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TOUSA Reversed: Victory for the Capital Markets and Rescue Financings
February 14, 2011
In a 113-page decision issued on February 11 (the "District Court Decision"), the United States District Court for the Southern District of Florida (Gold, J.) delivered a blistering rebuke to the Florida Bankruptcy Court (Olson, J.) when it quashed the portions of the famous / infamous 2009 TOUSA decision (the "Trial Decision") holding the so-called "Transeastern Lenders" liable for fraudulent transfers in connection with TOUSA's July 31, 2007 financing transactions (the "July 31 Loans").1 While there are three substantial caveats that must be noted (see below), the District Court Decision comprises an overwhelming affirmance of the validity and appropriateness of capital market financings (including rescue financings) for corporate groups that include subsidiary guarantees of the parent company's financial indebtedness.
REASONABLY EQUIVALENT VALUE
The July 31 Loans consisted of (1) $500 million of new first lien and second lien term debt and (2) an amended and restated revolving debt agreement. The Transeastern Lenders received a majority of the proceeds of the July 31 Loans to pay off a valid pre-existing debt, but were ordered to disgorge those proceeds in the Trial Decision on the basis that they were bad faith recipients of a fraudulent transfer. No decision has yet been rendered in the separate appeals filed by the so-called "First Lien Lenders" and "Second Lien Lenders" (the "Lender Appeals"), but if District Judge Jordan adopts District Judge Gold's findings and conclusions, the Lender Appeals should similarly result in reversal of the Bankruptcy Court's fraudulent transfer findings against the First and Second Lien Lenders.
A fraudulent transfer requires two distinct findings: (1) insolvency and (2) lack of reasonably equivalent value. A plaintiff's failure to prove either element is fatal to a fraudulent transfer claim. The issue of insolvency was not before Judge Gold (it is being litigated in the Lender Appeals) but Judge Gold held on multiple bases that the Bankruptcy Court's finding of fraudulent transfer as against the Transeastern Lenders was both clearly erroneous on the facts and a clear misinterpretation of applicable law.
Of particular importance not only to the Transeastern Lenders' appeal but also to the Lender Appeals, the District Court found that there was "overwhelming evidence" that TOUSA's subsidiaries (the so-called "Conveying Subsidiaries") received reasonably equivalent value in exchange for providing secured guarantees of the July 31 Loans.
Because the Bankruptcy Court predicated its fraudulent transfer holding against the Transeastern Lenders on the supposed lack of reasonably equivalent value received by the Conveying Subsidiaries in connection with the July 31 Loans, the District Court summarily rejected the Bankruptcy Court's adverse ruling against the Transeastern Lenders.
The District Court also found in favor of the Transeastern Lenders on numerous other grounds, including that they acted in good faith (contrary to the Bankruptcy Court's findings). The District Court also excoriated the Bankruptcy Court for, after a 13-day trial, adopting virtually verbatim the plaintiff's proposed findings of facts and conclusions of law and ignoring in their entirety the proposed findings and conclusions submitted by the Transeastern Lenders, the First Lien Lenders and the Second Lien Lenders.
The key to the District Court's analysis of whether the Conveying Subsidiaries received reasonably equivalent value was the Court's wholesale rejection of the Bankruptcy Court's requirement that the Conveying Subsidiaries needed to receive direct, identifiable and tangible property of a quantifiable value. Instead, the District Court agreed with the position advocated by the First and Second Lien Lenders (as adopted by the Transeastern Lenders) that, when dealing with an integrated corporate group, indirect benefits that preserve the net worth and going concern nature of subsidiaries (and the group as a whole) can constitute reasonably equivalent value, even though indirect, intangible and not precisely quantifiable. In the words of the District Court:2
[T]he decisive inquiry can be simplified to whether, based on the totality of the circumstances at the time of the transfer, the result was to preserve the debtor's net worth by conferring realizable commercial value on the debtor. Otherwise stated, but for the transfer, was there a realistic risk that the Conveying Subsidiaries and the enterprise would not financially continue to survive?
