Stay Relief Is Seldom Granted in Receivership Cases

The Ninth Circuit Court of Appeals, in SEC v. Wencke, 742 F.2d 1230 (9th Cir. 1984), set forth the three factors commonly applied by federal courts in determining whether to lift the stay in a receivership case:

(1) whether refusing to lift the stay genuinely preserves the status quo or whether the moving party will suffer substantial injury if not permitted to proceed; (2) the time in the course of the receivership at which the motion for relief from the stay is made; and (3) the merit of the moving party’s underlying claim. In reviewing the district court’s application of this test and ultimate decision, we apply an abuse of discretion standard.

Id. at 1231. The Circuit Court found that the District Court had abused its discretion in not lifting the stay after the receivership had been in place for seven years. See id. The District Court’s refusal to lift the stay meant that plaintiffs would not get their day in court to assert their claims against the receivership entities. See id.

Most courts applying the Wencke factors deny requests for stay relief. See SEC v. Universal Financial, 760 F.2d 1034, 1038 (9th Cir. 1985). In Universal Financial, the Circuit Court upheld the District Court’s denial of stay relief where (i) allowing movant to assert its claims against the estate would require the receiver to litigate in a different forum and significantly diminish the estate; (ii) the receivership had been pending for four years but the Receiver was still in the process of discovering information related to the movant’s underlying claims; and (iii) there was no doubt that the movant’s claims would succeed but that factor alone was insufficient to warrant lifting the stay. See id. at 1038-39. The Circuit Court also noted that, in the first Wencke case, the Court had properly denied stay relief even after the receivership had been pending for four years. See id. at 1039. There is a significant body of case law applying the Wencke factors to support the denial of stay relief where such stay relief would disrupt the status quo and/or take away property of the estate to the detriment of defrauded investors. See SEC v. Vescor Capital Corp., 599 F.3d 1189, 1197 (10th Cir. 2010) (Affirming denial of stay relief where secured creditor wanted to bring suit to foreclose on receivership property and reasoning, “We agree with the receiver that to remove the [creditor’s] properties from the receivership will upset the status quo, which attempts to preserve the assets of the defrauded investors.”) (citing SEC v. Byers, 592 F. Supp. 2d 532, 537 (S.D.N.Y. 2008) (rejecting movants’ attempts to challenge an injunction imposed involving a Ponzi scheme, applying Wencke, and concluding that “the best way to maintain the status quo is to permit [the receiver] to carry on with his investigation”)); see also SEC v. Illaramendi, 2012 WL 234016 *5 (D. Conn. Jan. 25, 2012) (Denying stay relief after applying Wencke factors and agreeing with Receiver’s argument that his interest in preserving the status quo is strong, as the costs of actively defending litigation in another state would be high and active defensive litigation would constitute a significant drain on receivership assets, regardless of any finding of liability.). In Illaramendi, the District Court also cites other case law showing a general opposition to forcing the receiver to defend the estate in ancillary litigation See id. The District Court specifically quoted case law from various Circuits stating

The purpose of a litigation stay is to enable the receiver to “do the important job of marshaling and untangling a company’s assets without being forced into court by every investor or claimant.” Acorn Tech. Fund, 429 F.3d at 443. “The receiver’s role, and the district court’s purpose in the appointment, is to safeguard the disputed assets,” and requiring the receiver to defend lawsuits drains receivership assets. Liberte Capital Grp., LLC v. Capwill, 462 F.3d 543, 551 (6th Cir. 2006); see also FTC v. Med Resorts Int’l, Inc., 199 F.R.D. 601, 609 (N.D. Ill. 2001) (permitting ancillary litigation would “[n]ot only … take [the receiver’s] attention away from other tasks, but the assets of the receivership estate would quickly be diminished”). Bearing in mind these realities, “[a] district court should give appropriately substantial weight to the receiver’s need to proceed unhindered by litigation, and the very real danger of litigation expenses diminishing the receivership estate.” Acorn Tech. Fund, 429 F.3d at 443.

Id. Further, the District Court has analyzed whether the movants present any evidence showing that they would suffer substantial injury if they were not granted relief from the stay. See Med Resorts, 199 F.R.D. at 609. In Med Resorts, where the movants did not meet that burden, the District Court refused to lift the stay. See id.

Similarly, in SEC v. Stanford Intern. Bank Ltd., 465 Fed Appx. 316, 321 (5th Cir. 2012), the Fifth Circuit Court of Appeals weighed heavily the interests of all of the investors and the preservation of the Estate for all as against the rights of one potential creditor to assert its rights by lifting the stay as to that one creditor. See id. (affirming the District Court’s ruling upholding the stay to prevent a bank from using funds of a receivership defendant to pay a creditor that had presented a letter of credit to the bank).

The Fifth Circuit offered the following analysis in applying the Wencke factors:

The first factor—whether the moving party will suffer substantial injury—weighs in favor of the Receivership. This factor is essentially a balancing of Trustmark’s interest with the interests of the Receivership. See Stanford I, 424 Fed.Appx. at 341 (“The first factor essentially balances the interests in preserving the receivership estate with the interests of the Appellants.”). While it is probable that Trustmark will suffer injury since it is not assured of recouping the full letter of credit amount from the Receivership, that does not outweigh the interest the Receivership has in maintaining the estate. The Receiver’s task to “marshal, preserve and conserve the receivership estate is as much for [Trustmark’s] benefit as for the benefit of all the other investors—investors who also lost amounts of money” is an important interest. Id. The final two factors cancel each other out with the second factor—the time in the course of the Receivership—weighing in favor of the Receiver, and the third factor—the merit of the moving party’s underlying claim—weighing in favor of Trustmark. This means that the Wencke factors, on balance, indicate that the district court’s decision was correct. We therefore affirm the ruling of the district court.

Id. Also, in considering whether to lift the stay, the Circuit Court took into account that the party seeking to lift the stay would certainly lose money as a result of the receivership action. Nevertheless, the Court determined that it is more important to preserve the Estate for the whole body of creditors.

In U.S. v. Acorn Technology Fund, L.P., 429 F.3d 438, 443 (3rd Cir. 2005), the Third Circuit Court of Appeals affirmed the District Court’s ruling upholding the receivership stay despite recognizing that a court should weigh the interests of litigants to have their day in court. See id. (affirming District Court ruling that defrauded investors were not entitled to stay relief against receivership estate).

The Third Court reasoned as follows:

A receiver must be given a chance to do the important job of marshaling and untangling a company’s assets without being forced into court by every investor or claimant. Nevertheless, an appropriate escape valve, which allows potential litigants to petition the court for permission to sue, is necessary so that litigants are not denied a day in court during a lengthy stay.

Id.

Accordingly, purported creditors are not likely to succeed on a motion for stay relief against the receivership estate based on the general preference of courts appointing receivers to allow the receiver to resolve claims against the estate through the receivership process in the most efficient manner possible.