In a recently published opinion, Judge John K. Olson of the United States Bankruptcy Court for the Southern District of Florida permitted the bankruptcy estates of TOUSA, Inc. and its debtor subsidiaries to avoid and recover more than $1 billion of liens and cash that the debtors had transferred to secured lenders in a transaction entered into six months prior to the debtors’ chapter 11 bankruptcy filing. Official Committee of Unsecured Creditors of TOUSA, Inc. v. Citicorp North America, Inc., 2009 Bankr. LEXIS 3311 (Bankr. S.D. Fla. Oct. 13, 2009). In a controversial decision, Judge Olson ruled that the transfers were voidable as fraudulent under federal bankruptcy law and New York and Florida state law.

In a controversial decision, Judge Olson ruled that the transfers were voidable as fraudulent under federal bankruptcy law and New York and Florida state law.

TOUSA and its network of subsidiaries build, market and finance the sale of detached single-family residences, town homes and condominiums. On January 29, 2008, TOUSA and several of its subsidiaries filed for chapter 11 bankruptcy protection in Florida. Prior to the bankruptcy filing, the debtors used joint ventures to rapidly expand their operations through a series of acquisitions. In 2005, for example, one of TOUSA’s subsidiaries participated in a joint venture to acquire the homebuilding assets of Transeastern Properties Inc. in Florida. The acquisition was financed by, among other things, $675 million of unsecured third-party debt, which TOUSA guarantied (the Transeastern Debt). In the wake of the economic downturn in the housing market, however, the joint venture failed. This resulted in litigation and, ultimately, a settlement payment of more than $420 million to the financiers of the joint venture. To finance the settlement, TOUSA and certain of its subsidiaries (referred to in the opinion as the Conveying Subsidiaries) borrowed $500 million from Citicorp Inc. and other lenders. As part of the settlement, TOUSA caused the Conveying Subsidiaries to guaranty the new loans (the Subsidiary Guaranties) and to grant liens on substantially all their assets to secure the Subsidiary Guaranties, despite that none of the Conveying Subsidiaries were obligors or guarantors of the old Transeastern Debt.  

The Unsecured Creditors’ Committee, which primarily represented creditors holding $1 billion of unsecured bond debt, filed an adversary proceeding to avoid and recover, as fraudulent transfers, the $500 million of liens on the Conveying Subsidiaries’ assets and the $420 million of settlement proceeds. The Committee also sought to avoid and recover, as a preferential transfer, security interests in a $207 million tax refund, which TOUSA had granted to the new lenders in connection with settlement of the Transeastern Debt. Ruling in favor of the Committee, the bankruptcy court ordered a shocking array of remedies in favor of the bankruptcy estates, including avoidance of the $500 million of liens on the Conveying Subsidiaries’ assets as fraudulent transfers under Bankruptcy Code sections 544 and 548 and New York and Florida state law; disallowance of the new lenders’ claims against the Conveying Subsidiaries; disgorgement of all principal, interest, costs, expenses and other fees received by the new lenders; disgorgement of $403 million of the settlement proceeds plus 9% prejudgment interest per year from the date of the transaction (July 31, 2007); payment of the costs incurred by the debtors and the Committee in prosecuting the adversary proceeding, including the fees and expenses of their attorneys, advisers and experts; and avoidance of all liens on the $207 million tax claim as a preferential transfer under section 547.

The bankruptcy court’s opinion has been criticized on several grounds, most notably with respect to the court’s sweeping rejection and invalidation of so-called “savings clauses” in upstream guaranties. Savings clauses purport to protect a guaranty from being avoided as a fraudulent transfer by limiting the guarantor’s liability to an amount that would not render the guarantor insolvent if the guaranty were enforced. In the TOUSA case, however, the bankruptcy court ruled that the savings clauses in the Subsidiary Guaranties were unenforceable because, among other things, they effectively prevented creditors from exercising their rights under federal bankruptcy law and state law to avoid fraudulent transfers. In other words, the court ruled that the savings clauses in the Subsidiary Guaranties constituted an impermissible “end run” around fraudulent transfer law.

The bankruptcy court’s opinion has been criticized on several grounds, most notably with respect to the court’s sweeping rejection and invalidation of so-called “savings clauses” in upstream guaranties.

Several of the defendants in the adversary proceeding have appealed the bankruptcy court’s decision to the United States District Court for the Southern District of Florida. The appellate proceedings will be watched closely as likely having a significant impact on the law of fraudulent transfers and the practice of including savings clauses in guaranties.