the tousa decision - Cadwalader_ Wickersham _ Taft by wuyunyi


                       June 27, 2012
Overview of TOUSA
• Timeline
• Creditors’ Committee complaint
• Rulings:
    o Bankruptcy Court for the Southern District of Florida
    o District Court for the Southern District of Florida
    o Eleventh Circuit Court of Appeals
• Scope of Section 550 under TOUSA
• Responses to the 11th Circuit’s decision
• Post-decision developments
• TOUSA, Inc. was a large home builder that operated a web of subsidiaries
  throughout the United States.
• June 2005: TOUSA and a subsidiary guarantee a loan made by the
  “Transeastern Lenders” to a joint venture operated by the subsidiary.
      o The loan was not secured or guaranteed by TOUSA’s major operating
• January 2007: The Transeastern Lenders allege that TOUSA is in default and
  owes the Transeastern Lenders over $2 billion.
• June 2007: TOUSA settles with the Transeastern Lenders for $421 million.
      o TOUSA finances the settlement through a new loan that is secured and
        guaranteed by certain TOUSA subsidiaries that were not obligors or
        guarantors under the Transeastern Lenders’ loan.
      o The new loan is syndicated through Citi to the market generally; some,
        but not all, participants in the new loan also are Transeastern Lenders.
      o The terms of the new loan require that proceeds be used (among other
        things) to pay the settlement amount to the Transeastern Lenders.
Timeline (continued)
• July 2007: TOUSA closes on the new loan and a subsidiary uses the
    proceeds to make the payment to the Transeastern Lenders.
•   January 2008: TOUSA and its subsidiaries that guaranteed the new loan file
    chapter 11 petitions in the Bankruptcy Court for the Southern District of
•   July 2008: The Creditors’ Committee files an adversary complaint challenging
    as fraudulent transfers both the liens and guaranties granted to the new
    lenders and the payment made to the Transeastern Lenders.
•   October 2009: The Bankruptcy Court avoids the new loan’s liens and
    guaranties, and orders the Transeastern Lenders to disgorge the payment.
•   February 2011: The District Court for the Southern District of Florida reverses
    the Bankruptcy Court and finds no fraudulent transfer and no liability on the
    part of the Transeastern Lenders.
•   May 2012: The Court of Appeals for the Eleventh Circuit reverses the District
    Court, finding that the subsidiaries’ granting the liens and guaranties to the
    new loan was a fraudulent transfer for which the Transeastern Lenders are
The Committee’s Complaint
• The Creditors’ Committee sought to avoid the liens and guaranties securing
  the new loan, as well as the payment to the Transeastern Lenders, as
  fraudulent transfers under bankruptcy code section 548, and to recover the
  payment under bankruptcy code section 550(a)(1).
      o Section 548 provides, among other things, that a debtor may avoid any
        transfer where the debtor (1) received less than reasonably equivalent
        value, and (2) was insolvent at the time of, or was rendered insolvent by,
        the transfer.
      o Section 550(a)(1) permits a debtor to recover damages for a fraudulent
        transfer from “the initial transferee of such transfer or the entity for
        whose benefit such transfer was made . . . .”
• The Transeastern Lenders and lenders under the new loan argued that the
  new loan benefitted the subsidiaries by giving TOUSA and its subsidiaries the
  opportunity to avoid bankruptcy, which constituted reasonably equivalent
  value under section 548.
• The Transeastern Lenders also argued that the liens and guaranties were not
  made for their benefit, and so they could not be liable for that transfer.
Bankruptcy Court Ruling
• The Bankruptcy Court held a 13 day trial, including substantial briefing and
  expert testimony.
• The Bankruptcy Court found that:
     o TOUSA and its subsidiaries were insolvent in July 2007 when the new
       loan and payment to the Transeastern Lenders were made.
     o The liens and guaranties granted by the subsidiaries were fraudulent
       transfers because the subsidiaries did not receive any direct benefit
       from the new loan, and the lenders did not show any tangible and
       concrete indirect benefits from the new loan of “cognizable value.”
     o The payment to the Transeastern Lenders was a fraudulent transfer
       because the subsidiaries did not receive any direct or significant indirect
       benefits from the settlement.
     o The Transeastern Lenders did not receive the settlement payment in
       good faith, as they had ample constructive notice of TOUSA’s and its
       subsidiaries’ insolvency and the lack of reasonably equivalent value for
       the new loan’s liens and guaranties.
District Court Ruling
• On appeal by the Transeastern Lenders and the new lenders, the District
  Court reversed on both points.
• The District Court found that:
     o The new loan allowed TOUSA to settle with the Transeastern Lenders,
       which avoided an event of default under other TOUSA debt agreements
       and provided TOUSA and its subsidiaries the opportunity to avoid
           The new loan and payment to the Transeastern Lenders “left the
            Conveying Subsidiaries in a better position to remain as going
            concerns than they would have been without the settlement,” and
            that was reasonably equivalent value for the liens and guaranties.
           The District Court did not attempt to quantify this value.
     o The liens and guaranties were for the benefit of the new lenders, not the
       Transeastern Lenders, and therefore the Transeastern Lenders could
       not be liable under section 550(a)(1) even if granting the liens and
