On February 11, 2011, the Hon. Alan Gold of the United States District Court for the Southern District of Florida reversed the October 30, 2009 fraudulent conveyance finding issued by the Bankruptcy Court in the TOUSA case as it pertained to lenders involved in TOUSA’s Transeastern joint venture. Lending institutions (particularly in the distressed sector) that were troubled by the TOUSA Bankruptcy Court’s prior decision, specifically its limited definition of “value” and broad view of third-party fraudulent conveyance liability, should take some comfort in the District Court’s opinion, which broadly reverses these aspects of the Bankruptcy Court’s decision. At the heart of the District Court’s decision are (i) the observation that the Bankruptcy Court had expanded fraudulent conveyance liability beyond its prior limits and (ii) the need to restore those limits in order to avoid imposing impossible burdens on lenders. While this decision is certainly significant on a number of levels, it likely is not the last word in the TOUSA cases given that the appeals of TOUSA’s first and second lien lenders remain pending before another District Court judge and there is a substantial likelihood of further appeal by one or more parties to the Eleventh Circuit Court of Appeals.
Please see the end of this alert for an important press time development.
Prior to filing for chapter 11 protection in early 2008, TOUSA, Inc. and its various subsidiaries (collectively, “TOUSA”) constituted one of the nation’s largest home builders. In June 2005, TOUSA, through one of its wholly-owned subsidiaries, became involved in a joint venture known as Transeastern (“Transeastern”). Transeastern was funded using $675 million of debt borrowed by various special purpose entities, a subordinated loan from one of the TOUSA subsidiaries and equity. In connection with this financing, the special purpose entities entered into a senior credit agreement with Deutsche Bank Trust Company Americas acting as administrative agent for the various Transeastern lenders (the “Transeastern Lenders”). Additionally, TOUSA, Inc. (the TOUSA parent entity) and TOUSA Homes LP (TOUSA’s primary operating subsidiary) issued certain completion and carve-out guarantees on the financing.
In late 2006, it became apparent that the viability of Transeastern was in jeopardy and on September 29, 2006, Deutsche Bank and the various Transeastern special purpose entities executed an agreement recognizing a potential event of default under the Transeastern financing. On October 31 and November 1, 2006, Deutsche Bank sent demand letters to TOUSA and TOUSA Homes LP demanding full payment pursuant to the guarantees.
TOUSA’s primary source of liquidity at the time was a revolving credit facility (the “Revolver”). To secure a waiver of TOUSA’s default under the Revolver due to TOUSA’s potential liability to the Transeastern Lenders, various TOUSA subsidiaries pledged assets as security under the Revolver to ensure the company’s continuing liquidity and on January 30, 2007, these subsidiaries became co-borrowers under the Revolver.
In late 2006, Deutsche Bank, on behalf of the Transeastern Lenders, brought suit against TOUSA, TOUSA Homes and the special purpose entities, arguing that TOUSA’s liabilities under the guarantees potentially exceeded two billion dollars – several times the total outstanding loan balance. After significant deliberations – during which TOUSA was independently advised that its ability to continue as a going concern was in serious doubt in the event of an adverse judgment – TOUSA’s board unanimously voted to settle the Transeastern Lenders’ claims for approximately $420 million plus interest (the “Transeastern Settlement”).
To finance the Transeastern Settlement, in July 2007, TOUSA and the majority of its subsidiaries, including those not obligated on the guarantees, entered into first and second lien term loan credit agreements for $200 million and $300 million respectively. These funds were transferred to the administrative agent of the Transeastern Lenders which, in turn, wired the funds to the various Transeastern Lenders (collectively, the “July 2007 Transaction”).
Despite the Transeastern Settlement, TOUSA’s financial condition continued to deteriorate in the wake of the August 2007 credit-market collapse. On January 28, 2008, TOUSA and its subsidiaries filed petitions for relief under chapter 11 of the Bankruptcy Code. Shortly after TOUSA’s jointly-administered bankruptcy was commenced, the Official Committee of Unsecured Creditors (the “Committee”) brought actions against a number of parties, including the Transeastern Lenders, to avoid the July 2007 financing as a fraudulent conveyance. A finding of fraudulent conveyance is only appropriate when a transaction (i) is made while an entity is insolvent or renders that entity insolvent and (ii) provides less than reasonably equivalent value to an insolvent entity. A number of cross-claims and third-party claims were filed, which were ultimately consolidated as a single adversary proceeding before the Bankruptcy Court for the Southern District of Florida.
