Definition of Reasonably Equivalent Value Narrowed as Pool of Potential Litigants is Expanded in Fraudulent Transfer Context

By: Steve Traditi

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re TOUSA, Inc.,[1] the Eleventh Circuit held that subsidiaries of a parent company did not receive “reasonably equivalent value” in exchange for liens granted to secure the obligations of the parent company in an attempt by the group to avoid bankruptcy.[2] The court also held that third party beneficiaries could be liable as parties “for whose benefit” the transfer was made.[3] In 2005, TOUSA, Inc., a large homebuilding company, entered into a joint venture in order to acquire homebuilding assets from Transeastern Properties, Inc., using monies borrowed from the so-called “Transeastern Lenders” to fund the acquisition.[4] When the housing market took a downturn in 2006, TOUSA defaulted and the Transeastern Lenders sued for more than $2 billion.[5] TOUSA agreed to settle the case for $421 million with money borrowed from a collection of lenders (the “New Lenders”). The New Lenders secured their loans by taking liens on the assets of certain of TOUSA’s subsidiaries (the “Conveying Subsidiaries”).[6]  After TOUSA and its subsidiaries, including the Conveying Subsidiaries, went into bankruptcy, TOUSA sought to avoid the New Lenders’ liens as fraudulent transfers arguing that the Conveying Subsidiaries did not receive reasonably equivalent value.[7] In addition, TOUSA sought to recover from the Transeastern Lenders by claiming that the Transeastern Lenders were the entities for whose benefit the transfer was made.[8]  The bankruptcy court agreed with TOUSA, but the district court reversed.[9] TOUSA then appealed to the Eleventh Circuit.

The Eleventh Circuit held that the Conveying Subsidiaries did not receive “reasonably equivalent value” in exchange for taking on the new debt, in accordance with section 548(a)(1)(B) of the Bankruptcy Code.[10] The Transeastern Lenders argued that the Conveying Subsidiaries received “reasonably equivalent value” in exchange for granting the liens because the settlement created the possibility that they might avoid bankruptcy. The Eleventh Circuit upheld the bankruptcy court’s finding that TOUSA and the Conveying Subsidiaries were destined for bankruptcy in spite of the settlement, and therefore the possible avoidance of bankruptcy was not “reasonably equivalent value.”[11]  

The Eleventh Circuit also held that the Transeastern Lenders were liable as “entities for whose benefit the transaction was made” under section 550(a).[12]  The Eleventh Circuit relied on In re Air Conditioning,[13] in which the Eleventh Circuit held that when a company secured a line of credit from a bank in order to pay a creditor before the company entered bankruptcy, the creditor benefitted and could be held liable.[14]  Here, the Eleventh Circuit extended the definition of the phrase “for whose benefit” from the context of a preference action under section 547,[15] as it was used in Air Conditioning, to the fraudulent transfer context, stating that the theory under which a transfer is avoided is irrelevant to the liability of the transferee from whom the trustee seeks to recover.[16] Transeastern Lenders were held liable because they benefitted from the direct transfer of $421 million.[17]

This ruling has several implications for transfers made to distressed entities that may be headed for bankruptcy.  First, the court’s narrow view of what constitutes “reasonably equivalent value” may increase uncertainty for lenders who are engaged in distressed lending, creating higher loan prices in the future. The Eleventh Circuit’s narrow view contrasts with the view taken by the Third Circuit in Mellon Bank v. Metro Communications.[18] There, the Third Circuit rejected the idea that “reasonably equivalent value” must be a tangible economic benefit.[19] Rather, that court viewed the ability to borrow and other intangible benefits as “reasonably equivalent value” under the Bankruptcy Code.[20] In addition, In re TOUSA, Inc. may increase the number of parties that will be subject to avoidance actions in the future through its interpretation of what constitutes a party “for whose benefit” a transaction was made. The Transeastern Lenders warned that this may impose “extraordinary” duties of due diligence on creditors who accept repayment for loans from distressed borrowers.[21] However, the Eleventh Circuit reasoned that creditors should undoubtedly perform due diligence when dealing with large sums of money.[22]