The South Florida Bankruptcy Court in the Tousa case ordered various creditors that had benefitted from a fraudulent conveyance to disgorge $421,000,000 to the jointly-administered Tousa bankruptcy estates. The court also ordered the avoidance of liens on the assets of various Tousa subsidiary entities who were also debtors in the bankruptcy proceedings. This case may raise increased focus upon the legal theory of fraudulent conveyance, which was the rationale used by the bankruptcy court to order the money returned.

The two major elements of a fraudulent conveyance are that (1) a debtor makes a transfer for less than reasonably equivalent value and (2) the transfer either makes the debtor insolvent or occurs at a time when the debtor was already insolvent. In a nutshell, the doctrine of fraudulent conveyance (or fraudulent transfer) gives a legal remedy to pre-existing creditors when a borrower makes transfers to third parties while insolvent, unless the transfer is for “reasonably equivalent value.” Fraudulent conveyances may deprive a borrower’s pre-existing creditors of recourse to assets that they relied on in making loans to the borrower. Fraudulent conveyances are legally reversible because they remove assets from the borrower’s balance sheet without replacing them with other assets of “reasonably equivalent value.”

The parent debtor company in Tousa, called Tousa Inc., had previously incurred $500,000,000 in debt in a unsuccessful business venture. To refinance that debt, it arranged for itself and its subsidiaries to receive loans and to give liens in order to raise the money to repay its business debts. The subsidiaries, however, were not liable for the business debts being repaid. Consequently, the Tousa subsidiaries did not benefit from the liabilities they incurred and the liens they gave in the debt refinancing and loan transaction.

As Tousa has confirmed, the liabilities and obligations incurred by subsidiaries in support of their parent companies, often called “upstream” obligations, are especially vulnerable to fraudulent conveyance attack by disgruntled junior or unsecured creditors of a bankruptcy estate. As in Tousa, subsidiaries may not fully benefit from loans and liabilities incurred for the sole benefit of parent corporations. Thus, subsidiaries do not receive “reasonably equivalent value” for incurring liabilities or giving lien-backed guaranties of such loans. Moreover, such new liabilities and obligations can render subsidiaries insolvent if they are not so already.

The court ruled that the business creditors who had been repaid from the proceeds of the fraudulent loan transaction had to return $421,000,000 of principal and interest received. Section 550 of the Bankruptcy Code allows for the disgorgement of payments made to a secondary transferee of a fraudulent transfer, or to the “entity for whose benefit such transfer was made.” Here, Section 550 allowed for recourse to the parties whose business debts had been repaid with the loan proceeds even though the fraudulent transfer itself was received by the lending banks. The liens placed on the subsidiaries’ assets were also avoided.