Previously published May 17, 2012

Keywords: TOUSA III, bankruptcy code, petition date, transeastern lenders

On May 15, 2012, the Eleventh Circuit Court of Appeals (the "Circuit Court") issued an opinion in In re TOUSA, Inc.,¹ in which it affirmed the original decision of the bankruptcy court and reversed the appellate decision of the district court. After a 13-day trial, the bankruptcy court had found that liens granted by certain TOUSA subsidiaries (the "Conveying Subsidiaries") to secure new loans (the "New Term Loans") incurred to pay off preexisting indebtedness to certain lenders (the "Transeastern Lenders") were avoidable fraudulent transfers. The bankruptcy court also found that the payoff to the Transeastern Lenders from the New Term Loan proceeds was subject to clawback.

On appeal, the district court had reversed the bankruptcy court on every major issue.² In reversing the district court this past Tuesday, the Circuit Court gave significant deference to the original factual findings of the bankruptcy court. The Circuit Court framed the two key issues on appeal as follows:

• The "Reasonably Equivalent Value" Issue: Whether the bankruptcy court erred in finding that the Conveying Subsidiaries did not receive reasonably equivalent value in exchange for pledging their assets to secure the New Term Loans; and
• The "For Whose Benefit" Issue: Whether the bankruptcy court erred in finding that the Transeastern Lenders were entities for whose benefit the liens were transferred. On the first issue, the Circuit Court focused narrowly on the evidentiary record and the posttrial factual findings of the bankruptcy court, in turn sidestepping the open legal question of what constitutes value in the context of upstream guaranties. On the second issue, the Circuit Court's decision, while arguably consistent with existing Eleventh Circuit precedent, appears to broaden the pool of potential defendants in avoidance actions under the Bankruptcy Code. Notably, although the bankruptcy court (in dicta) had sharply criticized the use of a so-called "savings clause" in the transferring documents in respect of the New Term Loans, neither the district court nor the Circuit Court addressed the bankruptcy court's statements regarding the efficacy of such savings clauses.³

Recap of the Facts

TOUSA and numerous affiliates, homebuilders operating throughout the country, filed for bankruptcy protection on January 29, 2008 (the "Petition Date"). As of the Petition Date, TOUSA had substantial outstanding indebtedness, including approximately $500 million worth of New Term Loans. TOUSA had entered into the New Term Loans six months prior to the Petition Date in order to finance repayment of the Transeastern Lenders and to resolve litigation relating to a related failed joint venture. Unlike the debt owing to the Transeastern Lenders, which was unsecured, the New Term Loans were secured by liens on the assets of substantially all of TOUSA's subsidiaries.

On July 14, 2008, the Creditors' Committee commenced an adversary proceeding against the lenders that had advanced the New Term Loans as well as the Transeastern Lenders. The Committee asserted that the liens granted by the "Conveying Subsidiaries" were avoidable fraudulent transfers because, among other things, the New Term Loans rendered the Conveying Subsidiaries insolvent, and the Conveying Subsidiaries did not receive reasonably equivalent value in return for providing security for the New Term Loans.

The Lower Court Rulings

After a lengthy trial, the bankruptcy court issued an opinion avoiding the liens granted by the Conveying Subsidiaries as fraudulent transfers under Section 548 of the Bankruptcy Code and finding that the Transeastern Lenders were direct transferees of those fraudulent transfers.⁴ The bankruptcy court held alternatively that the Transeastern Lenders were entities "for whose benefit" the Conveying Subsidiaries had granted liens on their assets, which rendered the Transeastern Lenders liable under Section 550(a) of the Bankruptcy Code. As a result, the bankruptcy court ordered the Transeastern Lenders to disgorge approximately $433 million that they had received from the proceeds of the New Term Loans.

On appeal, the district court reversed the bankruptcy court's central holdings and, in an unusual procedural step, quashed, rather than remanded, the bankruptcy court's decision as it related to the Transeastern Lenders' liability.⁵ Although it noted that a bankruptcy court's findings of fact generally should not be overturned absent clear error, the district court criticized the bankruptcy court for adopting findings of fact almost directly from the proposed findings of the Committee, which the district court decided was cause for it to undertake essentially a de novo review of the facts and issues on appeal.

On the issue of whether the Conveying Subsidiaries received reasonably equivalent value, the court relied heavily on the fact that the repayment of the Transeastern Loans eliminated the imminent risk of default and a parent bankruptcy, which the court found to be "an enormous economic benefit to these subsidiaries in terms of their viability as going concerns and their continued access to financing through the TOUSA parent." Because the factual record from the bankruptcy court made clear that none of the solvency tests were at issue (whether the New Term Loans transaction left the Conveying Subsidiaries (i) insolvent, (ii) with unreasonably small capital, or (iii) unable to pay their debts as they came due), the district court considered only the reasonably equivalent value prong of the fraudulent transfer analysis. On the second issue—whether the Transeastern Lenders could be considered entities "for whose benefit" the liens were granted because they received some of the proceeds of the New Term Loans—the district court rejected the reasoning of the bankruptcy court, finding that its analysis of Section 550(a) would improperly broaden that section's scope.