       guaranties was a fraudulent transfer.
Eleventh Circuit Ruling
• The Eleventh Circuit overruled the District Court.
• The Eleventh Circuit found that:
     o The Bankruptcy Court’s determination that the subsidiaries did not
       receive reasonably equivalent value was correct.
           Regardless of whether indirect and unquantified benefits can
            constitute “value,” here the indirect benefits of possibly avoiding
            bankruptcy were not of sufficient value to the subsidiaries.
     o The liens and guaranties were granted for the benefit of the
       Transeastern Lenders because:
           The new loan required TOUSA to use the loan proceeds to make
            the payment to the Transeastern Lenders, and
           TOUSA needed the new loan to have funds to make that payment.
     o Because the liens and guaranties were fraudulent transfers made for
       the benefit of the Transeastern Lenders, the payment can be disgorged
       under section 550.
Scope of Section 550 under TOUSA
• The Eleventh Circuit’s opinion is fairly brief, and leaves much unanswered.
• The court noted that the new lenders included some Transeastern Lenders,
  and “these lenders essentially converted their unsecured loans to the [joint
  venture] into secured loans to TOUSA and the [subsidiaries]”.
      o The decision could be limited to these facts and to similar
        circumstances where a refinancing is in actuality the same lenders
        improving their collateral or priority at the expense of other creditors.
• The Eleventh Circuit did not expressly limit the reach of its opinion in that
  way, however, and did not seem concerned that its decision should be limited.
• The court put the onus on creditors to “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 by someone other than the debtor.”
Responses: Don’t Panic
• The Eleventh Circuit remanded to the District Court to consider the remedies
  granted by the Bankruptcy Court:
     o Avoidance of the subsidiaries’ liens, guaranties and other obligations
       with respect to the new loan; and
     o Disgorgement of the payment to the Transeastern Lenders.
• Certain commenters have warned against reaching conclusions on the
  meaning of TOUSA until the District Court addresses remedies.
     o Remedies granted will determine whether TOUSA raises concerns for
     o “Diligence” that the Eleventh Circuit expects of creditors also may be
       elaborated upon.
Responses: Limited to Facts
• Other commenters have argued that TOUSA is the product of its specific
     o The Transeastern Lenders seemed to have insight into the terms of the
        new loan while it was being negotiated/syndicated.
      o The Transeastern Lenders knew that the new loan required that
        proceeds be used to make the settlement payment.
      o The Transeastern Lenders knew that, but-for the new loan, TOUSA
        could not make the settlement payment.
      o Certain Transeastern Lenders participated in the new loan.
• The decision may also apply only to repayments that are material in size,
  such that conducting diligence on the source of the repayment is reasonable.
• The Eleventh Circuit does not limit its ruling to these circumstances however.
• Moreover, the fact that the new loan was syndicated to any willing lender, and
  that there was only limited crossover between the new loan and the
  Transeastern Lenders, is problematic.
Response: Time to Panic
• Finally, some commenters view the TOUSA opinion as creating significant
  concerns for creditors.
• Creditors receiving repayment on debts may now be liable if that repayment
  was funded from the proceeds of a fraudulent transfer.
     o This may be true regardless of whether the creditor has any
       involvement in the fraudulent loan, or even if the creditor has no actual
       knowledge of the source of the proceeds.
     o 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
     o Existing holding company lenders may be at risk of liability if, even
       years after the refinancing, the company files a chapter 11 case and the
       refinancing loan is deemed to be a fraudulent transfer.
Response: Time to Panic (continued)
• It is not clear on what grounds a lender could refuse repayment based solely
  on a concern that the source of funds may have been a fraudulent transfer.
      o Lenders may be left in the untenable position of being exposed to
        potential fraudulent transfer liability for years after their loan has been
        repaid, without any ability to protect themselves or preserve their rights
        against the borrower.
• Creditors often have little to no ability to perform diligence on the origins of
  the funds being paid to them.
      o Requiring all creditors to perform this diligence would impose significant
        friction costs on doing business with any company suffering financial
• This reading of TOUSA could have significant consequences for credit
Post-Decision Developments
• June 5, 2012: The Transeastern Lenders file a petition for rehearing en banc,
  arguing that:
      o The panel erred by not regarding the Bankruptcy Court’s findings of fact
        as only proposed findings of fact warranting no special deference, as
        directed by Stern v. Marshall, 131 S. Ct. 2594 (2011).
      o The decision to hold the lenders liable for the lien transfer under section
        550(a)(1) conflicts with prior precedent.
• June 22, 2012: The LSTA files an amicus brief addressing the additional
  financial due diligence that TOUSA may impose on lenders before accepting
      o The LSTA expresses concern that the Eleventh Circuit sets an
        “unworkable standard” that could greatly disrupt commercial lending

                       Colin Adams
                       Executive Director, Morgan Stanley & Co., Inc.

