Florida District Court Affirms TOUSA Bankruptcy Court Decision Rejecting Fraudulent Conveyance Arguments | Practical Law

Florida District Court Affirms TOUSA Bankruptcy Court Decision Rejecting Fraudulent Conveyance Arguments | Practical Law

An update on In re TOUSA, in which the US District Court for the Southern District of Florida affirmed the decision of the US Bankruptcy Court for the Southern District of Florida, holding that the lenders' liens on collateral granted under an existing revovling creadit agreement were not subject to fraudulent conveyance attack under section 548 of the Bankruptcy Code, even though the agreement was amended and the revolver was drawn on after the borrower and certain of its subsidiaries were allegedly insolvent.

Florida District Court Affirms TOUSA Bankruptcy Court Decision Rejecting Fraudulent Conveyance Arguments

by PLC Corporate & Securities and PLC Finance
Published on 09 Mar 2011 • USA (National/Federal)
An update on In re TOUSA, in which the US District Court for the Southern District of Florida affirmed the decision of the US Bankruptcy Court for the Southern District of Florida, holding that the lenders' liens on collateral granted under an existing revovling creadit agreement were not subject to fraudulent conveyance attack under section 548 of the Bankruptcy Code, even though the agreement was amended and the revolver was drawn on after the borrower and certain of its subsidiaries were allegedly insolvent.
On March 4, 2011, the US District Court for the Southern District of Florida (District Court) issued a decision affirming the US Bankruptcy Court for the Southern District of Florida's (Bankruptcy Court) decision, which dismissed certain fraudulent transfer claims asserted by the Official Committee of Unsecured Creditors (Committee) against Citicorp North America, Inc. (Citicorp).
This is the second decision issued by the District Court in favor of the secured lenders in the TOUSA bankruptcy proceedings. The decision concerning the validity of "savings clauses" is still pending before the District Court. For more information on the background of the bankruptcy proceedings and other court decisions in the bankruptcy and their practical implications, see Practice Note, In Dispute: TOUSA.

Key Litigated Issues

The main issue on appeal was whether amendments to and drawings under a revolving credit agreement create new obligations to repay or cause new transfers to occur. This would subject the lenders to fraudulent conveyance liability under section 548 of the Bankruptcy Code if the borrower became insolvent before the agreement was amended or the revolver was drawn on.
Under section 548 of the Bankruptcy Code, a transfer (including a lien) or an obligation (including a promise to repay a loan) can be avoided if all of the following are true:
  • It was made while the debtor was insolvent or it rendered the debtor insolvent.
  • The debtor:
    • received less than reasonably equivalent value from the transaction; or
    • had actual intent to hinder, delay or defraud any creditor or future creditor.
  • It was made within two years before the date of the filing of the petition for bankruptcy.
For more information on fraudulent transfers, see Practice Notes, Fraudulent Conveyances in Bankruptcy: Overview and Fraudulent Conveyances: Issues and Strategies for Lenders and Private Equity Sponsors.

Background

The transfers at issue were a series of transactions that TOUSA and certain of its subsidiaries (conveying subsidiaries) entered into to obtain funding for various real estate projects. The first transaction was a revolving credit agreement that TOUSA and the conveying subsidiaries entered into in January 2007 with several banks, with Citicorp serving as administrative agent (January Revolver). The January Revolver was secured by substantially all of the assets of TOUSA and the conveying subsidiaries and allowed each to draw on the revolver directly as co-borrowers.
On July 31, 2007, the same day that TOUSA settled litigation with certain lenders who provided $675 million in funding to a failed joint venture (Transeastern Joint Venture Litigation), the parties amended and restated the January Revolver (July Revolver). However, all rights and obligations already incurred under the January Revolver, including the security interests and liens granted under the original security agreement, remained in full force and effect. It also permitted TOUSA and the conveying subsidiaries to obtain additional loans from new lenders.
The parties amended the revolver again in October 2007 and December 2007 (Subsequent Revolvers) to resolve default issues relating to the question of TOUSA's insolvency. For more information on the related adversary action concerning the loan taken to settle the Transeastern Joint Venture Litigation, see Legal Updates, TOUSA: Bankruptcy Court's Fraudulent Transfer Decision Quashed by District Court and FL Bankruptcy Court Finds TOUSA Loans Fraudulent Transfers.
The Committee claimed that TOUSA and each conveying subsidiary was insolvent or became insolvent as a result of the July Revolver and the Subsequent Revolvers. Specifically, the Committee argued that fraudulent transfers occurred during this period of alleged insolvency because:
  • Each draw on the July Revolver and the Subsequent Revolvers constituted the incurrence of new obligations.
  • The execution of the July Revolver constituted the incurrence of a new obligation to repay the July Revolver and the Subsequent Revolvers.
  • The lenders' reperfection of their liens in connection with the closing of the July Revolver constituted new transfers.

