Fraudulent Transfer Remedies: How Much Is Enough?

Revisiting the TOUSA Case Ruling on Fraudulent Transfers

One of the most powerful tools in the Bankruptcy Code available to bankruptcy trustees, or other estate representatives, to maximize creditors’ recovery 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:

• “With the actual intent to hinder, delay or defraud creditors” (§ 548(a)(1)(A)); or
• “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)).

Section 550 and Fraudulent Transfer Remedies

When it comes to remedies, the Bankruptcy 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 bankruptcy court orders, the value of such property from:

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

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.” [ii]

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 straightforward. If an insolvent debtor gives away a car to a family member, the transfer is avoided, and the car is recovered from the giftee. If the transfer is money for which the debtor received less than reasonably equivalent value, it may (hopefully) be recoverable from its initial transferee.

However, the decision gets more complicated if the initial transferee no longer has the property and questions such as the following arise:

• 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 such transfer was made”?
• What if the initial transferee and/or beneficiary of the transfer is judgment proof?
• 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, what happens if the debtor borrows money, 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?

The high-profile TOUSA Chapter 11 case in early 2008 raised these issues surrounding fraudulent transfer remedies. [iii]

In re TOUSA, Inc.

The Basics

Prior to filing Chapter 11, TOUSA, a Florida-based home builder, was the 13th largest home builder in the US as of 2006, with over $1.7 billion in liabilities. Around the time of the 2008 financial crisis, which stemmed, in part, from the subprime mortgage crisis, TOUSA borrowed $500 million from the ‘New Lenders’ to pay a debt to its former lenders, the ‘Transeastern Lenders,’ in order to settle a lawsuit. TOUSA secured the loan through liens on its subsidiaries’ assets. These subsidiaries were co-borrowers on the loan, though they were not party to the lawsuit TOUSA sought to settle. At the time of the loan, these ‘Conveying Subsidiaries’ were in financial distress, with unsecured bond claims of $1.06 billion. Six months later, in January 2008, TOUSA and its subsidiaries were in Chapter 11.

The creditors’ committee sued to avoid the transfer of the liens to the new lenders as a fraudulent transfer. The committee also sued to recover the value of the liens from the Transeastern Lenders, as the entities for whose benefit the liens had been granted. The liens’ value had plummeted during the roughly two-year period they had been in place, making the remedy nearly as valuable, dollar-wise, as cancellation of the New Lenders’ liens.

Both defendants argued that either of these remedies would make the debtors whole, and that granting both constituted a double recovery, which would violate 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.

Thus, the Transeastern Lenders urged a rule that where the avoided transfer is a non-possessory lien, such as was the case, the only sufficient remedy would be to cancel the liens. At a 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 that, as the persons for whose benefit the liens were transferred, the Transeastern Lenders should bear responsibility for making the debtors whole.

Which Fraudulent Transfer Remedy Did the Bankruptcy Court Grant?

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 court allowed the Committee 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 (encumbered assets) between the date the liens were granted and the date they were avoided. The value was found to total $505 million: the principal of $403 million plus interest.

The bankruptcy court specifically found that simply avoiding the obligations and liens to the New Lenders would “not restore the Conveying Subsidiaries to the financial condition that would have existed had the transfer never occurred.” [iii] The court also found that the debtors had been injured by having their assets encumbered by the fraudulently granted liens for over two years because (1) the assets securing the liens were not worth nearly as much as they had been when the liens were granted and (2) the debtors did not have the ability to use those assets during that time for restructuring purposes.

Significantly, the court found that neither the New Lenders nor the Transeastern Lenders had acted in good faith.

What About the Single Satisfaction Rule?

In regards to 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, in addition to the transaction and legal costs. That, together with avoidance of the liens, would, in turn, make the Conveying Subsidiaries whole. 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 — the Conveying Subsidiaries did not receive reasonably equivalent value in exchange for the liens granted to the New Lenders —but also that the Transeastern Lenders were liable under section 550(a) as entities for whose benefit the fraudulent transfer had been made. [iv] The Eleventh Circuit reasoned that “every creditor must exercise some diligence when receiving payment from a struggling debtor. It is far from a drastic obligation to expect some diligence from a creditor when it is being repaid hundreds of millions of dollars by someone other than its debtor.” [iv] The Eleventh Circuit ordered that the district court, on remand, should review, in the first instance, the remedies ordered by the bankruptcy court.

On remand, the bankruptcy court essentially reaffirmed the remedies listed above, and the district court adopted its findings and recommendations.  Notably, most of the subject parties settled their disputes in separate settlements. The district court found on remand the bankruptcy court’s remedy in this case to be appropriate because this matter had extraordinary circumstances. [v]

Revisiting In re TOUSA, Inc. Today

The TOUSA case was closely followed at the time, and several aspects of the case could have led to more instances of lenders potentially having monetary liability. TOUSA arguably weakened protections for loans to borrowers with complex corporate structures and to distressed companies generally and suggested a lender has due diligence obligations when accepting satisfaction of a debt.

However, the reach of TOUSA seems more limited. As explained by one bankruptcy court: “The Committee has not cited to a single case subsequent to TOUSA in which a court has applied the diminution in lien value remedy applied in TOUSA.” And “the case law indicates that a remedy of monetary damages equal to the diminution in value of property securing an avoidable lien may only be appropriate when such property was transferred beyond the debtor’s control.” [vi] Arguably, in TOUSA, strictly avoiding the liens as fraudulent transfers could have restored the debtors to their pre-transfer position.

Nonetheless, cases like TOUSA remain a warning to lenders, broadly emphasizing how bankruptcy courts have equitable discretion in fashioning section 550 remedies depending on the specific facts of that case. That should be of some concern to lenders, given the risks and uncertainties, and also of interest to investors, owners, executives, and professionals, who may be seeking to maximize recoveries in bankruptcy cases.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. The Nuts & Bolts Of Bankruptcy Law Series
2. Advanced Bankruptcy Transactions Series
3. Bankruptcy Intersections Series

This is an updated version of an article originally published on November 13, 2017 and updated on October 9, 2020.]

©2024. DailyDAC^TM, LLC. This article is subject to the disclaimers found here.

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References

[i] 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)).

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

[iii] 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).

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

[v] 3V Capital Master Fund Ltd. v. Official Comm. of Unsecured Creditors of TOUSA, Inc. (In re TOUSA, Inc.), 2017 U.S. Dist. LEXIS 230491, at *23 (S.D. Fla. March 8, 2017) (“It is true that in a typical bankruptcy case the default remedy is a simple return of property, as opposed to the more unusual remedy of monetary recovery. See Rodriguez v. Drive Fin. Servs., L.P. (In re Trout), 609 F.3d 1106, 1113 (10th Cir. 2010). However, as Judge Olson notes, ‘this is no ordinary case.’ Report at 9. The Bankruptcy Court was within its bounds to turn to an equitable solution.”).

[vi] In re Sabine Oil & Gas Corp., 547 B.R. 503 (Bankr. S.D. N.Y. 2016).