Opinion ID: 3014885
Heading Depth: 2
Heading Rank: 1

Heading: Wencke Standard

Text: In a trilogy of cases in the early 1980s, the Ninth Circuit laid out factors a District Court should consider when deciding whether to partially or wholly lift a stay of litigation entered pursuant to a receivership order. The court in Wencke I affirmed the inherent power of a District Court to enter a valid stay of litigation effective even against nonparties to the receivership action. 622 F.2d at 1369.1 The court then addressed, somewhat abstractly, the relevant 1 Similar to the instant case, the SEC brought suit in Wencke to have a receiver appointed to manage and investigate the assets of several companies and their controlling individuals after allegations of looting and fraudulent transactions. The district court appointed a receiver and issued an injunction staying all persons from continuing or initiating proceedings against receivership entities without leave of the court. Wencke I, 622 F.2d at 1367 & n.4. A nonparty to the receivership action sought to have the receivership stay lifted to allow it to enforce a state 5 issues presented when deciding whether to exempt a party from the litigation bar. Id. at 1373-74. The Wencke II court, faced with an appeal of the district court’s refusal to lift the same stay of litigation, set forth a three-part test to be used by a District Court: “(1) [W]hether 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.” Wencke II, 742 F.2d at 1231. In reviewing a district court’s refusal to lift a different receivership stay of litigation, the Ninth Circuit reaffirmed the three Wencke factors and clarified that they differ from the normal criteria used by courts for preliminary injunctions. SEC v. Universal Fin., 760 F.2d 1034, 1308 (9th Cir. 1985). The test “simply requires the district court to balance the interests of the Receiver and the moving party. . . . [T]he interests of the Receiver are very broad and include not only protection of the receivership res, but also protection of defrauded investors and considerations of judicial economy.” Id. We agree. Given how rare non-bankruptcy receiverships are, it is not surprising that we have not yet faced this exact issue 2 –or that few courts around the country have done so. The court judgment which had granted it a leasehold interest in and possession of one of the receivership entities. Id. at 1366. 2 In SEC v. Black, 163 F.3d 188 (3d Cir. 1998), we affirmed a district court’s partial lifting of an asset freeze order which was entered in receivership proceedings. There, though, the district court realized that its initial injunction had been overbroad and the court in fact did not have power over the funds in question. Id. at 196. This Court therefore did not have the opportunity to reach the 6 purposes of a receivership are varied, but the purpose of imposing a stay of litigation is clear. 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. 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. At the same time, we agree with the Wencke courts that the interests of litigants also need to be considered. Far into a receivership, if a litigant demonstrates that harm will result from not being able to pursue a colorably meritorious claim, we do not see why a receiver should continue to be protected from suit. Cf. Wencke II, 742 F.2d at 1232 (reversing the district court’s refusal to lift the stay, seven years into the receivership when the receiver was about to distribute assets and thereby disturb the status quo of the estate). On the other hand, very early in a receivership even the most meritorious claims might fail to justify lifting a stay given the possible disruption of the receiver’s duties. We note that when it is asked to lift a stay it would usually be improper for a district court to attempt to actually judge the merits of the moving party’s claims at such an early point in the proceedings. A district court need only determine whether the party has colorable claims to assert which justify lifting the receivership stay. See Wencke II, 742 F.2d at 1232. If it appears that a claim has no merit on its face, that of course may end the matter. But, if a claim may have merit–and factual development question of the standard to use where the district court chose (or declined) to modify an injunction over issues within its jurisdiction. Cf. id. at 197 (finding the third case in the Wencke trilogy, SEC v. Universal Financial, 760 F.2d 1034 (9th Cir. 1985), inapposite “because it relates to a stay of legal proceedings, as opposed to a freeze of assets, applicable to a nonparty”). 7 may be necessary to assess this–the district court will have to address the other Wencke factors. The experiences of other courts dealing with the Wencke standard are instructive. To the best of our knowledge, district courts in three other Circuits besides the Ninth, when considering whether to lift a receivership stay of litigation, have adopted or used the Wencke standard to guide their inquiry. A Maryland district court partially lifted a stay to allow a foreclosure action against property on which the receivership estate also had a judgment lien. United States v. ESIC Capital, Inc., 685 F. Supp. 483 (D. Md. 1988). The district court admitted that the receivership was only two years old, but concluded that the merits of the asserted claim were “substantial,” and that the movant would suffer “substantial injury” if the claim were not allowed to proceed. Id. at 485-86. The district court noted that a simple foreclosure action would be “painless for all concerned.” Id. at 486. A New York district court stated that it would have “compare[d] the interest of the receiver and the moving party,” but found it unnecessary where the receiver did not object to the partial lifting of a stay. United States v. First Wall St. SBIC, L.P., 1998 U.S. Dist. LEXIS 9487, at  (S.D.N.Y. June 26, 1998) (quoting ESIC Capital, 685 F. Supp. at 485, which cited Universal Financial for the Wencke premise). Most recently, a district court in Illinois refused to lift a stay of litigation where the receivership had only been in place for three months, the estate’s finances were complex, and the movants could not show that they would suffer substantial injury absent permission to sue. FTC v. 3R Bancorp, 2005 U.S. Dist. LEXIS 12503 (N.D. Ill. Feb. 23, 2005). The 3R Bancorp court relied solely on the first and second Wencke factors, while appearing to assume that the claim might have merit. Id. at ; see also FTC v. Med Resorts Int’l, Inc., 199 F.R.D. 601 (N.D. Ill. 2001) (finding that the first and second Wencke factors, which tipped in the direction of maintaining the receivership stay, outweighed the admittedly strong merits of the asserted claim). Ninth Circuit courts also have continued to use the standard. See, e.g., SEC v. Capital Consultants, LLC, 2002 U.S. Dist. LEXIS 6775 (D. Or. Mar. 19. 2002); SEC v. TLC Invs. & Trade Co., 147 F. Supp. 2d 8 1031 (C.D. Cal. 2001); SEC v. Am. Capital Invs., 1996 U.S. App. LEXIS 27685 (9th Cir. Oct. 22, 1996) (NPO). After consideration of the Wencke factors and their application by courts which have subsequently followed the standard, we are of the view that the Wencke test strikes an appropriate balance between allowing a litigant to choose the timing of his day in court, and respecting the purposes of a receivership stay. Accordingly, we adopt the Wencke standard for use in determining whether to lift a receivership stay. In the future we will review a District Court’s decision on whether to lift the receivership stay for abuse of discretion, just like any other choice of procedures chosen by a District Court to effectuate a receivership proceeding. See Black, 163 F.3d at 195; Am. Tel. & Tel. Co., 42 F.3d at 1427; accord Wencke II, 742 F.2d at 1231 (“In reviewing the district court’s application of this test and ultimate decision, we apply an abuse of discretion standard.”). Since the District Court did not use Wencke despite the urging of the parties, we must decide whether to remand this case. We agree with the Ninth Circuit that“[w]here the claim is unlikely to succeed (and the receiver therefore likely to prevail), there may be less reason to require the receiver to defend the action now rather than defer its resolution.” Wencke I, 622 F.2d at 1373. For the reasons set forth below, we agree that the Barracks’ claims against the SBA must fail as a matter of law, and that their mismanagement claims can only be brought derivatively and therefore also fail as a matter of law. As a result we have no need to send these claims back to the District Court for consideration under Wencke, and we will affirm the District Court’s refusal to lift the stay as to these claims for that reason. As described below, although the District Court erred in concluding that the Barracks’ fraud in the inducement claim was derivative, the record is sufficiently developed to allow this Court to apply the Wencke standard to that claim.