The United States District Court for the Southern District of Florida has reversed a bankruptcy court order that had required a group of lenders (“Transeastern Lenders”) to disgorge, as a fraudulent transfer, approximately $421 million paid to them by a joint venture partner (“TOUSA”) in satisfaction of their legitimate, uncontested loans to the joint venture that TOUSA had guaranteed. Together with pre-judgment interest, the total amount to be paid by the Transeastern Lenders was in excess of $480 million.

On appeal, the District Court reversed the bankruptcy court’s ruling in its entirety, citing numerous errors of law and fact, noting the widespread disagreement among commentators with the bankruptcy court’s decision, and roundly condemning the bankruptcy court’s wholesale adoption of the plaintiff creditors committee’s own pleadings in its memorandum opinion.

Click here to access a copy of the opinion.

Background

TOUSA, a nationwide homebuilder, relied heavily on bond indebtedness and a revolving credit facility for liquidity. TOUSA’s subsdiaries had guaranteed these facilities and pledged their assets to secure the revolving loans. The loans provided by the Transeastern Lenders to the joint venture were in default, and TOUSA had been sued by the Transeastern Lenders to collect certain completion and carve-out guaranties it had provided for those loans. Bankruptcy of TOUSA or any judgment in excess of $10 million against TOUSA would have triggered the default provisions under TOUSA’s non-joint venture bonds and credit facilities, threatening continued operations. TOUSA and its subsidiaries determined that a settlement of the joint venture litigation was in their best interests, and that repayment of the Transeastern Lenders would allow them to continue operations.

The funds used to repay the joint venture loans were the proceeds of new loans obtained by TOUSA, secured by the assets of TOUSA’s non-joint venture subsidiaries. Such subsidiaries were liable as co-borrowers on the new loans to TOUSA, but they had neither received the proceeds of such loans nor guaranteed the loans of the Transeastern Lenders to the joint venture. Not long after the settlement was concluded and the loan proceeds were paid to the Transeastern Lenders, the collapse of the homebuilding market forced TOUSA and its non-joint venture subsidiaries into bankruptcy.

Shortly after the bankruptcy filing, the creditors committee filed an adversary proceeding on behalf of the TOUSA subsidiaries alleging that the settlement payment and the subsidiaries’ pledge of assets in exchange for the settlement loan constituted a fraudulent transfer under section 548 of the Bankruptcy Code. The committee, in seeking disgorgement of the settlement funds, argued that the transaction left the subsidiaries insolvent, and the subsidiaries did not receive “reasonably equivalent value” for their guarantees of the settlement loan. The bankruptcy court agreed with the committee, holding that: (1) the subsidiaries’ pledge of assets was an avoidable transfer; (2) the Transeastern Lenders were entities “for whose benefit” the improper transfer was made; and (3) the transfer to the Transeastern Lenders should be disgorged.

On appeal, the District Court determined that the subsidiaries had no property interest in loan proceeds transferred by TOUSA to the Transeastern Lenders. Accordingly, the court held that the committee could not establish, as is required by section 548, that the transfer was of the subsidiary debtors’ property. Even if the subsidiaries held an interest in the new loan proceeds transferred to the Transeastern Lenders, the transfer was not fraudulent because the subsidiaries had received indirect economic benefits from the new loan that constituted “reasonably equivalent value.” Nonetheless, assuming that the subsidiary pledges could be avoided under section 548, the court held that their estates could not recover the transfer from the Transeastern Lenders under section 550 of the Bankruptcy Code because the Transeastern Lenders were neither the “initial transferees” nor the entities that benefited from such transfer. Finally, even if under some theory the Transeastern Lenders could be deemed “subsequent transferees” of the transfer, they would be protected under Section 550 because the new loan proceeds were transferred to them on account of a valid antecedent debt and were taken in good faith.

Important aspects of the District Court’s reasoning are briefly summarized below.

Section 548

  1. The TOUSA Subsidiaries Held no Interest in the Loan Proceeds Transferred to the Transeastern Lender

A transfer is avoidable under section 548 only if the debtor has an interest in the property transferred. Under the Eleventh Circuit’s “control” test, a debtor does not have an interest in property unless it can direct the disposal of the property. Here, where the property transferred consisted of proceeds of a loan to TOUSA, the court held that the subsidiaries did not control the loan proceeds because they could not direct payment of the proceeds to a payee of the subsidiaries’ choosing. Accordingly, because the loan was extended to TOUSA, and TOUSA directed the transfer to the Transeastern Lenders, the subsidiaries held no interest in the loan proceeds for purposes of section 548. Thus, the court held that the repayment of the joint venture debt was not an avoidable fraudulent transfer of the subsidiaries’ property.

