Vol 9 (2012) - Issue 5

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The TOUSA Case: Lenders, Beware of Distressed Borrowers

The TOUSA Case: Lenders, Beware of Distressed Borrowers Maja Zerjal, Associate, Proskauer Rose LLP, New York, USA In a closely followed case, the Unites States Court of Appeals for the Eleventh Circuit (the 'Court of Appeals') delivered a landmark decision1 confirming the bankruptcy court’s holding that certain subsidiaries (the 'Conveying Subsidiaries') of bankrupt homebuilder TOUSA, Inc. ('TOUSA') did not receive reasonably equivalent value for the liens provided to secure the payment of debt owed solely by their parent corporation. The Court of Appeals further held that the Transeastern Lenders, who were paid a settlement of USD 421 million with proceeds of the loan secured by the subsidiaries’ liens, were entities for whose benefit the liens were transferred, and thus fell within the scope of section 550(a)(1) of the Bankruptcy Code, which provides that an avoided transfer may be recovered from an entity for whose benefit such transfer was made. By reaching these conclusions, the Court of Appeals reversed the district court’s decision, and reinstated most of the findings of the bankruptcy court.

Background
In 2006, TOUSA was the thirteenth largest homebuilder in the United States. The company expanded its operations through the acquisition of several independent homebuilders. TOUSA leveraged its growth by increasing its indebtedness. The Conveying Subsidiaries normally guaranteed or were otherwise liable for the parent’s loans. In 2005, TOUSA borrowed over USD 600 million from the Transeastern Lenders to fund a joint venture. None of the Conveying Subsidiaries became guarantors or obligors under this debt.
After the explosion of the housing bubble, TOUSA defaulted on its Transeastern debt, and the Transeastern Lenders sued for damages exceeding USD 2 billion. Notably, TOUSA’s existing loan agreements provided that an adverse judgment for more than USD 10 million against TOUSA or any of its subsidiaries, or a bankruptcy filing by TOUSA or any of its subsidiaries constituted an event of default, which presented a serious risk for the company as a going concern. The Transeastern Lenders agreed to a settlement, pursuant to which TOUSA paid more than USD 421 million. The settlement amount was financed by new debt, procured by the New Lenders: (i) a USD 200 million loan from the First Lien Lenders, secured by first-priority liens on the assets of both TOUSA and the Conveying Subsidiaries, and (ii) a USD 300 million loan from the Second Lien Lenders, secured with second-priority liens on the assets of TOUSA and the Conveying Subsidiaries. The proceeds of the loan were wired to one of TOUSA’s subsidiaries, who then transferred the proceeds to the Transeastern Lenders. Pursuant to the loan agreements with the New Lenders, the loan proceeds had to be used to pay for the settlement with the Transeastern Lenders.
After TOUSA and the Conveying Subsidiaries filed for protection under chapter 11 of the Bankruptcy Code, the committee of unsecured creditors (the ‘Committee’) initiated an adversary proceeding against the Transeastern Lenders and the New Lenders. The Committee alleged that the transfer of the Conveying Subsidiaries’ liens to the New Lenders constituted fraudulent conveyance.