By Martin W. Taylor and Meghan Canty Sherrill
The 2009 bankruptcy court decision commonly known as the TOUSA decision caused shock waves throughout the lending community as it called into question any transaction in which a non-borrower has paid money, pledged collateral or provided a guaranty in support of the borrower's loan obligation. The same lending community, however, breathed a sigh of relief when the District Court quashed the bankruptcy court's opinion, seemingly relegating it to the ash heap of history. That relief did not last long though, as the Eleventh Circuit, on May 15, 2012, reversed the District Court and affirmed the bankruptcy court's opinion.
The Eleventh Circuit's decision is a clear reminder of the importance of adequate consideration when credit support is given even by an affiliate, if that party is insolvent or rendered insolvent or inadequately capitalized by the transaction. The decision clarifies that avoiding a bankruptcy filing by the credit support party is not sufficient value in all circumstances, particularly if its bankruptcy remains foreseeable.
As stated in the opinion, "[t]he opportunity to avoid bankruptcy does not free a company to pay any price or bear any burden."
To understand the potential impact of this decision, it is important to understand the history and structure of the ill-fated TOUSA loan transaction. TOUSA, Inc., was a major homebuilding enterprise that entered into a joint venture in June 2005 that was financed by a loan from lenders referred to as the "Transeastern Lenders." The joint venture failed and the Transeastern Lenders sued. A settlement was reached in July 2007 whereby TOUSA would pay $421 million to the Transeastern Lenders.
TOUSA, together with certain of its subsidiaries which were not involved in or liable for the original loan, incurred new debt from a new group of lenders to pay the Transeastern Lenders (the "Conveying Subsidiaries"). The new debt was secured by new first and second priority liens on the assets of TOUSA and the Conveying Subsidiaries.
Bankruptcy Court Ruling:
TOUSA and the Conveying Subsidiaries filed for bankruptcy under Chapter 11 soon after the settlement and lawsuits were promptly filed against the Transeastern Lenders and others to avoid the liens on the Conveying Subsidiaries' assets as fraudulent transfers and to recover the settlement payment ( i.e., the proceeds of the new debt that was paid to the Transeastern Lenders). The bankruptcy court held that (i) the transfer of liens to the New Lenders was a fraudulent transfer because the Conveying Subsidiaries were insolvent before and after the transfer and because they failed to receive a reasonably equivalent value in exchange for the granting of the liens, and (ii) the proceeds could be recovered from the Transeastern Lenders because those Lenders were "an entity for whose benefit [the] transfer was made." As a result, the bankruptcy court avoided the liens and ordered the Transeastern Lenders to disgorge $403 million plus prejudgment interest.
District Court Ruling:
The Transeastern Lenders appealed to the district court, arguing that the Conveying Subsidiaries received substantial value in exchange for the liens because the settlement avoided certain, immediate bankruptcy for TOUSA, which would have resulted in the collapse of the TOUSA enterprise, including the Conveying Subsidiaries. In addition, the Transeastern Lenders argued that they could not be held liable for the value of the transfer under section 550(a) (1) of the Bankruptcy Code because they were a subsequent transferee of the loan proceeds, which were wired from the New Lenders to a TOUSA subsidiary and then to the Transeastern Lenders and, as a result, they were not "an entity for whose benefit such transfer was made." The district court agreed with the Transeastern Lenders on substantially all accounts and quashed the bankruptcy court decision.
Eleventh Circuit Ruling:
The Eleventh Circuit, in reversing the district court order and affirming the bankruptcy court, stated that "the opportunity to avoid bankruptcy does not free a company to pay any price or bear any burden" and that "the bankruptcy court correctly asked 'based on the circumstances that existed at the time the investment was contemplated, whether there was any chance that the investment would generate a positive return.'" Transeastern Lenders v. Official Comm. of Unsecured Creditors (In re TOUSA, Inc.), Case No. 11-11071, 2012 U.S. App. LEXIS 9796 (11th Cir. May 15, 2012) [enhanced version available to lexis.com subscribers].
Because the record supported the bankruptcy court's conclusion that there was no chance the transfer of the liens would generate a positive return for the Conveying Subsidiaries, the bankruptcy court's decision was affirmed. 