  1. Reasonably Equivalent Value

Even assuming that the committee could show that the subsidiaries held an interest in the transferred loan proceeds, the court determined that the subsidiaries received reasonably equivalent value in exchange for the transfer. The court, citing extensive case law, adopted a broad definition of “value” and concluded that a debtor may receive reasonably equivalent value if a transfer allows the debtor to avoid an impending default or bankruptcy. The court found that this principle was clearly applicable here, where the debtors’ operations were interrelated and the subsidiaries had guaranteed repayment of TOUSA’s bonds and the revolving loan. A failure to fund the joint venture settlement likely would have prompted a default of TOUSA’s other bonds and credit agreement and triggered the subsidiaries’ repayment obligations. The court found that the settlement loan prevented default and left the subsidiaries in a better position to operate as a going concern. Alternatively, the court noted, had the settlement agreement not been funded, the enterprise would likely have lost its day-to-day financing, the subsidiaries would have become liable for more than a billion dollars of debt, and the enterprise would have been forced into bankruptcy. By avoiding this outcome, even if only for a short time, the subsidiaries received reasonably equivalent value.1 Because the subsidiaries received reasonably equivalent value, the transfer to the Transeastern Lenders could not be avoided under section 548.

Section 550

Based on its finding that the transfer of the settlement loan proceeds to the Transeastern Lenders was not a fraudulent transfer under section 548, the court noted that it was not required to consider the section 550 recovery provisions. But since section 550 provided an alternate justification for reversing the bankruptcy court, the court analyzed the issue, assuming that the transfer was otherwise avoidable under section 548. Section 550 provides for the disgorgement of fraudulently transferred property from the initial transferee, the entity for whose benefit the transfer was made, or a subsequent transferee. But section 550 does not require disgorgement from a subsequent transferee that receives payment of a valid antecedent debt in good faith without knowledge of the voidability of the transfer, or from any subsequent transferee who acquired the property for value and in good faith.

The bankruptcy court had justified its disgorgement holding by treating the Transeastern Lenders as parties for whose benefit the settlement loan was made, effectively collapsing the pledge of the TOUSA subsidiaries’ assets to secure TOUSA’s new loans and the payment of the proceeds from such loans to the Transeastern Lenders into one integrated transaction. The District Court disagreed. The court stated that only an entity that received a benefit from the initial transfer qualified as an entity for whose benefit the transfer was made. Here, the court determined that the Transeastern Lenders did not benefit from the initial transfer – the subsidiaries’ pledge of assets in exchange for TOUSA’s receipt of the settlement loan proceeds. Instead, the Transeastern Lenders benefitted from the subsequent transfer by TOUSA of the loan proceeds. Thus, because the Transeastern Lenders’ benefit “flow[ed] from the manner in which the initial transfer [was] used by its recipient,” the “for whose benefit” language of section 550 did not apply.

The court further noted that the bankruptcy court had not addressed whether the Transocean Lenders had a defense to disgorgement under section 550 even if they were a subsequent transferee of a fraudulent transfer from the subsidiary debtors. Assuming for argument’s sake that this were the case, the Transeastern Lenders could avail themselves of the exceptions to liability expressly reserved in section 550, as the payments to them were on account of a valid antecedent debt and were received in good faith. The court rejected the bankruptcy court’s finding that the lenders exhibited “bad faith” by not thoroughly investigating TOUSA’s financial standing before accepting payment on the settlement agreement. The court stated that the Transeastern Lenders “had no reason or legal duty to conduct such extraordinary due diligence with respect to the provenance of the funds with which they were being repaid.”

Conclusion

The District Court’s reversal in this case is significant as it overturns a clearly flawed trial court decision in a complex matter that dealt with fundamental aspects of fraudulent transfer law under the Bankruptcy Code. In the process, the decision provides useful perspectives on a lender’s due diligence obligations when receiving repayment of a legitimate, uncontested debt, the extent to which non-monetary benefits may constitute “reasonably equivalent value,” and the perils of adopting a party’s pleadings verbatim in a court’s memorandum opinion. Nonetheless, the creditors committee may seek appeal of the decision to the Eleventh Circuit, in which event the TOUSA case may have more to reveal.