TMA | Turnaround Management Association



TOUSA:

District Court “Quashes” Bankruptcy Court Decision

For Lenders, an Encouraging Development, but the Saga Continues…….

The United States District Court for the Southern District of Florida reversed the October 30, 2009 fraudulent conveyance finding issued by the Bankruptcy Court in the TOUSA case as it pertained to lenders involved in TOUSA’s Transeastern joint venture. Lending institutions (particularly in the distressed sector) should take some comfort in the District Court’s opinion, which broadly reverses the Bankruptcy Court decision. It’s likely not the last word in the TOUSA cases given that the appeals of TOUSA’s first and second lien lenders remain pending before another District Court judge and there is a substantial likelihood of further appeal by one or more parties to the Eleventh Circuit Court of Appeals.

FACTS

Prior to the filing for chapter 11 protection in early 2008, TOUSA, Inc. and its various subsidiaries (collectively, “TOUSA”) constituted one of the nation’s largest home builders. In June 2005, TOUSA, through one of its wholly-owned subsidiaries, became involved in a joint venture known as Transeastern (“Transeastern”). Transeastern was funded using $675 million of debt borrowed by various special purpose entities, a subordinated loan from one of the TOUSA subsidiaries and equity. In connection with this financing, the special purpose entities entered into a senior credit agreement with various Transeastern lenders (the “Transeastern Lenders”). Additionally, TOUSA, Inc. (the TOUSA parent entity) and TOUSA Homes LP (TOUSA’s primary operating subsidiary) issued certain completion and carve-out guarantees on the financing.

In late 2006, it became apparent that the viability of Transeastern was in jeopardy and on September 29, 2006, the lenders and the various Transeastern special purpose entities executed an agreement recognizing a potential event of default under the Transeastern financing. On October 31 and November 1, 2006, the lenders sent demand letters to TOUSA and TOUSA Homes LP demanding full payment pursuant to the guarantees.

TOUSA’s primary source of liquidity at the time was a revolving credit facility (the “Revolver”). To secure a waiver of TOUSA’s default under the Revolver due to TOUSA’s potential liability to the Transeastern Lenders, various TOUSA subsidiaries pledged assets as security under the Revolver to ensure the company’s continuing liquidity and on January 30, 2007, these subsidiaries became co-borrowers under the Revolver.

In late 2006, the lead lender, on behalf of the Transeastern Lenders, brought suit against TOUSA, TOUSA Homes and the special purpose entities, arguing that TOUSA’s liabilities under the guarantees potentially exceeded two billion dollars – several times the total outstanding loan balance. After significant deliberations – during which TOUSA was independently advised that its ability to continue as a going concern was in serious doubt in the event of an adverse judgment – TOUSA’s board unanimously voted to settle the Transeastern Lenders’ claims for approximately $420 million plus interest (the “Transeastern Settlement”).

To finance the Transeastern Settlement, in July 2007, TOUSA and the majority of its subsidiaries, including those not obliged on the guarantees, entered into first and second lien term loan credit agreements for $200 million and $300 million respectively. These funds were transferred to the administrative agent of the Transeastern Lenders which, in turn, wired the funds to the various Transeastern Lenders (collectively, the “July 2007 Transaction).

Despite the Transeastern Settlement, TOUSA’s financial condition continued to deteriorate in the wake of the August 2007 credit-market collapse. On January 28, 2008, TOUSA and its subsidiaries filed petitions for relief under chapter 11 of the Bankruptcy Code. Shortly after TOUSA’s jointly-administered bankruptcy was commenced, the Official Committee of Unsecured Creditors (the “Committee”) brought actions against a number of parties, including the Transeastern Lenders, to avoid the July 2007 financing as a fraudulent conveyance. A finding of fraudulent conveyance is only appropriate when a transaction (i) is made while an entity is insolvent or renders that entity insolvent and (ii) provides less than reasonably equivalent value to an insolvent entity. A number of cross-claims and third-party claims were filed, which were ultimately consolidated as a single adversary proceeding before the Bankruptcy Court for the Southern District of Florida.

TOUSA had approximately $1 billion of unsecured debt outstanding and maintained a $700 million secured revolving credit facility (the “Existing Loans”), guaranteed by many of TOUSA’s subsidiaries.

TOUSA also took over the assets and liabilities of the joint venture, which improved the revolver, increasing available credit to TOUSA. The New Loans were guaranteed by all of TOUSA’s subsidiaries. With consent of the already-secured revolving lenders, the new lending was secured pari passu by substantially all assets of TOUSA’s subsidiaries.

After a lengthy trial, the bankruptcy court determined that the upstream guarantees supporting the New Loans were fraudulent conveyances because the subsidiaries had not received reasonably equivalent value in exchange for their guarantees and ordered the Transeastern Lenders to return the $420 million settlement payment, with interest, to TOUSA.

BANKRUPTCY COURT RULING

On October 30, 2009, the Bankruptcy Court issued its decision which consisted of a nearly verbatim adoption of the Committee’s proposed findings. The Bankruptcy Court declared, among other things, that the July 2007 Transaction was a fraudulent conveyance with respect to TOUSA’s subsidiaries (the “Conveying Subsidiaries”) and that the Transeastern Lenders were entities for whose benefit the conveyance was made. The appeals were ultimately consolidated before the Hon. Adalberto Jordan while the Transeastern appeal was set to be heard by the Hon. Alan Gold. The Hon. Alan Gold issued a 113-page opinion in the Transeastern appeal, in which he reversed, in detail, many aspects of Bankruptcy Court’s Decision.

Some of the key issues in the ruling were: standard of review; direct liability; beneficial transfer liability and reasonably equivalent value.

CONCLUSION

Lending institutions that were troubled by the extremely broad view of liability and limited construction of “value” and “property” adopted by the Bankruptcy Court should be comforted by the District Court’s February 11, 2011 decision. We have not yet heard the definitive word on TOUSA’s implications. In the interim, however, some of the major points to take away from the District Court’s decision include:

• The Bankruptcy Court’s decision in TOUSA drew enormous attention primarily because it purported to expand lenders’ potential fraudulent conveyance liability well beyond previous precedent. Pending a contrary opinion in the appeals of TOUSA first and second lien lenders or from the Eleventh Circuit, however, Judge Gold’s decision appears to curtail that expansion and should signal a return to previous standards of due diligence and acceptable conduct.

• Where a trial court adopts one party’s proposed findings of fact nearly verbatim, that party is likely to have considerable appellate exposure, as the reviewing court is unlikely to accord any deference to such findings.

• The burden is on the party claiming that a fraudulent transfer has occurred to prove lack of reasonably equivalent value.

• A cash infusion to a parent entity to stave-off bankruptcy may constitute value to subsidiaries where it is unclear that such subsidiaries could continue to operate as going concerns absent a solvent parent entity. Consequently, lending institutions should have increased confidence in the viability of subsidiary credit support for parent-level financing.

• Reasonable equivalence must be measured as of the time of the transaction rather through “retrospection”.

-- Substantial portion of the above was provided by Chadbourne & Parke LLP --

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