The Circuit Court Decision

STANDARD OF REVIEW

In its May 15 opinion, the Circuit Court held to the established standard of review for trial court findings. In particular, the panel noted that while determinations of law made by either court below would be reviewed de novo, the findings of fact of the bankruptcy court would be reviewed for clear error. In the words of the Circuit Court, this meant that such findings would not be disturbed "unless, in the light of all the evidence, 'we are left with the definite and firm conviction that a mistake has been made.'"⁶ Notably, the Eleventh Circuit nowhere mentioned the district court's scathing critique of the bankruptcy court's wholesale adoption of the prevailing party's proposed factual findings, or its alternative standard of review.

ANALYSIS

The Reasonably Equivalent Value Issue

On the first issue on appeal, the Circuit Court affirmed the bankruptcy court's finding that the Conveying Subsidiaries did not receive reasonably equivalent value in exchange for granting liens to secure the New Term Loans.

As a threshold matter, the court noted that the issue of fair consideration was "largely a question of fact" and consequently, "considerable latitude must be allowed to the trier of the facts."⁷ In light of this deferential standard, the Circuit Court determined that it did not need to adopt either the narrow definition of "value" adopted by the bankruptcy court or the broader definition adopted by the district court (which considered indirect benefits to the subsidiary). Instead, even assuming that all of the purported benefits of the transaction were legally cognizable, the Circuit Court concluded that the bankruptcy court's finding of lack of reasonably equivalent value was not clear error.

In so ruling, the Circuit Court agreed with the bankruptcy court that, on the factual record before it, the incurrence of the new indebtedness at best delayed TOUSA's inevitable bankruptcy filing. This benefit, in the Circuit Court's view, cannot by itself constitute reasonably equivalent value: "The opportunity to avoid bankruptcy does not free a company to pay any price or bear any burden."⁸

The "For Whose Benefit" Issue

The Circuit Court also agreed with the bankruptcy court that, pursuant to Section 550(a), the Transeastern Lenders were entities "for whose benefit" the Conveying Subsidiaries granted their liens. Although the Circuit Court noted that benefit to a guarantor by the payment of the underlying debt of the debtor presents the "paradigm case" of a benefit under Section 550(a), the court noted that this was not the only circumstance where the statute applies. Building on its earlier decision in In re Air Conditioning, Inc. of Stuart,⁹ the Circuit Court continued to take an expansive view of Section 550(a), holding that when a debtor grants a lien to a lender, a creditor who receives proceeds of the loans may be subject to liability under Section 550(a), if the initial grant of the lien is later avoided.

In so ruling, the Circuit Court was fairly dismissive of the Transeastern Lenders' argument that the Circuit Court's reading of Section 550(a) "would drastically expand the potential pool of entities that could be liable for any transaction," calling it "unsubstantiated."¹⁰

The Circuit Court recognized that its ruling will require more diligence on the part of creditors who receive proceeds of loans made to a "struggling debtor."¹¹ However, the court appeared to give short shrift to these concerns, on least on the facts before it, instead admonishing that "[i]t 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."¹²

Conclusion

The Eleventh Circuit's decision in In re TOUSA, Inc., although framed narrowly on the factual findings of the bankruptcy court, nonetheless creates greater uncertainty for lenders and other creditors seeking repayment from distressed debtors. In the case of upstream guaranties, the decision leaves open the question of whether the avoidance or postponement of bankruptcy of the corporate family, or other indirect economic benefit to a subsidiary, can provide "value" within the meaning of Section 548. The appellate court's expansive reading of Section 550(a) also may increase the pool of potential defendants in avoidance actions, at least in the Eleventh Circuit, and may require creditors receiving payments pre-bankruptcy to engage in greater diligence as to the source of such payments. However, while the decision will be unwelcome to lenders who had celebrated the district court's energetic reversal of the TOUSA bankruptcy court decision, it nonetheless appears consistent with much of the existing constructive fraud case law in regard to the issue of whether reasonably equivalent value was received in exchange for certain transfers.

Footnotes

1 Senior Transeastern Lenders v. Official Committee of Unsecured Creditors, (In re TOUSA, Inc.), 11th Cir., 11- 11071.

2 See our Legal Update, "In re TOUSA—Florida District Court Reverses and Quashes Bankruptcy Court Fraudulent Transfer Decision," available at www.mayerbrown.com/publications/In-re-TOUSAFlorida-District-Court-Reverses-and-Quashes-Bankruptcy-Court-Fraudulent-Transfer-Decision-02-14-2011.

3 None of the parties to the appeal raised the savings clause issue in their briefs. We discussed the particulars of the bankruptcy court's original analysis in our Legal Update, "Viability of Guaranty 'Savings Clauses' Questioned by Florida Bankruptcy Court Decision," available at http://www.mayerbrown.com/publications/ /Viability-of- Guaranty-Savings-Clauses-Questioned-by-Florida- Bankruptcy-Court-Decision-12-02-2009/ .

4 Official Committee of Unsecured Creditors of Tousa, Inc. v. Citicorp North America, Inc., (In re TOUSA, Inc.), 422 B.R. 783 (Bankr. S.D. Fla. 2009).

5 3V Capital Master Fund Ltd. v. Official Committee of Unsecured Creditors of TOUSA, Inc., 444 B.R. 613 (S.D. Fla. 2011).

6 Circuit Court opinion, p. 26.

7 Circuit Court opinion, p. 29.

8 Circuit Court opinion, p. 33.

9 American Bank of Marin County v. Leasing Service Corp. (In re Air Conditioning, Inc. of Stuart), 845 F.2d 293 (11th Cir. 1988).

10 Circuit Court opinion, p. 38.

11 Circuit Court opinion, p. 39.

12 Id.

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