In a welcome bit of good news for lenders, US District Court Judge Gold (Southern District of Florida) reversed the portion of the 2009 bankruptcy court decision in the TOUSA, Inc. bankruptcy cases that had ordered the disgorgement of $403 million plus interest based on the holding that the amounts were received by certain lenders to the TOUSA parent in connection with a pre-petition transaction that constituted a fraudulent transfer. In the same decision, the bankruptcy court also ordered, among other things, (i) the avoidance of obligations, including liens, incurred by certain of the TOUSA subsidiaries (the “Conveying Subsidiaries”) under a $200 million first lien facility (the “First Lien Facility”) and a $300 million second lien facility (the “Second Lien Facility”) and (ii) the disgorgement of principal, interest, and fees paid to the lenders under the First Lien Facility and the Second Lien Facility, but these rulings are the subject of a separate pending appeal.

The bankruptcy court’s ruling raised a number of troubling issues for commercial lenders, including, but not limited to, the judge calling into question the enforceability of fraudulent conveyance “savings clauses,” common in commercial loan agreements.

TOUSA, Inc. and its subsidiaries designed, built, and marketed homes under a variety of brand names. In June 2005, TOUSA entered into a joint venture to acquire certain properties owned by Transeastern Properties, Inc. in Florida. To fund the purchase of the Transeastern Properties, TOUSA and its joint venture subsidiary entered into a credit agreement (the “Transeastern Loan”) for third-party funding with certain lenders (the “Transeastern Lenders”). The Conveying Subsidiaries were not parties to the Transeastern Loan, nor did they execute guarantees for the benefit of, or pledge collateral to, the Transeastern Lenders. With the turn in the housing market, the joint venture ran into hard times, and litigation ensued between TOUSA and the Transeastern Lenders.

TOUSA then entered into a settlement agreement with, among others, the Transeastern Lenders by which TOUSA agreed to pay approximately $420 million to the Transeastern Lenders (the “Transeastern Settlement”). To fund the Transeastern Settlement, TOUSA and the Conveying Subsidiaries, as borrowers, entered into the First Lien Facility and the Second Lien Facility (together, the “New Loans” from the “New Lenders”).1 The Conveying Subsidiaries were neither obligated under the Transeastern Loan nor parties to the litigation between TOUSA and the Transeastern Lenders. On July 31, 2007, approximately $426 million of proceeds of the New Loans were paid to the Transeastern Lenders (together with the New Loans, the “July 31 Transaction”). The Conveying Subsidiaries pledged substantially all of their assets to secure repayment of the New Loans, but the Conveying Subsidiaries did not receive any of the proceeds advanced under the July 31 Transaction.

On January 28, 2008, TOUSA and the Conveying Subsidiaries filed for bankruptcy protection, and the creditors’ committee commenced an adversary proceeding seeking to unwind the Conveying Subsidiaries’ obligations under the July 31 Transaction and to recover the more than $420 million paid to the Transeastern Lenders. In a 182-page opinion, the bankruptcy court judge found, among other things, (i) that the Conveying Subsidiaries were insolvent at the time of, or rendered insolvent by, the July 31 Transaction, (ii) that the Conveying Subsidiaries were left with unreasonably small capital as a result of the July 31 Transaction, and (iii) that the July 31 Transaction could be avoided as a fraudulent transfer because the Conveying Subsidiaries did not receive reasonably equivalent value in

exchange for the obligations incurred and liens granted by the Conveying Subsidiaries under the July 31 Transaction. In addition to having to return the monies received on July 31, 2007, the Transeastern Lenders were also required to pay prejudgment interest for a total disgorgement of more than $480 million.

On appeal, the District Court began its analysis of whether there was a fraudulent transfer by breaking the July 31 Transaction into three distinct asset transfers:

  1. TOUSA caused certain of the Conveying Subsidiaries to convey the liens on their real property assets and become obligated to the New Lenders;
  2. In exchange for the liens and the obligations, the New Lenders loaned funds and provided the New Loans to TOUSA; and
  3. TOUSA used the funds from the New Lenders in part to satisfy its $421 million debt to the Transeastern Lenders.

Based on these three transfers, the bankruptcy court had found the Transeastern Lenders liable under two different bases of liability for two distinct fraudulent transfers: first as direct transferees of the proceeds of the New Loans, and second as entities “for whose benefit” the Conveying Subsidiaries transferred the liens to the New Lenders. On the first basis of liability, the District Court concluded that the Conveying Subsidiaries, which were co-borrowers under the New Loans, did not have a property interest in the funds transferred because only TOUSA—and not the Conveying Subsidiaries—could control their disposition. The District Court then spent a considerable portion of its opinion discussing whether both of these bases of liability were flawed because the Conveying Subsidiaries received reasonably equivalent value in exchange for these transfers despite the fact that the Conveying Subsidiaries were not parties to the litigation that was being settled with the proceeds of the New Loans. The bulk of the discussion centered around what can be considered as “value.”

