March 31, 2014

Where Did They Get That Payoff?

by Stites & Harbison, PLLC

As the saying goes: "Don't look a gift horse in the mouth." But, should you question the source of the horse? Most lenders with non-performing loans welcome a lump-sum settlement no matter the origins of the money; however, the recent Eleventh Circuit Court of Appeals decision in In re Tousa, Inc., 680 F.3d 1298 (11th Cir. 2012) may cause you to ask a few more questions before you accept such benevolence.

Tousa, Inc., the parent corporation, owed "Transeastern Lenders" $675 million. Tousa was the only obligor for the Transeastern loan. Tousa and some of its subsidiaries borrowed $500 million from several "New Lenders" to settle the Transeastern loan. Six months after the Transeastern loan was paid, Tousa and its subsidiaries filed bankruptcy.

During the bankruptcy case, the trustee filed suit attempting to claw back the loan payments from Tousa to New Lenders. The bankruptcy court avoided the subsidiaries' obligations to the New Lenders, voided the New Lenders' liens on the subsidiaries' assets, and ordered the Transeastern Lenders to repay the settlement funds. The 11th Circuit agreed with the bankruptcy court holding that under 11 U.S.C. § 548(a)(1)(B), the transfers were avoidable as a constructive fraudulent conveyance since the subsidiaries did not receive reasonably equivalent value in exchange for granting liens on their assets.

The 11th Circuit also held that 11 U.S.C. § 550(a)(1) allowed recovery from the Transeastern Lenders since they were the entities for whose benefit the liens were transferred. Also, Transeastern Lenders could not claim to be acting in good faith under 11 U.S.C. § 550 since they "should have questioned the source of the payment."

The moral of the story: mind the source of the loan payoff and structure the transaction in such a way to prevent clawback of the money under a future fraudulent transfer lawsuit.