While such an analysis is often fact intensive, and significant deference is to be accorded on appeal to the Bankruptcy Court's findings, no such deference is warranted here given the undisputed record as supported by the underlying legal documents. Here, the Conveying Subsidiaries themselves…had a vital stake in the Transeastern Settlement as a result of their own guarantees on the Revolver and bond debt. The Conveying Subsidiaries' very existence was contractually tied through their pre-existing guarantees to the outcome of the claim in the Transeastern Litigation against the TOUSA parent which had guaranteed the debt….
[E]liminating the threat of these claims against the Conveying Subsidiaries' parent, and indirectly against each of them, constituted 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, which, in turn, allowed them, for a period of time, to continue to pay interest to the bondholders, the very creditors at issue….
Reduced to its essence, the evidence of the integrated nature of TOUSA's business, and the reliance of the various TOUSA affiliates on each other, the underlying documents in evidence and the testimony presented at trial overwhelming[ly] established [reasonably equivalent value to the Conveying Subsidiaries].
Although the remedial scheme imposed in the Trial Decision has been mooted by the reversal of the fraudulent transfer ruling, the District Court Decision nonetheless addressed several other issues, which will produce sighs of relief throughout the commercial lending industry.
First, the Bankruptcy Court required the Transeastern Lenders to disgorge the funds they received to pay off the antecedent debt on the theory that the lenders were entities for whose benefit the purported fraudulent transfer was made based, according to Judge Gold, on a flawed analysis under Bankruptcy Code § 550. Judge Gold rejected this erroneous conclusion because the Bankruptcy Court ignored that avoidance of a Bankruptcy Code § 548 fraudulent transfer is the essential legal prerequisite to a Bankruptcy Code § 550 recovery. In addition, Judge Gold held that the Bankruptcy Court failed to appreciate that the Transeastern Lenders were subsequent transferees that took the proceeds for value, which is protected them from any action under § 550.
Second, Judge Gold held that the Bankruptcy Court's rejection of the Transeastern Lenders' good faith defense and ultimate findings of bad faith and gross negligence were "patently unreasonable and unworkable."3 Citing numerous scholarly articles criticizing the heightened standard of diligence imposed on lenders by the Trial Decision, Judge Gold held that the Bankruptcy Court erred as a matter of law in seeking to "pose an unfair burden on creditors to investigate all aspects of their debtors and the affiliates of those debtors before agreeing to accept payments for valid debts owed."4
Third, although not necessary to his decision, Judge Gold noted that the Bankruptcy Court also "erroneously disregarded" the arguments advanced by the Second Lien Lenders that the existence of an "identity of interest" between TOUSA and its subsidiaries meant that a benefit to the corporate group constituted a per se benefit to each member of the corporate group, including subsidiaries who did not receive direct, quantifiable property as a result of the challenged transfers.5
Fourth, citing substantial Supreme Court and Circuit Court precedent, as well the instructions provided to new federal judges in their training sessions, Judge Gold repeatedly criticized the Bankruptcy Court's near-verbatim adoption of the plaintiff's proposed findings of fact and conclusions of law.6 Based on this fact and his conclusion that the "record allow[ed] only one resolution of the factual issues at stake," Judge Gold took the extraordinary step of quashing the Trial Decision as it related to the Transeastern Lenders rather than the customary appellate action of remanding the decision to the Bankruptcy Court for further proceedings.7 Judge Gold also, in dicta, speculated that the Eleventh Circuit (if there is an appeal) may want to consider the Transeastern Lenders' "persuasive" arguments that the Bankruptcy Court demonstrated an inability "to approach the Defendant's evidence and arguments fairly."8
- While some may believe that District Courts have little interest in Bankruptcy Court appeals and routinely rubber stamp the factual findings in the trial decision, the TOUSA District Court Decision demonstrates that District Courts sometimes do provide meaningful appellate review especially where the Bankruptcy Court decision contains numerous clearly erroneous factual findings that go directly to the heart of the adverse decision.
- The District Court Decision does much to restore the capital market's confidence in the validity and appropriateness of providing financing to a parent company based on the credit support and assets of the parent company's operating subsidiaries. This is not merely a matter of convenience and security for the lenders but also a critical factor for borrowers seeking to obtain financing at reasonable rates based on the creditworthiness of the corporate group as a whole rather than simply the equity interests held by the parent company.