BANKRUPTCY COURT RULING
Following a three week trial in July 2009, and an additional day of rebuttal testimony by the Committee in August 2009, the Bankruptcy Court ordered all parties to submit post-trial pleadings containing proposed findings of fact and conclusions of law. On October 30, 2009, the Bankruptcy Court issued its decision (the “Decision”), which consisted of a nearly verbatim adoption of the Committee’s proposed findings. The Bankruptcy Court declared, among other things, that the July 2007 Transaction was a fraudulent conveyance with respect to TOUSA’s subsidiaries (the “Conveying Subsidiaries”) and that the Transeastern Lenders were entities for whose benefit the conveyance was made. Accordingly, the Bankruptcy Court avoided the transfer of approximately $421 million to the Transeastern Lenders and ordered disgorgement. In reaching this conclusion, the Bankruptcy Court declared that if the Conveying Subsidiaries received “any value at all, it was minimal and did not come anywhere near the $403 million of obligations they incurred.” The Transeastern Lenders, as well as other parties, appealed the Decision and obtained a stay of the disgorgement obligations pending resolution of the appeal. Oddly, the various appeals were docketed with different judges, although the appeals of the TOUSA’s first and second lien lenders were ultimately consolidated before the Hon. Adalberto Jordan while the Transeastern appeal was set to be heard by the Hon. Alan Gold. The appeals were briefed on identical schedules and oral argument was heard jointly by judges Jordan and Gold.
THE DISTRICT COURT’S RULING
On February 11, 2011, the Hon. Alan Gold issued a 113-page opinion in the Transeastern appeal, in which he reversed, in detail, many aspects of Bankruptcy Court’s Decision. Given the lengthy nature of Judge Gold’s decision, it would be impracticable to fully describe each aspect of his ruling. However, several of his rulings are particularly noteworthy and are briefly described below.
Standard of Review
First, the District Court clarified that where a trial court adopts one party’s proposed findings virtually verbatim, such factual findings should not be accorded deference on appeal. Appellate courts typically review a trial court’s conclusions of law de novo (or as if no prior trial was held), while factual findings are only set aside if “clearly erroneous.” However, the District Court noted that a trial court’s decision to adopt one party’s findings verbatim (or nearly so) amounts to “an abandonment of the duty and the trust that has been placed in the judge . . . .” While litigants are obviously not in a position to prevent a judge from adopting proposed findings verbatim, they should be aware that if such findings are issued, risk of a lower standard of review on appeal with respect to factual findings is dramatically increased.
Next the court noted that although the Bankruptcy Court found the Transeastern Lenders liable under two distinct theories of fraudulent conveyance (direct transferee liability and as entities for whose benefit the transfer was made) these two theories were mutually inconsistent. Moreover, the Bankruptcy Court’s reasoning with respect to each theory was held to be incorrect as a matter of law. First, the District Court found that the Transeastern Lenders could only be held liable on a direct-transferee theory for a transfer of the debtors’ property (in this case the conveying subsidiaries). Because the court found that the only property received by the Transeastern Lenders (the term loan proceeds) was controlled by the parent entity and ear-marked for immediate payment to the Transeastern Lenders, the District Court found that the conveying subsidiaries neither controlled nor had a property interest that property.
Beneficial Transferee Liability
The District Court also found that the Bankruptcy Court erred in finding that the conveying subsidiaries could recover from the Transeastern Lenders because the July 2007 Transaction, as a whole, was for the “ultimate benefit” of the Transeastern Lenders. The District Court noted that there are only three types of entities from whom recovery is possible under section 550 of the Bankruptcy Code following avoidance of a transfer under section 548: an initial transferee, an entity for whose benefit such initial transfer was made or a subsequent transferee. The District Court found that the transfer referred to in section 550 must be the same transfer as is avoided under section 548. Thus, the transfer at issue was properly the transfer of liens to the term loan lenders rather than the transfer of funds to the Transeastern Lenders. The Bankruptcy Court therefore erred by attempting to collapse each aspect of the July 2007 Transaction for avoidance purposes when only the transfer of liens was potentially avoidable as a fraudulent conveyance. In making this finding, the District Court rejected the “impossible burden” placed on creditors by the Bankruptcy Court to “investigate all aspects of their debts and the affiliates of those debtors before agreeing to accept payments for valid debts owed.”
Reasonably Equivalent Value
In addition to dispensing with both of the Committee’s section 550 arguments for recovery against the Transeastern Lenders, the District Court also found that the Bankruptcy Court erred in finding that the July 2007 Transaction constituted a fraudulent conveyance at all. Specifically, the District Court found that the Bankruptcy Court’s conclusion that the Conveying Subsidiaries did not receive reasonably equivalent value in connection with the July 2007 Transaction was both legally incorrect and clearly erroneous as a matter of fact.
