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Appointment of Receiver Mandatory in Indiana, Notwithstanding Subordination Agreement

The Indiana Court of Appeals recently held in a published opinion that the appointment of a receiver for the benefit of a mortgagee who agreed to subordinate its mortgages was mandatory under Indiana law.  PNC Bank, Nat'l Assoc. v. LA Dev., Inc., __ N.W.2d __, 2012 WL 3156539 (Ind. Ct. App. Aug. 6, 2012).

In LA Development , the lender extended multiple loans to the borrower and, as security for such loans, the borrower granted the lender mortgages on certain real property in Indiana.  In both mortgages, the borrower expressly consented to the appointment of a receiver upon default. After the loans matured, the borrower required additional funds to complete one of its developments. A third party/creditor agreed to advance funds to the borrower, provided that the existing lender execute a subordination agreement with the creditor.  The subordination agreement stated that the lender's "liens, mortgages, encumbrances, and security interests of every kind . . . are hereby SUBORDINATED AND MADE SECONDARY AND INFERIOR to the liens, mortgages, encumbrances, security interests and assignments" of the creditor in the real estate.

Approximately six months after completion, the lender filed a complaint for, among other things, foreclosure and appointment of a receiver against the borrower and the creditor.  In a separate motion for the appointment of a receiver, the lender alleged that the borrower had agreed to the appointment of a receiver and that such appointment was mandatory under Indiana law.  See Ind. Code. § 32-30-5-1(4).  One month later, the creditor filed an answer, cross-claim, and counter-claim alleging that the lender waived its right to the appointment of a receiver in the subordination agreement.  The creditor also filed an objection to the lender's motion for the appointment of a receiver, asserting that because the lender's mortgages were subordinated in their entirety, the creditor's rights were superior to any request for a receivership that the lender might make pursuant to its mortgages.  The trial court denied the lender's request for a receiver, and the lender appealed.

On appeal the lender argued that a receivership was mandatory under Indiana law because the property was not sufficient to discharge the mortgaged debt and the borrower had agreed in writing, and specifically the mortgage, to the appointment of a receiver.  The creditor did not contest that the lender had satisfied the requirements in the statute, but instead argued that the lender waived such right in the subordination agreement.

The Indiana Court of Appeals began its analysis by noting that it must derive parties' intentions from their written expression with in the four corners of a contract.  The court stated that both parties had credible arguments and thus the subordination agreement was ambiguous.  Due to this ambiguity, the court reviewed other documents executed by and among the borrower, lender and creditor at the time the subordination agreement was executed.  The court noted that a forbearance agreement entitled the lender to take any and all actions and exercise all rights and remedies granted to it under the loan documents.  The court further noted that the forbearance agreement reserved all rights of the lender under the loan documents and any remedies against the borrower.  According to the court, the rights granted to the lender in the forbearance agreement simply could not be reconciled with the argument advanced by the creditor. 

In addition, the court recognized that the lender's rights and remedies were not confined to the mortgages.  The subordination agreement, however, only subordinated the lender's mortgages, and not the lender's rights and remedies that might be found elsewhere.  Because only the lender's mortgages were subordinated, the court concluded that only mortgage liens, and not all rights and remedies of the lender, were subordinated. The court therefore reversed the trial court and held that the appointment of a receiver was mandatory under Indiana law.

The decision in LA Development reminds parties to subordination agreements to carefully consider the intended impact of such agreements. In the event that the parties intend for all rights and remedies of an existing lender to be subordinated, it is simply not sufficient to rely on subordination of security interests, mortgages, liens and other encumbrances.  The decision further reminds drafters of loan documents to review and reconcile provisions in different agreements to ensure consistency in the event that an ambiguity exists, thus allowing a court to consider extrinsic evidence.  Finally, LA Development should cause parties to revisit the distinction between encumbrances on the one hand, and claims on the other, especially in the context of a bankruptcy.  Where a lender to a subordination agreement intends to receive a distribution from the debtors and/or its estate prior to any distribution being made to the creditor, the subordination agreement should expressly state that all liens, security interests, mortgages and other encumbrances, as well as claims and all rights to distributions or proceeds are subordinated.

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Barnes & Thornburg LLP's Finance, Insolvency and Restructuring Department handles all aspects of general representation of secured and unsecured creditors, borrowers, guarantors, trustees, and creditors' committees, including negotiating and drafting loan agreements, negotiable instruments, and other commercial transactions in both litigation and transactional aspects of the practice. Our lawyers represent creditors and obligors nationally in out-of-court workouts and refinancings, as well as in various state and federal courts, including bankruptcy proceedings, repossessions, and...

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