In a previous Financial Services Flash, we brought to your attention the decision of the United States Bankruptcy Court for the Southern District of Florida (the “Bankruptcy Court”) in the case of In re Tousa. In a decision that raised serious concerns for lenders in the United States, Justice Olson held that the first and second ranking secured lenders of Tousa Inc. (“Tousa”) did not act in good faith and were grossly negligent in providing Tousa with a secured loan less than six months before Tousa filed for bankruptcy. Tousa obtained the $500 million loan from two lender groups (the “New Lenders”) in order to settle a lawsuit commenced by some of its existing creditors (the “Transeastern Lenders”). The Bankruptcy Court effectively reversed the loan, and any benefits enjoyed by the lenders were required to be disgorged.
On February 11, 2011, the United States District Court for the Southern District of Florida (the “District Court”) issued a decision in the Transeastern Lenders’ appeal of In re Tousa, overruling the Bankruptcy Court’s decision. This decision provides some comfort to lenders, as it specifically rejects the Bankruptcy Court’s position on a number of controversial issues. An appeal by the New Lenders on related issues remains pending before a different court in the same district.
In the first instance, Justice Olson had held that the loan advances were fraudulent in that they were not in exchange for “reasonably equivalent value”. Justice Gold of the District Court rejected this conclusion by interpreting “value” more broadly than the Bankruptcy Court did. Specifically, Justice Gold determined that the settlement of the litigation did constitute value received in exchange for the security interests granted. This value was reasonably equivalent to the advances, in that it permitted Tousa to continue operating. While Tousa became insolvent only a short time later, Justice Gold held that it was inappropriate for Justice Olson to have considered events that occurred subsequent to the date of the transaction at issue in determining their validity or propriety.
A particularly controversial element of the Bankruptcy Court’s decision was Justice Olson’s determination that the lenders were negligent in providing the funds, when they had enough publicly available information to know that Tousa’s financial position was precarious. Justice Gold rejected this interpretation, holding that placing additional inquiry obligations on a lender in such circumstances would create an “impossible burden” for the lender.
Some uncertainty remains, as Justice Gold did not address the Bankruptcy Court’s decision with respect to the New Lenders. In fact, Justice Gold specifically noted that his decision is not binding on the appeal of the New Lenders that is currently under way. While this decision provides a positive indication that lenders will not be subject to the additional requirements of making an inquiry into a borrower’s financial position imposed upon them by the Bankruptcy Court’s decision, it is not yet certain that the New Lenders’ appeal will have a similar result.
Structuring a lending transaction with a borrower that is experiencing financial distress must be done with the proper safeguards and in consideration of all the risks.