First, the District Court found that the Bankruptcy Court erred by not concluding that reasonably equivalent value was given in light of its finding that the Conveying Subsidiaries had a property interest in the proceeds of the term loans and by failing to measure reasonably equivalent value against such an interest. The District Court concluded that if the value of the property interest transferred from the Conveying Subsidiaries to the Transeastern Lenders was “minimal,” then only minimal value in exchange was needed to reach reasonable equivalence. However, given the Bankruptcy Court’s finding that the Transeastern Lenders were also liable for the lien transfers to the Term Loan Lenders, the District Court opted to conduct a further analysis into reasonable equivalent value. In so doing, it concluded that the Bankruptcy Court erred in concluding that reasonably equivalent value was not provided with respect to the lien transfers.
The District Court began its analysis on this point by noting that the Bankruptcy Court improperly shifted the burden of proving reasonably equivalent value to the defendants when under established Eleventh Circuit precedent “the burden of proving lack of reasonably equivalent value . . . rests on the party challenging the transfer.” Additionally, the Bankruptcy Court erred in finding that the conveying subsidiaries did not receive an indirect economic benefit constituting reasonably equivalent value in exchange for the lien transfers. While the District Court accepted the Bankruptcy Court’s conclusion that each conveying subsidiary must have received an indirect benefit, it found that it was legal error to hold that avoidance of bankruptcy (even for a short time) was not property and therefore not “value” for purposes of a reasonably equivalent value analysis. Instead, the District Court found that precedent demanded a broad construction of “value,” rather than relying, as the Bankruptcy Court did, on a narrow Webster’s Dictionary definition of value unsupported by either case law or other authority. When applying appropriately broad definitions of “value” and “property” the District Court found that, although the Conveying Subsidiaries were not themselves liable on the Transeastern Guarantees, they received value in exchange for their grant of liens because that grant had the potential to stave off a parent-entity bankruptcy that could well have destroyed the entire company as a going-concern. This “indirect benefit,” the opportunity to avoid default, was sufficient to establish reasonably equivalent value under the facts of this case.
Finally, the District Court rejected the Bankruptcy Court’s overall approach to analyzing the July 2007 Transaction, which it characterized as “review [of] the transaction at issue through the lens of retrospection to point out that bankruptcy ultimately was not avoided.” Instead, the District Court noted that “reasonably equivalent value must be evaluated as of the date of the transaction.”
The District Court’s decision in the TOUSA Transeastern appeal amounts to a point-by-point refutation of virtually all aspects of the Bankruptcy Court’s Decision with respect to the Transeastern Lenders. Lending institutions that were troubled by the extremely broad view of liability and limited construction of “value” and “property” adopted by the Bankruptcy Court should be comforted by the District Court’s February 11, 2011 decision. However, given the pending first and second lien appeals before the Hon. Adalberto Jordan, and the likely further appeal to the Eleventh Circuit, we expect that we have not yet heard the definitive word on TOUSA’s implications. In the interim, however, some of the major points to take away from the District Court’s decision include:
- The Bankruptcy Court’s decision in TOUSA drew enormous attention primarily because it purported to expand lenders’ potential fraudulent conveyance liability well beyond previous precedent. Pending a contrary opinion in the appeals of TOUSA first and second lien lenders or from the Eleventh Circuit, however, Judge Gold’s decision appears to curtail that expansion and should signal a return to previous standards of due diligence and acceptable conduct.
- Where a trial court adopts one party’s proposed findings of fact nearly verbatim, that party is likely to have considerable appellate exposure, as the reviewing court is unlikely to accord any deference to such findings.
- The burden is on the party claiming that a fraudulent transfer has occurred to prove lack of reasonably equivalent value.
- A cash infusion to a parent entity to stave-off bankruptcy may constitute value to subsidiaries where it is unclear that such subsidiaries could continue to operate as going concerns absent a solvent parent entity. Consequently, lending institutions should have increased confidence in the viability of subsidiary credit support for parent-level financing.
- Reasonable equivalence must be measured as of the time of the transaction rather than through “retrospection.”
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UPDATE: At press time, we received an Order from Judge Jordan in the first lien term loan and the second lien term loan appeals inviting the parties to make supplemental submissions on how Judge Gold's decision impacts the issues in those appeals. Of significant note, the Order provides: "The parties, intervenors, and amici curiae are not to argue whether Judge Gold's ruling is correct but instead are to assume the ruling is correct."