By now many of you will have heard about the recent decisions in the TOUSA (pdf) bankruptcy case. There are several other write-ups out there that cover the many important elements of this case in detail, but here I wanted to just say a few words about one issue of significance to senior secured lenders. The question of whether subsidiaries can properly guarantee a loan made to the parent company (without it being a fraudulent conveyance) sometimes comes up in loan transactions, and having an understanding of the issues here can be really helpful.
You'll recall that the TOUSA case is about fraudulent conveyances. As explained in our last post, in simple terms, a bankruptcy court can void (and claw back) payments made if the debtor was insolvent at the time of the transaction and if it received less than "reasonably equivalent value" for what it gave up in the deal. Setting aside the question of solvency, then, here's our issue:
QUESTION: If a subsidiary of the borrower guarantees the loan (and/or provides a lien or other support), do you have to show that the subsidiary received some of the proceeds of the loan in order to demonstrate that it got "reasonably equivalent value" in the transaction?
SHORT ANSWER: No. Reasonably equivalent value can be received through intangible and indirect benefits as well as by direct benefits such as cash proceeds.
The court in the TOUSA case explained that you can take a relatively broad view of what constitutes "value." In TOUSA, the company's subsidiaries became co-borrowers on the loan and provided liens on their assets. The loan proceeds were used to pay off a significant liability. The court found that the subsidiaries had received value in exchange for this because they had received "indirect economic benefits" from the loan. The benefits were, among other things, "the opportunity to avoid default, to facilitate the enterprise's rehabilitation, and to avoid bankruptcy, even if it proved to be short lived" (here, the companies ended up in bankruptcy anyway). The court clarified that it is not just cash, but all kinds of interests in property -- including intangible things like "promises to act or forbear to act" and indirect or contingent benefits -- that can be considered.
But was the value "reasonably equivalent" to the property rights that were transferred? In this case, yes. A "legitimate and reasonable" expectation that default could be avoided and the enterprise strengthened by the transaction can be enough value. For the TOUSA subsidiaries, absent the loan transaction, there was a realistic risk that the companies would not have been able to continue to survive. The value to the companies was their ongoing existence, and the court found that this met the standard for being reasonably equivalent to what they gave up in the deal. It was not necessary to quantify the benefits and determine a precise dollar valuation in order to come to this conclusion.
Of course, as with all things legal, the analysis can get rather complex and the conclusions will vary depending on the facts at hand (full disclaimers, no promises, your results may vary, don't try this at home, etc.). A takeaway from the TOUSA case is that you can look at a lot of different things when considering if there was value received -- and showing that there was "reasonably equivalent value" may not be quite as difficult as it sometimes seems.