Bankruptcy Court Decision and Proceedings

In the bankruptcy proceeding, the Committee brought fraudulent transfer claims under Florida and New York law. In its initial adversary complaint against Citicorp the Committee claimed that TOUSA was insolvent on July 31, 2007 and that it entered into the July Revolver without receiving fair consideration. In defending against Citicorp's motion to dismiss, the Committee relied on Rubin v. Manufacturers Hanover Trust Co., arguing that every time TOUSA or the conveying subsidiaries drew on the July Revolver, they incurred an obligation (661 F.2d 979 (2d Cir. 1981)). The Bankruptcy Court rejected this argument, but allowed the Committee to amend its complaint.
The Committee filed an amended complaint alleging fraudulent transfer claims under New York law and section 548 of the Bankruptcy Code. It argued that the July Revolver was a new loan commitment and that TOUSA and the conveying subsidiaries did not receive reasonably equivalent value or fair consideration in exchange for incurring obligations as borrowers and guarantors. At oral argument, the Committee expressly stated that it was rejecting Rubin and no longer relying on it.
The Bankruptcy Court again granted Citicorp's motion to dismiss the amended complaint, except as to any new collateral pledged under the July Revolver and the Subsequent Revolvers. The Bankruptcy Court explained that the liens under the January Revolver were granted under a credit agreement entered into in October 2006, when TOUSA's solvency was not in dispute. These liens carried forward to the January Revolver and remained in effect under the July Revolver. Therefore, no new transfers occurred when the lenders reperfected their liens on existing collateral. Transfers occurred only on the original lien perfection dates, during which time TOUSA and the conveying subsidiaries were unquestionably solvent.
Instead of filing a second amended complaint as permitted by the Bankruptcy Court, the Committee appealed to the District Court.

Arguments on Appeal

The Committee raised the following three arguments on appeal:
  • Reliance on Rubin. TOUSA and the conveying subsidiaries incurred new obligations every time they drew on the July Revolver and the Subsequent Revolvers (see Reliance on Rubin).
  • Obligation Argument. TOUSA and the conveying subsidiaries incurred an obligation to repay the July Revolver and the Subsequent Revolvers at the time that they executed the July Revolver and promised in writing to do so (see Obligation Argument).
  • Transfer Argument. TOUSA and the conveying subsidiaries made a transfer by granting the lenders liens under the July Revolver (see Transfer Argument).

Outcome

The District Court rejected all three of the Committee's arguments. In addition, it agreed with the Bankruptcy Court that no transfer of liens occurred on or after July 31, 2007, except to the extent that any new collateral was pledged under the July Revolver and the Subsequent Revolvers.

Reliance on Rubin

The District Court rejected the Committee's argument that TOUSA and its conveying subsidiaries incurred new obligations each time they drew on the July Revolver and Subsequent Revolvers, holding that:
  • In expressly abandoning Rubin in the lower court proceedings, the Committee effectively waived this argument.
  • The Committee failed to make any persuasive arguments for an exception to apply allowing an argument to be raised for the first time on appeal.
  • The Committee's reference to post-July 31, 2007 draws in the amended complaint was not sufficient to put the Bankruptcy Court on notice that the Committee was still relying on Rubin, despite its counsel's express disavowal of this case.
While the District Court was able to dispose of the Rubin argument on procedural grounds, in a footnote it questioned the continuing validity of its underlying legal theory, noting that 44 states rejected its holding through passage of the Uniform Fraudulent Transfer Act (UFTA), under which guaranty obligations are incurred only on the date the guaranty agreement is executed and not on the date of any future advances.

Obligation Argument

The District Court also found unpersuasive the Committee's alternative argument that TOUSA and its conveying subsidiaries incurred an obligation to repay the July Revolver and the Subsequent Revolvers at the time that they entered into the July Revolver. The District Court explained that, because the obligations already incurred under the January Revolver remained in full force and effect under the July Revolver, they were not voided, extinguished or superseded by the July Revolver. The new obligations were nothing more than the previous obligations from the January Revolver.
The District Court also rejected the Committee's argument that the July Revolver was a new obligation because it was materially altered to allow TOUSA to incur $500 million in term loan debt from new lenders. It explained that while TOUSA and the conveying subsidiaries were permitted to incur additional debt, it was not required to do so, and regardless, any new obligations incurred were concerning the new lenders and not to Citicorp.

Transfer Argument

The District Court rejected the Committee's argument that TOUSA and the conveying subsidiaries made a transfer by granting liens under the July Revolver. Under section 548 of the Bankruptcy Code, a transfer is made when the liens are perfected and the liens under the July Revolver were already perfected under the January Revolver. Accordingly, the District Court explained that reperfection of the liens on collateral previously pledged under the January Revolver was not a transfer of liens under the July Revolver, except as to new collateral pledged under the July Revolver and the Subsequent Revolvers. For purposes of section 548 of the Bankruptcy Code, transfers occurred only on the original lien perfection dates, not at the time of reperfection. On the original lien perfection dates, TOUSA was unquestionably solvent, so there could be no fraudulent transfer liability.

Practical Implications

The District Court's decision affirming the Bankruptcy Court is an important case for secured lenders because it provides additional comfort that deteriorations in a debtor's financial condition will not expose them to fraudulent conveyance liability for fulfilling pre-existing lending commitments, even where the underlying agreements are amended or drawn on after the borrower becomes insolvent. The decision reaffirms that lenders' responsibility to perform due diligence into a borrower's financial condition occurs at the onset of the original lending arrangement and does not renew each time the facility is amended or drawn on.

Court Documents