With the meltdown of the capital markets, industry experts are busy analyzing how the Fed's rescue plan and other global conditions will impact the escalating rate of commercial loan defaults.

It's no surprise that commercial loan delinquencies are increasing at a dramatic rate. In fact, the number of commercial properties taken over by banks through foreclosures is up 23 percent -- to a value of more than $14 billion.

Despite the alarming figures, there are ways lenders can mitigate losses.

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In the case of some properties, the lender may want to foreclose on the asset and then sell it, allowing the debtor to remain in possession of the property until gaining control at foreclosure. But this can be risky, since the borrower has little incentive to maintain the condition of the property.

If you have a willing borrower, another course of action is to take possession and control directly by means of a deed-in-lieu or similar instrument. But this may not be wise, as the property may be acquired with title problems, liens or other difficulties.

Another option is a bankruptcy -- voluntary or involuntary. A Chapter 11 bankruptcy is filed when a debtor wants time to solve its financial problems while maintaining business operations, while a Chapter 7 is filed for purposes of liquidating and closing a business. There are other forms of bankruptcies, but these two are most commonly encountered by commercial lenders. Confusion between bankruptcy and receivership -- an action in which the lender seeks to protect its security by having an independent third party take possession -- is very common, even with some lenders and attorneys. The most basic and fundamental difference is fairly simple. A bankruptcy is an action filed to protect a borrower/debtor from collection actions by creditors. To that end, bankruptcy courts and rules are primarily aimed at protecting the borrower, not the lender.

Receivership protects property

For these reasons, an optimum solution may be to seek state or federal court appointment of a receiver -- an impartial third party -- who can oversee and protect the asset during the foreclosure process and ideally bring a higher recovery on the loan. This can be accomplished by stipulation with a cooperative borrower or through an adversarial proceeding if necessary.

Most commercial loan documents provide for the appointment of a receiver in the event of a default. Different jurisdictions and different judges' attitudes about appointing a receiver can range from viewing it as routine to seeing it as an extreme step. In the case of a showing of special circumstances (damage to the value of the underlying security, potential loss of franchise, failure to pay taxes or wages, etc.) a receiver may be appointed ex parte -- with little or no notice to the debtor or opposing counsel.

The benefits of a receivership are many. The appointment of a third party to take possession of a property and operate the business will shield the lender from liability, since the receiver is an officer of the court, not an agent of the lender. The receivership can be as critical to the lender as the foreclosure itself, since the property's cash now goes into the receivership estate and the borrower cannot use it for nonproperty expenses like legal fees.

Challenges of an operating business

When considering the options, lenders need to remember the vast difference between operating businesses such as hotels and restaurants and traditional income properties like office buildings and shopping centers. Receiverships can help deal with the complexities of an operating business -- such as payroll and employment, tax liabilities, vendor and supplier relationships, franchise agreements, utility services, and inventories that may require immediate attention.

Typically, a receiver is responsible for protecting the property that represents the security for the loan -- its improvements, furniture, fixtures, equipment and income -- as well as accounting for all receipts and disbursements and repairs and maintenance.

The receivership estate generally has no legal obligation to debts incurred prior to the receiver's appointment, which protects the lender's interest and also acts as a barrier against some creditor actions such as garnishment, attachment, or repossession of assets without court consent.

While dramatic changes or improvements to the property or its business operation are not usually a part of the receiver's duties, the receiver does have the authority to spend money to correct safety hazards, avoid deterioration, and maintain the asset and its value.

The options for dealing with a nonperforming commercial loan are many, and the informed lender servicer or asset manager will use all of the available tools to protect the security in all its forms -- and also see that control passes into the hands of objective and skilled professionals.

Bill Hoffman is president, CEO and founder of Trigild, a San Diego-based company specializing in maximizing recovery on nonperforming commercial loans. The company held its annual Trigild Lender Conference on Oct. 22-24 at the Omni Hotel in San Diego. Hoffman also is an attorney, licensed real estate broker and certified hotel administrator.