Occasionally we find a bankruptcy case that we know will be of interest to lenders, and this is one of them. I’m calling this one a “two-step” not just because it makes for a catchy title, but also because this is the second time we’ve seen this case, and this time the outcome is less favorable.
When we last heard about the TOUSA case, the court had decided in favor of the lenders, finding that there wasn’t a fraudulent transfer when new liens were given and old loans repaid on the eve of bankruptcy. (You'll recall that the court typically examines two issues in deciding if there's a fraudulent transfer: whether the company is insolvent (which this one clearly was), and whether "reasonably equivalent value" was transferred to the debtor in exchange for the loan/liens.) In the original TOUSA appeal, the court found that, based on the facts, reasonably equivalent value had been received in exchange for new liens granted by the TOUSA subsidiaries.
In the second step of this dance, on a second level of appeal, the 11th Circuit Court of Appeals has now reversed that decision. The appellate court thought that TOUSA’s projections were unachievable and bankruptcy was inevitable at the time the new loan and liens were given. So, liability was not soley with the new lenders, but with the previous lenders who were repaid by the new loan proceeds. The court found that the previous (repaid) lenders were “beneficiaries” of the liens much like the new lenders were -- because the proceeds of the new loans were used to pay them off. Based on this decision, the old lenders who were paid off pre-bankruptcy may end up having to give back the money (we await further court action to see if this happens).
What can we make of this outcome? Have we really gone two steps forward and one step back? It is important to note that, in making its decision, the court didn't re-open the inquiry into the facts of the case. This decision was based largely on a procedural issue (one of those very technical legal things that many of you would rather visit the dentist than hear about). The court only decided that the original court that heard the case was entitled to deference as to its findings of fact, and that its finding that there wasn’t “reasonably equivalent value” should stand. Significantly, the court did not get into the issue of whether “indirect benefits” can provide reasonably equivalent value in factual situations that are not the same as this one. It is still possible for “value” to include intangible benefits such as the opportunity to avoid bankruptcy.
Still, this case is telling us to exercise caution before cranking up the music and hitting the dance floor. It's clear from this case that courts aren't always going to find that avoidance of bankruptcy is reasonably equivalent value, i.e., worth the high price the company is asked to pay. The court warned that creditors must “exercise some diligence” when receiving payments from debtors they know are in trouble, to make sure the value being given bears reasonable resemblance to the value being taken. A bankruptcy court, looking at the situation with the benefit of hindsight, might reach conclusions the lenders wouldn’t have reached at the time. And it could result, as here, in liability not only for the amount of repayments, but also for the value of liens granted to the new lenders. Watch your step!