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November 12, 2017

Laura Davis Jones
Pachulski Stang Ziehl & Jones LLP


One of the most powerful tools in the Bankruptcy Code available to bankruptcy trustees (or other estate representatives) to maximize the recovery of creditors is the power to avoid and recover fraudulent transfers of a debtor’s property.  These include transfers that are made, or obligations that are incurred, by a debtor (a) with the actual intent to hinder, delay or defraud creditors (§ 548(a)(1)(A)), or (b) constructively fraudulent transfers, i.e., transfers made or obligations incurred for which the debtor receives less than reasonably equivalent value, that are made while the debtor is insolvent or that render the debtor insolvent or unable to pay its debts, or that leave it with inadequate capital to engage in business (§ 548(a)(1)(B)).

Fraudulent Transfer Remedies – Overview

When it comes to remedies, the Code is very flexible.  Once a transfer or obligation is “avoided” under section 548, several options for “recovering” the avoided transfer are provided in section 550.  The trustee can recover the fraudulently transferred property or, if the court orders, the value of such property, from:

    • the “initial transferee of such transfer” (§ 550(a)(1)); or
    • “the entity for whose benefit such transfer was made” (id.); or
    • “any immediate . . . transferee of such initial transferee” (§ 550(a)(2)) or
    • “any . . . mediate transferee of such initial transferee” (id.).[1]

An important restriction is the “single satisfaction rule” which provides that “[t]he trustee is entitled to only a single satisfaction under subsection (a) of this section” (§ 550(d)).  After all, section 550 “is designed to restore the estate to the financial condition that would have existed had the transfer never occurred.”[2]

Often, the remedy is obvious.  Sometimes, it is enough to avoid the transfer or obligation, without need for recovery.  For instance, if a one-sided settlement is avoided, it is enough that the agreement is torn up; there is nothing to recover.  Likewise, if a debt is incurred or liens granted without receiving reasonably equivalent value, it may be enough to avoid the obligation and the liens.  If the transferred property is intangible, it is often enough simply to cancel the transfer documents.

Even when recovery is required under section 550, it will most often be straight-forward.  If an insolvent debtor gives away a car to a family member, the transfer is avoided and the car recovered from the giftee.  If the transfer is money for which the debtor received less than reasonably equivalent value, the money may (hopefully) be recoverable from its initial transferee.

If the initial transferee no longer has the property, however, the decision gets more complicated.  Should the trustee sue the initial transferee for the value of the property, or should the trustee attempt to recover the property itself from the immediate or mediate transferee?  Is there an “entity for whose benefit the transfer was made”?  What if the initial transferee and/or beneficiary of the transfer is judgment proof, or what if the mediate transferees have good faith defenses?  Ease of recovery would typically become the trustee’s primary concern.  The inadequacy of one remedy pushes the trustee in the other direction.

What happens though, if the trustee has more than one option?  For instance, if the debtor borrows money and encumbers its assets and transfers money away in the same transaction (and the money is recoverable), can the trustee both avoid the lien and recover the money without violating the single satisfaction rule?  Does the trustee have to choose between avoiding the loan and the lien and recovering the money?  What if there is also an entity for whose benefit the transfer was made?  Can the trustee deploy partial remedies against each?  Can the court fashion its own hybrid remedy?

Fraudulent Transfer Remedies – TOUSA

A case now pending in the Eleventh Circuit in the bankruptcy case of the homebuilder TOUSA raises these issues.[3]  Although TOUSA involves a failed leveraged buyout, the issue could arise elsewhere. TOUSA borrowed $500 million from the “New Lenders” with its subsidiaries as co-borrowers, secured by liens on the subsidiaries’ assets, to pay a debt to former lenders (the “Transeastern Lenders”) for which the subsidiaries were not liable (to settle a lawsuit to which they were not parties). These “Conveying Subsidiaries” were already in financial distress, with unsecured bond claims of $1.06 billion.  Six months later, TOUSA and subsidiaries were in chapter 11.

The creditors’ committee sued (1) to avoid the transfer of the liens to the New Lenders as a fraudulent transfer, and (2) recover the value of the liens from the Transeastern Lenders, as the entities for whose benefit the liens had been granted.  That value had plummeted during the over two year period that the liens had been in place, making that remedy nearly as valuable, dollar-wise, as cancellation of the New Lenders’ liens.

