Eleventh Circuit Avoids Upstream Transfers as Fraudulent

English: Little Stour looking upstream

The Eleventh Circuit recently avoided, as fraudulent transfers, certain liens pledged by subsidiaries to secure a $500 million loan made to their parent, Tousa, Inc.  See Senior Transeastern Lenders v. Official Comm. of Unsecured Creditors (In re Tousa, Inc.),  No. 11-11071, 2012 WL 1673910 (11th Cir. May 15, 2012).  These liens were avoided as upstream transfers that, pursuant to section 548 of the Bankruptcy Code, did not provide reasonably equivalent value to the subsidiaries of Tousa.


As of 2006, Tousa, along with its subsidiaries, was the thirteenth largest homebuilding enterprise in the U.S.  The Company had grown rapidly by acquiring independent homebuilders, which ended up owning most of the assets of the enterprise and generating virtually all of the revenue.  To finance the growth, Tousa issued over $1 billion in public bonds and borrowed approximately $224 million from Citicorp North America, Inc. under a revolving loan facility.  The Tousa’s subsidiaries guaranteed the bond debt and were jointly and severally liable, as obligors, for the revolving loan.

In 2005, Tousa entered into a joint venture to acquire certain homebuilding assets from Transeastern Properties, Inc.  Tousa borrowed money to finance this acquisition from a separate group of lenders, but none of Tousa’s prior subsidiaries became obligors or guarantors of this financing.

The downturn in the housing market soon threatened the joint venture.  By October 2006, the lenders of the joint venture alleged loan defaults and demanded payment.  In December 2006, these lenders Tousa and alleged that Tousa was liable for damages in excess of $2 billion.

In July 2007, Tousa settled the litigation with its lenders, by agreeing to pay such lenders in excess of $421 million.  To finance this settlement, Tousa and its subsidiaries borrowed $500 million in term loans from CitiCorp, the same lender that had previously extended the revolving facility.  Tousa and its subsidiaries pledged their assets to secure the two term loans.

Six months later, shortly after the collapse of the housing market, Tousa and its subsidiaries filed bankruptcy.

Fraudulent Transfer Under the Code

Pursuant to section 548(a) of the Code, a trustee, debtor-in-possession or a court-authorized representation may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred within 2 years of a debtor’s bankruptcy filing, if the debtor received less than reasonably equivalent value in exchange for such transfer or obligation and

  1. the debtor was insolvent at the time or was made insolvent by the transfer;A cash fare transfer ticket
  2. the transaction left the debtor with unreasonably small capital;
  3. the debtor incurred or would incur debts that were beyond its ability to pay; or
  4. the debtor incurred such transfer for the benefit of an insider.

See 11 U.S.C. § 548(a)(1).  The state laws have similar fraudulent transfer provisions and some states even have longer look back periods such as four years (instead of the 2 years under the Code).  A trustee can choose to avoid a transfer under section 548 of the Code or applicable state law.  See 11.U.S.C. § 544(b)(1).

Section 550 of the Code provides the remedy to recover an avoidable transfer under sections 544 (applicable state law) and 548 (Bankruptcy Code).  Pursuant to section 550, a trustee may recover, for the benefit of a bankruptcy estate, the property transferred or the value of the property transferred from:

  • the initial transferee of such transfer or the entity for whose benefit such transfer was made; or
  • an immediate or mediate transferee of such initial transferee.


After Tousa filed bankruptcy, the appointed committee of unsecured creditors (Committee) filed a lawsuit to avoid the liens granted to Citicorp (for the settlement loan) and the $421 million payment made to the lenders of the joint venture.  The Committee alleged that the pledging of new liens by the Tousa subsidiaries in favor of Citicorp constituted a fraudulent transfer under section 548(a)(1)(B) of the Code, because the subsidiaries (a) either were insolvent at the time, were made insolvent by the transfer, had unreasonably small capital, or were unable to pay their debts as they came due; and (b) did not receive reasonably equivalent value for the liens (transfers) provided.

