In October 2009, the Honorable John K. Olson, Bankruptcy Judge of the United States Bankruptcy Court for the Southern District of Florida, issued a controversial decision in the case of Official Committee of Unsecured Creditors of TOUSA, Inc. v. Citicorp North America, Inc. (In re TOUSA, Inc.),1 in which he ordered that the sum of $403 million paid by TOUSA to settle litigation with its lenders be avoided and disgorged by the lenders and repaid as a fraudulent transfer. On February 11, 2011, Judge Olsen‟s decision, and much of the basis for its reasoning, was reversed without remand by a strongly worded 113-page opinion of the Honorable Alan S. Gold of the United States District Court for the Southern District of Florida.2 While the District Court reversal is no doubt welcome news to the lending industry, the mere fact that there can be such divergent opinions on these issues is a reminder to lenders of the serious and far-reaching risks arising from, and in connection with, fraudulent conveyance claims.


In June 2005, TOUSA Homes LP, a wholly-owned subsidiary of TOUSA, Inc. (“TOUSA” or the “Debtor”), and Falcone/Ritchie LLC, formed TE/TOUSA LLC (the “Transeastern Joint Venture”), a joint venture to acquire certain home building assets owned by Transeastern Properties, Inc. in Florida. The Transeastern Joint Venture was funded with $675 million of third-party debt capacity. As a condition precedent to the Transeastern Joint Venture credit agreements, TOUSA and TOUSA Homes LP executed various guaranties (the “Transeastern Guaranties”).

Because of the housing downturn, the Transeastern Joint Venture failed, and the entities providing financing for the Transeastern Joint Venture (the “Transeastern Lenders”) issued notices of default and commenced litigation demanding payment under the Transeastern Guaranties. TOUSA ultimately executed settlements with the Transeastern Lenders on July 31, 2007, which included the payment of more than $421 million to the Transeastern Lenders. To finance the settlements, TOUSA and a number of its subsidiaries (the “Conveying Subsidiaries,” and collectively with TOUSA, the “Debtors”) borrowed $200 million pursuant to a first lien term loan facility and $300 million pursuant to a second lien term loan facility secured by liens on substantially all of their assets (the “New Loans”). Although the Conveying Subsidiaries were not defendants in the litigation and were not liable to the Transeastern Lenders, they nonetheless incurred liabilities and granted liens to secure their parent‟s liabilities resulting from the New Loans.

After TOUSA and the Conveying Subsidiaries filed their chapter 11 petitions on January 29, 2008, the Official Committee of Unsecured Creditors (the “Committee”) sought to avoid these obligations and transfers as fraudulent conveyances pursuant to sections 544(b), 548, and 550 of the Bankruptcy Code and comparable state law provisions. The Bankruptcy Court for the Southern District of Florida upheld these fraudulent conveyance claims and ordered that the Transeastern Lenders must return the $403 million received from TOUSA to settle the Transeastern Joint Venture litigation. In addition, the Court ruled that the liens obtained by the holders of TOUSA‟s $200 million first lien notes (the “First Lien Lenders”) and $300 million second lien notes (the “Second Lien Lenders”) be avoided, and that the holders of these notes disgorge and pay back to the TOUSA bankruptcy estate all payments of interest and principal on account of such notes. The Transeastern Lenders and the First and Second Lien Lenders then pursued separate appeals of the Bankruptcy Court‟s order. Judge Gold‟s decision reversed the Bankruptcy Court‟s order only as it relates to the Transeastern Lenders, while the appeal of the First and Second Lien lenders remains pending.

Section 548 of the Bankruptcy Code enables a trustee or a debtor in possession to avoid fraudulent transfers and obligations made within two years before the entry of an order for relief in a case under the Bankruptcy Code. These transfers and obligations are voidable (a) if made with actual intent to hinder, delay, or defraud creditors, or (b) if the debtor received less than reasonably equivalent value in exchange for the transfer or obligation and either (i) was or became insolvent as a result thereof, (ii) was left with unreasonably small capital to engage in or continue business, (iii) intended to incur or believed it would incur debts beyond its ability to pay such debts as they matured, or (iv) made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business. Under section 544(b) of the Bankruptcy Code, a trustee or a debtor in possession may also avail itself of the fraudulent conveyance provisions under applicable state law, which often has a reach-back period that is longer than the two-year period under section 548 of the Bankruptcy Code. In the TOUSA case, the Committee proceeded under both Florida and New York fraudulent conveyance laws, as well as section 548 of the Bankruptcy Code.

