TOUSA was once one of the nation’s largest home builders. But its size was built on high levels of debt, including more than $1 million in public bonds. When the real estate market collapsed in 2007, the company borrowed money to pay off borrowed money: $500 million to settle loans incurred in a 2006 acquisition.
Not so fast, said the hedge funds that owned the builder’s bonds. They claimed that the latest loan amounted to a fraudulent transfer of the company’s value to the lending institutions.
The Bankruptcy Court – and now the 11th Circuit – agreed, leaving banks to wonder exactly how far their liabilities extend with respect to the money they lend.
For your convenience, here’s a look at what the decision means for lenders and borrowers going forward:
Just When I Thought I Was Out . . . Eleventh Circuit Rules in TOUSA that Refinanced Lenders Can Be “Pulled Back In” and Held Liable if a Replacement Loan is a Fraudulent Transfer (Cadwalader, Wickersham & Taft LLP)
“Taken on its face, the Eleventh Circuit’s reasoning may mean that a lender whose loan is refinanced – regardless of whether the lender consents to the refinancing – may be liable if the refinancing loan requires that the proceeds be used to pay off existing debt and the refinancing loan is subsequently deemed to be a fraudulent transfer. This is troubling, as companies often obtain secured debt (including debt secured by operating subsidiaries) to refinance unsecured holding company debt that is maturing at a time when the company is no longer investment grade or is otherwise unable to refinance on an unsecured basis.” Read the update>>
“… the Eleventh Circuit’s decision appears to impose a duty on creditors receiving payments from troubled companies to determine the source of funds for such payments and to weigh the risk of fraudulent transfer liability with respect to such payments—a duty that will no doubt materially undermine the ability of troubled companies to effectively manage and settle their debts in efforts to avoid potentially catastrophic bankruptcy filings.” Read the update>>
Eleventh Circuit Issues New TOUSA Decision, Upholds Finding That Upstream Guarantees Were Fraudulent Transfers (Davis Wright Tremaine LLP)
“The decision … undermines the enforceability of upstream guarantees given by subsidiaries for the benefit of a parent borrower. To protect against its effects, lenders will need to ensure that subsidiary guarantors are solvent or will tangibly benefit from loans to the parent corporations.” Read the update>>
“The one item that the 11th Circuit did not address was the remedies ordered by the Bankruptcy Court, which included both avoidance of the TOUSA subsidiaries’ guarantees and related collateral grants and recovery of the $421 million from the Transeastern Lenders… The Transeastern Lenders had argued that the Bankruptcy Court improperly awarded a double remedy by ordering recovery both from the New Lenders and from the Transeastern Lenders. The 11th Circuit declined to address this, instead remanding the matter back to the Bankruptcy Court for consideration of the issue of remedies.” Read the update>>
“The Eleventh Circuit makes clear its intent in a passage found late in its opinion: ‘[E]very 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 from someone other than its debtor.’ In other words, if you are a creditor, beware of subsidiaries bearing gifts.” Read the update>>
Tousa Roller Coaster (Orrick, Herrington & Sutcliffe LLP)
“… the Circuit Court’s decision demonstrates the willingness of a court to scrutinize, and avoid, complex financing arrangements. However, lenders who have no other option with respect to a rescue financing can take solace in several statements made by the Circuit Court indicating that Tousa was a unique situation. With that uniqueness in mind, the Circuit Court struck a balance between the need for lenders to provide financing to struggling borrowers and the requirement that all creditors are treated fairly and in accordance with the Bankruptcy Code.” Read the update>>
“Although not binding outside the 11th Circuit, TOUSA poses new challenges. The Court cited the key question raised by the Bankruptcy Court which lenders and borrowers in financially distressed situations face: Based on the circumstances that exist at the time an investment is contemplated, is there any chance that the investment would generate a positive return? This decision may usher in a new wave of fraudulent transfer litigation in situations involving ‘upstream’ guarantees and grants of liens.” Read the update>>
- Making Sense of Fraudulent Transfers, Intangible Benefits, and Lender Liability After TOUSA II (Quinn Emanuel Urquhart & Sullivan, LLP)
- In Re Tousa: District Court Reverses Bankruptcy Court’s Order Requiring Lenders To Disgorge $480 Million As Fraudulent Transfer (Sheppard Mullin Richter & Hampton LLP)
- TOUSA Fraudulent Transfer Decision Reversed by District Court (Katten Muchin Rosenman LLP)
- In re TOUSA, Inc.: Commercial Lending and Debt Trading Markets Breathe a Sigh of Relief (Morrison & Foerster LLP)
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