In response, Citicorp and the lenders of the joint venture argued that the Tousa subsidiaries did receive reasonable equivalent value, including the following benefits:

  • The Tousa subsidiaries avoided a default and acceleration on their own loan obligations, as guarantors and obligors, based on the lawsuit against Tousa brought by the lenders of the joint venture.  If a default on the $1 billion bond debt and revolving facility would have occurred, Tousa and its subsidiaries would have had to file bankruptcy sooner.
  • The Tousa subsidiaries averted other adverse business effects from the lender lawsuit.
  • One Tousa subsidiary received control over a $28 million property.
  • The Tousa subsidiaries received a higher debt ceiling on the Citicorp revolving loan.
  • The Tousa subsidiaries received new tax benefits from incurring new debt.
  • The Tousa subsidiaries could continue to use the centralized services provided by Tousa.

Separately, the lenders of the joint venture argued that they did not constitute initial transferees or entities for whose benefit the transfers were made, as required by section 550, as the initial recipient of the loan proceeds from CitiCorp was a Tousa subsidiary (who subsequent paid the lenders $421 million from the loan proceeds).

Bankruptcy Court’s Ruling

Section 548(a)(1)(B)(i) of the Code defines value as being “property” or “satisfaction or securing of a present or antecedent debt of the debtor.”    Using this definition, the bankruptcy court found that the Tousa subsidiaries could not have received reasonably equivalent value, in the form of property, because they did not obtain “some kind of enforceable entitlement to some tangible or intangible article.”  The bankruptcy court also held that the other examples of value, i.e., all the tax benefits, property and services identified above, did not otherwise provide reasonably equivalent value, as provided under section 548(a)(1)(B)(i)’s definition, to the Tousa subsidiaries.

The bankruptcy court made other extensive findings about how the financing of the settlement with the lenders of the joint venture harmed Tousa’s subsidiaries significantly.  Among other things, the bankruptcy court found that an earlier bankruptcy for Tousa and its subsidiaries, even if necessary, might have provided a better result for the enterprise.  In this regard, the bankruptcy court blamed the majority shareholders of the debtor for refusing to raise capital through investments–as opposed to loans–to prevent the dilution of the majority’s shares.

The bankruptcy court ultimately avoided the liens on the Tousa subsidiaries and ordered the lenders of the joint venture to disgorge the proceeds that they had received.  On appeal, the district court reversed the holding of the bankruptcy court and entered a judgment in favor of the lenders, finding, among other things, that the indirect benefits such as the opportunity to avoid bankruptcy did provide reasonably equivalent value under section 548, even if such value could not necessarily be quantified.

Eleventh Circuit Appeal

On the second appeal, the Eleventh Circuit reversed the district court, finding that the bankruptcy court, as the trier of fact, had considerable latitude in concluding that the Tousa subsidiaries did not receive “reasonably equivalent value.”  See Tousa, 2012 WL 167910 at *12.

In response to the lenders’ argument that staving off bankruptcy brought significant value to the subsidiaries, the Court found that “[a] corporation is not a biological entity for which is can be presumed that any act which extends its existence is beneficial to it.”  Id.  Thus, according to the Court, “[t]he opportunity to avoid bankruptcy does not free a company to pay any price or bear any burden[;] [a]fter all, there is no reason to treat bankruptcy as a bogeyman, as a fate worse than death.” Id. at *14.

The Eleventh Circuit also found that the lenders of the joint venture were entities for whose benefit the subsidiaries pledged their assets as collateral to Citicorp.  This was evidenced by the loan documents of the settlement loan, which required that the  proceeds of the loan by Citicorp be paid to the lenders of the joint venture.  Thus, according to the Eleventh Circuit, these lenders were, in fact, entities who benefitted from, and could be held liable for, the avoidable transfers under section 550(a) of the Code.


One of the messages that the Eleventh Circuit opinion sends is that bankruptcy can result in third parties second guessing the pre-bankruptcy decisions of a large, integrated company with a complex capital structure.  While there was little question that the Tousa subsidiaries had tied their financial future to their parent, through over $1 billion in guaranties and direct commitments to lenders, the question remained whether the bankruptcy court and parties in interest could properly separate the financial affairs of the subsidiaries and parent at any point in time.

The creditors’ committee picked a point in time when the subsidiaries had not sufficiently documented their reliance on their parent’s resources to justify entering into a sophisticated financial transaction with the parent.  The bankruptcy court and the Eleventh Circuit ultimately agreed that the subsidiaries were better off not further entangling their capital structure with that of the parent, through the financing of the settlement.  According to the Eleventh Circuit, this was the case even if the subsidiaries would inevitably have to file for bankruptcy because of loan defaults by the parent.  In the end, this case proved to be a good example of how bankruptcy avoidance laws can be used to untangle the proverbial scrambled egg.