• News
• Views & Visions: A Bowles Rice Publication
• Articles & Alerts
• Presentations & Events
• Connect With Us
• Blogs

      A recent decision from the United States Court of Appeals for the 11th Circuit (the “Court”) resulted in an expensive lesson for a consortium of lenders.  The Court, In Re TOUSA, took a narrow view in determining what constitutes reasonably equivalent value when it comes to avoidance of a fraudulent transfer under bankruptcy law.

        TOUSA, Inc. (“TOUSA”) was the thirteenth largest homebuilding enterprise in the United States.  The company grew rapidly, primarily through acquiring homebuilders that became its subsidiaries.  In 2005, TOUSA incurred a great deal of debt from a group of lenders (hereinafter the “Transeastern Lenders”) to fund the acquisition of homebuilding assets from Transeastern Properties, Inc. in Florida.  By 2006, the Transeastern Lenders sued TOUSA, seeking damages in excess of $2 billion, for loan defaults. 

        In 2007, TOUSA settled with Transeastern Lenders, promising to pay more than $421 million.  To finance the settlements, TOUSA and certain of its subsidiaries (hereinafter the “Conveying Subsidiaries”) incurred new debt.  Citicorp North America, Inc. (“Citicorp”) and other lenders (the “New Lenders”) provided loans to TOUSA, secured by liens on the assets of TOUSA and liens on the assets of the Conveying Subsidiaries.  These loans required that the funds be used to pay the $421 million settlement with Transeastern Lenders.

        Six months later, TOUSA and the Conveying Subsidiaries filed for bankruptcy relief under Chapter 11.  A group appointed in the bankruptcy case, the Committee of Unsecured Creditors of TOUSA (“the Committee”), subsequently filed suit against Transeastern Lenders and New Lenders, seeking to avoid as a fraudulent transfer, the liens and security interests given to New Lenders by TOUSA’s subsidiaries, and to order the Transeastern Lenders to disgorge the proceeds of the loan. The Committee alleged that the liens granted by the Conveying Subsidiaries was a fraudulent transfer under the Bankruptcy Code because the Conveying Subsidiaries did not receive the proceeds of the loan or any other reasonably equivalent value in exchange for the liens on their assets.

        In response, Transeastern Lenders and New Lenders claimed that the transfer was not fraudulent because the Conveying Subsidiaries received reasonable equivalent value from the following: the economic benefit of avoiding default and bankruptcy, a higher debt ceiling, new tax benefits, the elimination of adverse business effects from the Transeastern litigation, and the opportunity to retain access to various services provided by TOUSA.

        The Court held that the Conveying Subsidiaries did not receive value in exchange for the liens they granted to New Lenders.  Rather, the Court found that the Conveying Subsidiaries’ initial avoidance of bankruptcy, even if considered a “value” under the fraudulent transfer law, did not constitute reasonably equivalent value in relation to the costs of the transaction.  Moreover, the Court found that the Conveying Subsidiaries’ bankruptcies were inevitable and the transaction, at most, only delayed it.  The Court rejected additional arguments for a finding of reasonably equivalent value, explaining that the Conveying Subsidiaries did not need a higher debt ceiling, they received no tax benefit, and they would have retained access to TOUSA’s services even if they had not engaged in the transaction.

        The Court also affirmed the bankruptcy court’s holding that the Committee could recover the $421 million settlement payment from the Transeastern Lenders under the Bankruptcy Code, which allows recovery of the property transferred from the entity for whose benefit the transfer was made.  Although the Transeastern Lenders argued that they were not entities that benefitted from the funds transfer, the Court found this argument to be contradicted by the loan agreements, which required that the proceeds of the loans be transferred to the Transeastern Lenders.  

        Although the Court’s view in Tousa is considered by some a narrow interpretation of “reasonably equivalent value” under the Bankruptcy Code’s fraudulent transfer law, lenders must be careful in structuring loans, refinancings and workouts when a parent borrower intends to collateralize the facility with subsidiary assets.  Failure to do so may be an expensive lesson.