The Eleventh Circuit also found that, even though the settlement funds were technically wired to a TOUSA subsidiary before they were transferred to the Transeastern Lenders, TOUSA never had any real control over the funds because the loan agreement with the New Lenders required TOUSA to transfer the funds to the Transeastern Lenders. The Transeastern Lenders were, therefore, an entity for whose benefit the transfer was made within the meaning of section 550(a)(1), exposing them to disgorgement as a fraudulent transferee. 
According to the decision, "every creditor must exercise some diligence when receiving payment from a struggling debtor. It is far from a drastic obligation to expect some diligence from a creditor when it is being repaid hundreds of millions of dollars by someone other than its debtor."
Although TOUSA involved a settlement payment from a struggling debtor, the implications could be much farther reaching. In fact, the TOUSA decision is a powerful reminder and cautionary tale that should be heeded by every lender and lawyer whenever structuring a deal where multiple borrower-related parties are involved, whether at loan origination or in the course of a workout.
In short, any time a non-borrower provides any support for a loan, there is a potential risk that such support (whether in the form of a collateral pledge, a payment or a guaranty) could be later avoided and, in the case of a payment, disgorged if the entity providing that support did not receive reasonably equivalent value and was either insolvent at the time it provided the support or was rendered insolvent as a result of providing that support. 
TOUSA is relevant not only in structuring the financing for a settlement payment, but also in originating a debt financing for a corporate family. The presence of upstream guarantees in those financings requires that thought be given to the legal and economic relationship among the entities bound to repay the loan. In a complex, multi-party loan transaction, however, it may not be easy or realistic to determine what constitutes "reasonably equivalent value" or to determine whether a party is or will be rendered insolvent or inadequately capitalized as a result of the proposed transaction.
Moreover, even if a solvency certificate or opinion is obtained at the time of the transaction, those may be disregarded by a bankruptcy judge if the facts presented to the court conflict with the facts or assumptions in the certificate or the opinion. As such, careful thought and analysis must be given to the loan structure to eliminate or at least minimize the fraudulent transfer risks highlighted by the TOUSA case.
Marty Taylor is a partner with the law firm of Troutman Sanders in Orange County, California. Marty's financial institutions practice focuses on all aspects of finance, with an emphasis on real estate secured financing, including new financings, modifications, out-of-court workouts, restructures, bankruptcies, liquidations, foreclosures, note sales and OREO sales. Marty has been practicing for over twenty years, representing financial institutions for much of that time throughout the up and down real estate finance markets. That experience has provided Marty with substantial experience, and in-depth knowledge and understanding, with respect to both the technical aspects and practical applications of structuring, negotiating, documenting and closing complex real estate financing transactions, as well as with respect to the various rights, remedies and defenses of the parties involved in a failed financing transaction. Marty may be reached at 949-622-2718 or at firstname.lastname@example.org.
Meghan Canty Sherrill is an associate with the law firm of Troutman Sanders in the Bankruptcy and Commercial Litigation practice groups. Her primary practice areas include the representation of financial institutions and borrowers in both bankruptcy courts and in federal and state court litigation. Additionally, Meghan specializes in creditor's rights and has worked successfully to obtain favorable results for lenders both in and out of court. Meghan may be reached at 949-622-2734 or at email@example.com.
 This language is not found in any traditional fraudulent transfer test and the idea that a positive return must be found in order to have reasonably equivalent value is troubling.
 The New Lenders are not safe either as the case against them has been stayed pending the outcome of the case against the Transeastern Lenders. Given the outcome as described above, it is likely that their liens will be avoided as against the Conveying Subsidiaries.
 For example, fraudulent transfer risk is present any time a single project entity or other subsidiary or affiliate of the main corporate entity provides support for a master facility or otherwise becomes obligated for that facility and not just for the amount of the loan for which it directly received benefit (i.e., loan proceeds).
© TROUTMAN SANDERS LLP. ADVERTISING MATERIAL. These materials are to inform you of developments that may affect your business and are not to be considered legal advice, nor do they create a lawyer-client relationship. Information on previous case results does not guarantee a similar future result.
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