- The burden to prove a fraudulent transfer, including that subsidiaries did not receive reasonably equivalent value in exchange for guaranteeing the parent company's obligations, rests with the plaintiff even if that value is indirect, intangible, unquantifiable and based on the integration and identity of interests of the corporate group rather than direct value received by the subsidiaries.
- The July 31 Loans were clearly "rescue finance" provided to a financially-troubled debtor in order to stave off a potential bankruptcy of the corporate group that was worth avoiding under the circumstances existing at the time of the financing. In fact, TOUSA did file for Chapter 11 less than seven months later, albeit largely due to "the catastrophic economic events that independently doomed the housing market shortly after the July 31 [Loans]"9 rather than due to the increased debt burden resulting from the July 31 Loans themselves. As the District Court noted, "whether a debtor received reasonabl[y] equivalent value must be evaluated as of the date of the transaction," not "through the lens of retrospection."10
- While it is certainly appropriate to be an advocate in drafting proposed findings of fact and conclusions of law, litigants should remain mindful of the old adage, "be careful what you ask for because you just may get it." Here, the District Court clearly perceived that the plaintiff-Committee overreached in its submission (proposing numerous findings that were not only wrong but were also in conflict with various proposed conclusions of law), thus substantially undermining the credibility of the Bankruptcy Court's decision in its favor.
There are three (at least) very important caveats to keep in mind with respect to the TOUSA District Court Decision.
- First, as noted above, the First and Second Lenders should be encouraged that the District Court Decision as to the Transeastern Lenders bodes well for their separate Lender Appeals pending before Judge Jordan. However, the District Court Decision is not binding on Judge Jordan and he is required to make his own independent conclusions as to whether the record below was clearly erroneous and as to whether the Conveying Subsidiaries received reasonably equivalent value in exchange for providing their secured guarantees of the July 31 Loans. Courts disagree all the time and, conceivably, that could happen here, and Bracewell & Giuliani as counsel for the Second Lien Lenders certainly knows better than to count its TOUSA houses before they are built.
- Second, a cause of action highly relevant to the First and Second Lien Lenders was not present or discussed in the Transeastern litigation. Specifically, the Bankruptcy Court held that the First and Second Lien Lenders' security interests in a substantial tax refund received post petition by TOUSA constituted an avoidable preferential transfer. While the preferential transfer issue is solely a question of law rather than fact and, therefore, subject to de novo review by Judge Jordan, there is nothing in the District Court Decision to provide encouragement (or discouragement) to the First and Second Lien Lenders as to how Judge Jordan will decide that issue.
- Third, for those keeping score, it is now one-to-one, meaning one court has found in favor of the plaintiff-Committee and one has found in favor of the defendant-Transeastern Lenders. There is still one more decision definitely to come—Judge Jordan's decision on the Lender Appeals—and possibly a fourth decision to come if the plaintiff-Committee decides to appeal the District Court Decision to the Eleventh Circuit Court of Appeals, which Judge Gold appears to think is likely. Circuit Courts affirm lower court decisions more often than they reverse them, but there is certainly no assurance that the Eleventh Circuit would do so here, notwithstanding the exceptionally strong views expressed by Judge Gold.
In the meantime, however, there is certainly just cause for interim celebration by the Transeastern Lenders specifically and by the First and Second Lien Lenders and the capital markets in general. Justice, in their (and our) view, has prevailed.
1 In re TOUSA, Inc., Slip Op., Case No. 10-60017-CIV/GOLD (S.D. Fla. Feb. 11, 2011); rev'g in part In re TOUSA, Inc. (Official Comm. Of Unsecured Creditors v. Citicorp), 422 B.R. 783 (Bankr. S.D. Fla. 2009).
2 Slip Op. at 78-80 (emphasis in original).
3 Id. at 103.
4 Id. at 107.
5 Id. at 63 & n.43.
6 Id. at 43-45; 86 & 111-12.
7 Id. at 112.
8 Id. at 111 n.65.
9 Id. at 31.
10 Id. at 85.