Fraudulent Transfer Risk Expanded: In re TOUSA: Eleventh Circuit Expands Fraudulent Transfer Risk for Lenders to Distressed Borrowers

Sullivan & Cromwell LLP - June 11, 2012

On May 15, 2012, the Eleventh Circuit Court of Appeals issued an opinion reversing the decision of the District Court for the Southern District of Florida and affirming the bankruptcy court’s original determination in In re TOUSA that (a) liens granted by certain subsidiaries in connection with a refinancing of their parent’s indebtedness and (b) proceeds of the refinancing paid to the parent’s existing creditors were each avoidable under sections 548 and 550(a) of the Bankruptcy Code, respectively, as fraudulent transfers. Applying established principles of fraudulent transfer law, the court found that a pledge made by a subsidiary as a co-borrower is avoidable as a fraudulent transfer if the subsidiary itself did not receive reasonably equivalent value in exchange for the pledge and was either insolvent at the time that the debt was incurred or rendered insolvent as a result of its incurrence. Significantly, in an extension of its ruling in the In re Air Conditioning, Inc. of Stuart preferential transfer decision, the Eleventh Circuit agreed with the bankruptcy court that, in circumstances as those present in TOUSA, if existing creditors are repaid with the proceeds of a new loan that is secured in part by avoidable liens, the existing creditors can be required to disgorge the repayment under section 550(a) of the Bankruptcy Code as entities “for whose benefit [the avoidable transfer] was made.”

The TOUSA decision places a noteworthy additional burden on lenders being refinanced to (and reminds new lenders that they should) assess a distressed borrower’s financial condition, the structure and terms of the new financing and, perhaps more importantly, the value of the new loan to any subsidiary providing a secured upstream guaranty or acting as a co-borrower, particularly if, as in TOUSA, some or all of the lenders being refinanced are participating in the new loan.