Contact                Colin is a Senior Credit Analyst in Morgan Stanley’s Distressed/Special
                       Situations Group in New York. Colin is primarily focused on litigation,
                       bankruptcy and process driven credit investments and ideas. Recent credits
• 212.761.1620         include: ATPG Oil & Gas; Eastman Kodak; Fontainebleau Las Vegas; General
                       Motors / General Motors Nova Scotia Finance; and Washington Mutual Bank,
                       Prior to joining Morgan Stanley, Colin was a Managing Director with Citadel
                       Securities LLC, where he acted as a financial advisor to companies and groups
                       of creditors in both in and out of court restructurings. Notable representations
                       included: the senior secured lenders of Extended Stay America; an ad hoc
                       group of holders of second lien debt of Green Valley Ranch Hotel & Casino; and
                       the Fairmont Turnberry Isle.
                       Prior to that, Colin was a Partner in the Restructuring Group of Kirkland & Ellis
                       LLP. At Kirkland, Colin represented debtors (including the management and
                       boards of portfolio, privately held and public companies) and distressed
                       investors (including hedge funds, private equity sponsors and strategic
                       investors) in connection with out of court restructurings, bankruptcy cases and
                       the acquisition of distressed assets and securities.
                       Colin holds a J.D. with a Certificate in Business Law from the University of
                       California Los Angeles, and an A.B. in History and Economics from Duke

                           Peter M. Friedman
                           Partner, Cadwalader Wickersham & Taft LLP

Contact                    Peter Friedman is an acclaimed restructuring lawyer who counsels and litigates
                           on behalf of major parties in high stakes, complex bankruptcies. In each of the
                           past two years, Peter was named one of five "Rising Stars" in the restructuring
• 202.862.2347             bar by Bankruptcy Law360, and has been ranked in Chambers USA as a
                           leading lawyer since 2010. Notable representations include: LyondellBasell
                           (Debtors), General Motors and Chrysler (Presidential Task Force on the Auto
                           Industry), Dynegy Holdings LLC (US Bank as Indenture Trustee), Lehman
                           Brothers (Morgan Stanley), Blockbuster Inc. (Icahn Associates), Inner City
                           Media Company (Yucaipa), Northwest Airlines (Debtors), WorldCom (Debtors),
                           Enron (Debtors), Caribbean Petroleum (Debtors) , Xerium Inc. (Debtors),
                           Heartland Industries (Creditors Committee) and USG (Equity Committee).

                           Peter clerked for the Honorable Joel M. Flaum of the United States Court of
                           Appeals for the Seventh Circuit. He worked in the White House Counsel's office
                           and the White House Office of Legislative Affairs from 1994-1995.

                           Peter graduated from Northwestern University School of Law, Order of the Coif
                           and cum laude and was an editor of the Journal of Criminal Law and
                           Criminology. He received his undergraduate degree from Trinity College in
                           Connecticut with honors.

                          Douglas S. Mintz
                          Special Counsel, Cadwalader Wickersham & Taft LLP

Contact                   Doug Mintz is special counsel in the firm's Financial Restructuring Department,
                          resident in the Washington, D.C. office. He has experience in all aspects of
                          bankruptcy and restructuring, representing secured lenders, debtors and official
• 202.862.2475            and ad hoc creditors' committees. Doug served as the lead associate in
                          Cadwalader's representation of United States Treasury in the restructuring of
                          Chrysler, a deal named M&A Advisor's Magnus Deal of the Year for 2009.

                          Doug has frequently lectured on topics including Fraudulent Transfers in
                          Leveraged Buyouts and Assets Sales in Bankruptcy. For his recent work on
                          cases like GM, Chrysler and Lyondell, The M&A Advisor named Doug a Runner-
                          Up for its "40 Under 40" M&A Advisor Recognition Awards.

                          A frequent author and Managing Editor of Cadwalader's Restructuring
                          Review, Doug received his B.A., magna cum laude, from the University of
                          Maryland, and his J.D. from the University of Virginia School of Law. He is
                          admitted to practice in the State of New York and the District of Columbia and
                          before the Southern District of New York and the District Court for the District of

                       Josh Brant
                       Associate, Cadwalader Wickersham & Taft LLP

Contact                Josh Brant is an associate in the firm's Financial Restructuring Department, and
                       is based in New York.
• 212.504.6775         Josh received his B.A. from Washington University in St. Louis and his J.D. from
                       Columbia University. He is admitted to practice in the State of New York and
                       before the Bankruptcy and District Courts for the Southern and Eastern Districts
                       of New York.

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