On February 11, 2011, the United States District Court for the Southern District of Florida reversed the controversial decision of the Bankruptcy Court in In re TOUSA that required a group of lenders to disgorge nearly a half billion dollars in repayment of indebtedness which the Bankruptcy Court found constituted a fraudulent transfer under Sections 548 and 550 of the Bankruptcy Code.
The Bankruptcy Court decision in Official Committee of Unsecured Creditors of TOUSA, Inc., et al. v. Citicorp North America, Inc., et al. (In re TOUSA, Inc. 422 B.R. 783 (Bankr. S.D. Fla. 2009) infamously raised significant concerns for lenders generally by (i) suggesting that a creditor who receives a validly tendered debt payment outside of the 90-day preference period is nevertheless at risk of having the payment avoided as a fraudulent transfer in the event that a court cannot find objective, specifically quantifiable equivalent value to the obligor’s subsidiaries who pledged assets to secure the debt and (ii) imposing upon creditors a duty to investigate the internal refinancing structures of their debtor-obligors.
THE BANKRUPTCY COURT’S TOUSA DECISION
TOUSA, Inc., together with certain of its affiliates and subsidiaries, is an enterprise of builders, manufacturers and designers of residential property throughout the United States that commenced Chapter 11 proceedings in 2008. Pre-petition, TOUSA, Inc., the parent company, had been part of a failed joint venture and had incurred significant debt obligations to a lending syndicate (the “JV Lenders”) in connection therewith. Seven months prior to the commencement of the bankruptcy cases, the parent company repaid the JV Lenders by entering into new loans and financing arrangements with a new group of lenders (the “New Lenders”), secured by liens on the assets of both the parent company and certain of its operating subsidiaries who were not obligated on the debt being repaid to the JV Lenders.
The Official Committee of Unsecured Creditors in the TOUSA bankruptcy cases commenced an action to (i) avoid the obligations incurred, and the liens granted to secure those obligations, by the operating subsidiaries in favor of the New Lenders pursuant to sections 544 and 548 of the Bankruptcy Code and (ii) recover $421 million paid to the JV Lenders on two alternative theories, asserting that the TOUSA subsidiaries were insolvent and the JV lenders were either direct transferees of the new loan proceeds paid in satisfaction of an antecedent debt owed to them or, alternatively, indirect transferees, as entities “for whose benefit” an improper transfer was made. The Bankruptcy Court agreed, treating the financing of the new loans, the grant of liens to the New Lenders to secure them and the payoff to the JV Lenders as a single, integrated transaction and avoiding both the liens granted to the New Lenders and the payments made to the JV Lenders.
THE DISTRICT COURT’S REVERSAL
The District Court disagreed and rejected the Committee’s assertion that the JV Lenders were recipients of a fraudulent transfer from the TOUSA subsidiaries, because the proceeds of the new loans were not controlled by those subsidiaries. Further, the specific terms of the loans authorized only the parent company to control distribution and required that such proceeds be used to repay the JV Lenders. As a result, because the funds at issue were not property of the TOUSA subsidiaries, the transfer to JV Lenders could not be avoided under a direct transfer theory.
The District Court likewise rejected the Committee’s assertion that the JV Lenders were indirect transferees of an avoidable transfer and concluded that the JV Lenders were not indirect beneficiaries of the transfer of liens to the New Lenders by the TOUSA subsidiaries under Section 550 of the Bankruptcy Code. The District Court also found that the Bankruptcy Court erred in its conclusion that, as a matter of law, the TOUSA subsidiaries did not receive reasonably equivalent value, citing the indirect benefits rendered to the TOUSA subsidiaries as a result of the transactions and the weight of authority in support of the view that “indirect, intangible, economic benefits, including the opportunity to avoid default, to facilitate the enterprise’s rehabilitation and to avoid bankruptcy, even if it proved to be short lived, may be considered in determining reasonably equivalent value.” The District Court also characterized the ruling of the Bankruptcy Court as imposing an unfair burden on creditors to investigate all aspects of debtors and debtor affiliates before agreeing to accept payments for valid debts owed, rejecting explicitly that such investigation is necessary to support a determination that a creditor acted in good faith in accepting such payment.
The District Court’s decision does not implicate the Bankruptcy Court’s decision as it relates to the fraudulent transfer claims against the New Lenders. The appeal of that decision by the New Lenders is currently pending before the Honorable Adalberto J. Jordan, also in the District Court. There may well be further appeals, but for now, the District Court decision should be of some comfort to lenders in their dealings with distressed borrowers.