Lenders Beware: Eleventh Circuit's Ruling In TOUSA Increases Fraudulent Transfer Risk

On May 15, 2012, the United States Court of Appeals for the Eleventh Circuit held that security interests and liens granted by subsidiaries of a borrower to refinance obligations owed to the borrower's lenders constituted fraudulent transfers under section 548(a)(1) of the Bankruptcy Code in the borrower's and subsidiaries' bankruptcy cases. Senior Transeastern Lenders v. Official Committee of Unsecured Creditors (In re TOUSA, Inc.), 2012 WL 1673910 (11th Cir. 2012). This decision delivers a cautionary message to lenders because it increases the likelihood that more courts will invalidate upstream guaranties given by subsidiaries for the benefit of a parent borrower.

In this case, TOUSA, a large homebuilder, acquired assets owned by Transeastern Properties, Inc., funding the acquisition through a $675 million loan. When the business failed, TOUSA's lenders sued for repayment of the loan, and the parties ultimately reached a settlement whereby TOUSA agreed to pay the lenders $421 million. To finance the settlement, and despite TOUSA's distressed financial condition, TOUSA and various of its subsidiaries borrowed $500 million from a new group of lenders secured by liens on substantially all of their assets. Importantly, the subsidiaries were not parties to the litigation and not indebted to the original lenders. Nonetheless, the subsidiaries provided guaranties, incurred liabilities and granted liens to the new lenders to secure their parent's liabilities in connection with the settlement financing.

TOUSA and the subsidiaries filed bankruptcy cases only six months after the settlement financing. Thereafter, the creditors' committee commenced an action to avoid the security interests, liens and payments made under the guaranties as fraudulent transfers pursuant to sections 544(b) and 548 of the Bankruptcy Code because (i) the subsidiaries were insolvent at the time they executed the guaranties and security agreements, and (ii) they did not receive reasonably equivalent value in exchange for the guaranties and security interests. Following a 13-day trial, the bankruptcy court, finding that the subsidiaries had not received reasonably equivalent value for the upstream guaranties and grants of liens on substantially all of their assets since the subsidiaries received none of the loan proceeds, ruled in favor of the committee, voided the liens obtained by the holders of TOUSA's secured notes and ordered the original lenders to return the $421...