Both sets of defendants argued that either of these remedies would make the debtors whole, and that granting both constituted a double recovery, violating the single satisfaction rule.  Section 550(d) does not require that the “single satisfaction” be at the sole expense of a “single defendant” but, needless to say, each group argued that the appropriate remedy was the one applicable to the other group of defendants.  Thus, the Transeastern Lenders urged a rule that where the avoided transfer is a non-possessory lien, such as this case, the only remedy, and a sufficient remedy, is to cancel the liens.  At minimum, they argued, cancellation of the liens held by the initial transferee must come first, and only then could the committee seek the value of the transferred property from the beneficiaries of the transfer.  For their part, the New Lenders argued of course that the Transeastern Lenders, as the persons for whose benefit the liens were transferred, should bear responsibility for making the debtors whole.

The bankruptcy court granted both remedies.

    • First, it allowed the Committee to avoid the obligation incurred and the liens transferred to the initial transferee (i.e., the New Lenders), who were also required to disgorge amounts paid on account of their claims against the Conveying Subsidiaries.
    • Second, the Committee was also entitled to recover from the entities for whose benefit the liens had been granted (i.e., the Transeastern Lenders), the value of the transferred liens, measured by the difference in the value of the liens (i.e., the value of the encumbered assets) between the date the liens were granted and the date they were avoided.  The amount to be disgorged was $505 million, consisting of the principal amount of $403 million, plus interest.

The bankruptcy court specifically found that simply avoiding the obligations and liens to the New Lenders “will not restore the Conveying Subsidiaries to the financial condition that would have existed had the transfer never occurred.”  The debtors had also been injured by having their assets encumbered by the fraudulently granted liens for over two years, because the assets securing the liens were not worth nearly as much as they had been when the liens were granted, and the debtors had not had the ability to use those assets during that entire time for restructuring purposes.  Significantly, the bankruptcy court found that the neither the New Lenders nor the Transeastern Lenders had acted in good faith.

What about the single satisfaction rule?  The bankruptcy court had an equitable solution.  It ordered that the amounts disgorged by the Transeastern Lenders would be disbursed to the Conveying Subsidiaries only to the extent needed to compensate for the diminution in the value of their assets between the time that liens were placed upon them in favor of the New Lenders and the time the liens were removed, and for transaction and legal costs.  That, together with avoidance of the liens, would make the Conveying Subsidiaries whole.  Then, all amounts left over would be distributed to the New Lenders.  It found this sharing of the burden between the New Lenders and the Transeastern Lenders to be the fairest solution to the equitable dilemma of who should be responsible for restoring the debtors to the position they occupied before the transaction.

The district court reversed the bankruptcy court on liability, but the Eleventh Circuit reversed, holding that not only were the New Lenders liable, but also affirming the determination that the Transeastern Lenders were liable under section 550(a) of the Code as entities for whose benefit the fraudulent transfer had been made.[4]  On remand, the bankruptcy court essentially reaffirmed the remedies listed above and the district court adopted its findings and recommendations.

The Transeastern Lenders have appealed to the Eleventh Circuit for the second time.  Again, they argue that the sole remedy in avoidance cases involving non-possessory liens should be cancellation of the liens, no matter the circumstances or the damage done by the lien.  Thus the pending decision in TOUSA should help answer these questions: (a) whether the multiple remedies for an avoided fraudulent transfer in section 550(a) are mutually exclusive, or may they be combined; (b) where the avoided transfer is the creation of a lien, whether the only remedy available under section 550(a) is the cancellation of the lien; and (c) whether section 550 directs the manner in which the bankruptcy court is to adjust or allocate those remedies to satisfy the “single satisfaction” rule, or limit the bankruptcy court’s discretion to fashion a remedy that will restore the estate to its pre-transfer financial condition.

 

Laura Davis Jones

Laura Davis Jones is a named and managing partner of Pachulski Stang Ziehl & Jones LLP, a national law firm specializing in restructurings.  Laura began her career as a law clerk in the Bankruptcy Court (D. Del.), and has been very active representing debtors, creditors’ committees, noteholder groups, purchasers, and other substantial parties in national and regional bankruptcies and out-of-court workouts.

 


 

Footnotes

[1] Immediate and mediate transferees, however, have a defense if they take for value and in good faith and did not know of the voidability of the transfer, or if they are the “immediate or mediate good faith transferee” of such a person (§ 550(b)).  There are other limitations not discussed here, such as the right of a good faith transferee to a lien to secure costs of improvements (§ 550(e)).

[2] Kingsley v. Wetzel (In re Kingsley), 518 F.3d 874, 877 (11th Cir. 2008).

[3] Official Comm. of Unsecured Creditors of Tousa, Inc. v. Citicorp N. Am., Inc. (In re Tousa, Inc.), 422 B.R. 783 (Bankr. S.D. Fla. 2009).

[4] Senior Transeastern Lenders v. Official Comm. of Unsecured Creditors (In re TOUSA, Inc.), 680 F.3d 1298 (11th Cir. 2012).