement, solicitation, or confirmation hearing is necessary for a receivership, although the supervising court or state law may require analogs of some of these. With fewer steps and roles, the process tends to be faster.
- Cost The cost of a receivership is often lower than a full-scale Chapter 11 reorganization bankruptcy. While a receiver must be compensated, unlike a trustee in bankruptcy, a receiver is usually not paid a commission. And the secured creditor normally bears the financial burden in the event there is a shortfall in revenues that can be used to pay for the receiver and his or her counsel.
- The “Home Rule” If the receivership action is filed in the hometown of your nonprofit, the court will often be more sympathetic to your charitable cause and your impact on the local community.
Shortcomings to Receivership for a Nonprofit
- Loss of Control Once a receiver is appointed, the displaced management members (typically the Board of Directors of the nonprofit) usually do not have a role in the corporation. The Board of Directors will typically no longer have a say in the sales of the assets or the receivership process as a whole. The creditor has most of the control over the sale and distribution process under a receivership as compared to bankruptcy proceedings.
While receivership is not a well-known course of action, it can be a good option in certain circumstances to keep a nonprofit organization in-tact and ready to serve their community. If your nonprofit is facing an inability to pay debts though, we always recommend consulting an experienced nonprofit attorney to assess your unique situation. You can request a consultation with a member of our legal team here. And if your nonprofit is already involved in a receivership case, you can read our article on things to keep in mind during a receivership case.