Reasonably Equivalent Value

As part of its analysis, the Bankruptcy Court found that the Conveying Subsidiaries did not receive reasonably equivalent value in exchange for the obligations they incurred and transfers that they made because they received none of the proceeds of the loans they became obligated to repay. The Bankruptcy Court held that all of the proceeds went to pay off the Transeastern Lenders and settle the related litigation, with no direct or indirect benefit accruing to the Conveying Subsidiaries. The Bankruptcy Court explained that none of the indirect benefits asserted by the defendants, such as improvement of the day-to-day business operation of the Conveying Subsidiaries as a result of the settlement of the Transeastern Litigation and the forestalling of the bankruptcy of TOUSA, which would have deprived the Conveying Subsidiaries of a variety of services provided by TOUSA‟s corporate offices, such as access to a centralized cash management system, purchasing, payroll, and benefits administration, constituted “value” under section 548 because they did not constitute (1) property (2) received by the debtor (3) in exchange for the obligation or transfer.

The District Court, however, rejected the Bankruptcy Court‟s holding and found that “the weight of authority supports 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 provided to be short lived, may be considered in determining reasonable equivalent value. An expectation, such as in this case, that a settlement which would avoid default and produce a strong synergy for the enterprise, would suffice to confer „value‟ so long as that expectation was legitimate and reasonable.”3 In finding that reasonably equivalent value had been received by the Conveying Subsidiaries, the District Court also noted that the Bankruptcy Court erred by not applying the “totality of the circumstances” test in measuring reasonable equivalency. The District Court found that the evidence of the integrated nature of TOUSA‟s business, the effect that an adverse judgment in the Transeastern litigation would have on the enterprise, and the fact that the boards of directors of each of the TOUSA subsidiaries had found the transactions to be in the “best interests” and for the “benefit” of the individual subsidiaries, was so overwhelmingly apparent that no further remand for proof of quantification was required, and that the extraordinary step of giving no deference to the Bankruptcy Court‟s findings was warranted.4 The fact that the ability to stave off bankruptcy was actually short-lived was irrelevant, according to the District Court, because whether a debtor receives reasonably equivalent value must be evaluated at the time of the transaction.5

Property Interest of the Debtor

The District Court also rejected the Bankruptcy Court‟s holding that the Conveying Subsidiaries had a basis for recovering the funds from the Transeastern Lenders because they had a property interest in the proceeds of the loans from the First and Second Lien Lenders by virtue of becoming obligated on the debt as “co-borrowers.” The District Court utilized the Eleventh Circuit‟s test of control, and found that since the Conveying Subsidiaries lacked the ability to control the use of the loan proceeds, which were within the control of TOUSA alone, such proceeds were not the property of the Conveying Subsidiaries, even though they were co-borrowers on the loan. Since there was no transfer by the Conveying Subsidiaries of any interest in their property to the Transeastern Lenders, the payment of such proceeds by TOUSA was not a transfer subject to avoidance under section 548.6 Meaning of “An Entity for Whose Benefit Such Transfer was Made” Section 550(a) of the Bankruptcy Code provides that to the extent that a transfer is avoided under section 548, the trustee may recover the property transferred or, if the court so orders, the value of such property, from “the initial transferee of such transfer or the entity for whose benefit such transfer was made.” As one of its theories of liability, the Bankruptcy Court held that the Conveying Subsidiaries were able to recover from the Transeastern Lenders on the fraudulent transfer of the First and Second Liens because the Transeastern Lenders were entities “for whose benefit” the First and Second Liens were granted. The District Court, however, rejected this argument holding that “the „for whose benefit‟ language does not apply where the „benefit‟ is not the immediate and necessary consequence of the initial transfer, but flows from the manner in which the initial transfer is used by its recipient -- the „benefit must derive directly from the [initial] transfer,7 not from the use to which it is put by the transferee.‟”8 Here, the transfer by TOUSA to the Transeastern Lenders of the loan proceeds was for the separate payment of an antecedent debt, and was not a direct consequence of the liens granted to the First and Second Lien Lenders.

Lender’s Standard of Good Faith

The District Court also held that the Bankruptcy Court erred by imposing what it described as strict liability on the Transeastern Lenders, concluding that even if the Transeastern Lenders were treated as immediate transferees of property from the Conveying Subsidiaries, no recovery was available against the Transeastern Lenders because they accepted the proceeds of the New Loan for value and there was insufficient evidence that they acted in bad faith or had knowledge of the voidability of their transfers.9 The District Court stated that “if the Bankruptcy Court‟s ruling were to stand, it would pose an unfair burden on creditors to investigate all aspects of their debtors and the affiliates of those debtors before agreeing to accept payments for valid debts owed.”10 The District Court also stated that “[t]he net result of the Bankruptcy Court‟s improper finding is to impose extraordinary duties of due diligence on the part of creditors accepting repayment -- duties that equal or exceed those imposed on lenders in extending credit in the first place."11


While the District Court‟s opinion served to soundly refute many of the controversial holdings in the Bankruptcy Court‟s opinion that troubled lenders,12 it remains to be seen what impact it will have on the litigating posture and aggressiveness of debtors, trustees, and creditor committees going forward, and how other courts rule in fraudulent conveyance proceedings in the future. The next word on these controversial issues may come from the Eleventh Circuit.