In Judge Gold’s view, the bankruptcy court took a restrictive view of what should be considered as value received by the Conveying Subsidiaries when it limited its consideration to “property” received by the Conveying Subsidiaries and defined “property” as “some kind of enforceable entitlement to some tangible or intangible article” based on the definition of value in Webster’s Dictionary. The District Court found this view too restrictive and instead embraced 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 reasonable equivalent value.” The District Court continued: “. . . [T]he decisive inquiry can be simplified to whether, based on the totality of the circumstances at the time of the transfer, the result was to preserve the debtor’s net worth by conferring realizable commercial value on the debtor.”

Based on the more expansive view of value, the District Court concluded from the record that the Conveying Subsidiaries received reasonably equivalent value, and considered:

  1. The prevention of a default by the Conveying Subsidiaries on $1.06 billion of bond debt for which a vast majority of the Conveying Subsidiaries were jointly and severally liable. Had the Transeastern Settlement not worked, it was virtually certain that a judgment would have been entered against TOUSA, and the entry of a judgment in excess of $10 million would have constituted an event of default for outstanding bond debt for which the Conveying Subsidiaries were guarantors. The District Court considered this the most valuable indirect benefit received by the Conveying Subsidiaries.
  2. Tax benefits. In connection with the Transeastern Settlement, TOUSA and the Conveying Subsidiaries obtained the right to future tax benefits totaling approximately $74.8 million.
  3. Resolutions from the Boards of Directors. Officers and directors of all of the Conveying Subsidiaries executed formal resolutions or consents approving the New Loans. All of these documents specifically state that the New Loans are in the “best interest” and for the “benefit” of the Conveying Subsidiaries. The District Court did not discuss the formalistic nature of these resolutions and whether there was any substantive consideration by the directors of the asserted benefits.
  4. The direct link between the financial net worth of the Conveying Subsidiaries and the fate of the TOUSA parent. The District Court specifically recognized that the Conveying Subsidiaries were dependent on the TOUSA enterprise as a whole as, among other things, their primary source of liquidity. Therefore, a threat to the TOUSA parent constituted an existential threat to the Conveying Subsidiaries.

The District Court rejected the notion that a determination of whether value constituted reasonably equivalent value requires precise mathematical quantification and held that the Conveying Subsidiaries did in fact receive reasonably equivalent value in exchange for the transfers involved in the July 31 Transaction. This finding disposed of both bases of liability identified by the bankruptcy court.

Notably, the District Court also discussed the bankruptcy court’s finding that the Transeastern Lenders acted in bad faith and were grossly negligent because they knew or should have known that TOUSA and the Conveying Subsidiaries were insolvent (or very close to being insolvent) on July 31, 2007. The District Court stated that affirming such a finding would impose an unreasonable standard for lenders accepting repayment of debt outside of any preference period by requiring them to investigate not only the solvency the debtor, but the solvency of the debtor’s subsidiaries, the debtor’s method for financing the debt repayment, and whether all of the subsidiaries involved in the debt repayment were also receiving reasonably equivalent value. The District Court did not address an argument that the Transeastern Lenders had effectively converted an unsecured claim against an insolvent TOUSA into full payment by using the assets of the subsidiaries. The District Court also did not substantively address that several of the Transeastern Lenders were members of the New Lenders group.

The District Court did point out an inconsistency in the ruling of the bankruptcy court, which concluded that the subsidiaries could have refinanced even if the revolver and the bonds were in default. Since the bankruptcy court found the subsidiaries to be insolvent, such a finding is arguably inconsistent with the ability of the subsidiaries to effectively refinance.

Taken as a whole, this opinion should provide a level of comfort to lenders who deal with borrowers with complex corporate structures and a signal to bondholders who seek to utilize fraudulent transfer law to unwind payments to senior lenders that courts may not be receptive to some of their arguments. The District Court noted in length that the bondholders had been advised of the enterprise nature of TOUSA and that the Transeastern Lenders were just trying to collect on a legitimate debt. Reading between the lines, the District Court apparently had little sympathy for the bondholders who were viewed as attempting to better their position through the use of the fraudulent transfer statute to the detriment of the Transeastern Lenders despite the fact that the Conveying Subsidiaries that were guarantors of the bonds were neither borrowers under nor guarantors of the Transeastern Loan. This opinion not only mitigates dangerous precedent for lenders, but it also provides helpful guidance by identifying certain precautions that can be taken at the time of a transaction to prevent the transaction from later being unwound in bankruptcy as a fraudulent transfer. That being said, the District Court’s opinion will undoubtedly be appealed, so the final chapter of the TOUSA saga may not yet be written.