The US housing market plummeted in the late 2000s, forcing many homebuilders into bankruptcy. Tousa, Inc., a large homebuilder, sought Chapter 11 bankruptcy protection after taking on over $1 billion in debt to fund rapid growth. When the housing market crashed, Tousa defaulted on $675 million in loans from 2005. In 2009, a US bankruptcy court ruled that Tousa's arrangement of $500 million in new debt in 2007 to pay off the 2005 loans was a fraudulent conveyance. The court voided over $500 million in secured debt and liens, in one of the largest lender liability cases related to the real estate crisis.

1. US HOUSING MARKET
Real estate bust hits lenders
David Conaway writes from the USA on the state
of the big players in the domestic housing market
I
n the wake of the global credit ordered the lenders, which include resolved the defaults by Tousa
crisis, the US housing market Bank of America, CIT Group, agreeing to pay the lenders $421
plummeted with values declining Citigroup and Wells Fargo, to million in satisfaction of the 2005
as much as 50% and home disgorge such value for the benefit Florida loans.
foreclosures at record highs. With of the Tousa Chapter 11 To pay for this settlement, in
lower asset values and frozen credit bankruptcy estate. July 2007, Tousa arranged for
markets, it became difficult if not Tousa, Inc. was a “roll-up” of $500 million of new debt, again
impossible for US homebuilders to US homebuilders in Florida, with Citicorp as the initial
continue business operations. Maryland, Pennsylvania, Las administrative agent. The loan
Many US homebuilders, Vegas and Denver, which Tousa terms required that Tousa
particularly those who operated on acquired from the late 1990’s until subsidiaries with no connection to
a highly leveraged basis, have been the 2007 real estate bust. Tousa or involvement in the 2005 Florida
forced to liquidate assets to pay off conducted its operations through loans be co-borrowers and to
DAVID H. CONAWAY lenders. Tousa, Inc. (and its numerous US based subsidiaries. pledge their assets to the lenders as
Shumaker, Loop & Kendrick,
LLP (USA)
subsidiaries) is one of the largest To fund its rapid growth, security for payment of the $500
US homebuilders to seek Chapter Tousa took on more than $1 billion million debt. Of the $500 million
11 protection. The Tousa in unsecured bond debt. In loan proceeds, the settlement
Bankruptcy Court’s ruling on 13 addition, in June 2005, a Tousa required that approximately $421
October 2009 is one of the most affiliate located in Florida million be used to pay off the
significant lender liability cases in borrowed $675 million to fund lenders involved in the 2005
recent history. In its 182-page acquisitions and operations. The Florida loans, and that the
ruling, the United States administrative agents for these remainder of the loan proceeds be
Bankruptcy Court for the obligations included Citicorp used to pay various fees, costs, and
Southern District of Florida North America, Inc. and Deutsche claims associated with the loan
avoided as fraudulent conveyances Bank Trust Company Americas. transactions.
secured obligations of almost $500 When the housing market crashed, Within about six months after
million and the liens granted to Tousa’s Florida affiliate declared closing the July 2007 loan
secure such debts. The Court also the loans in default. The parties transactions, Tousa filed Chapter
30 Winter 2009/10

2. US HOUSING MARKET
“To fund its rapid
relating to fraudulent conveyances. savings clauses are common in
In reaching this conclusion, commercial loan agreements, and
the Court noted the following: generally provide for an automatic
growth, Tousa 1. Tousa’s stock price had fallen reduction of obligations and liens
from $23 per share in 2006 to to the point where they do not
took on more below $4 per share in April trigger the elements of a Section
than $1 billion in 2007. 548 fraudulent conveyance. The
2. The evidence showed that Bankruptcy Court rejected these
unsecured bond Tousa’s management, material arguments, stating that such
debt. stock owners and the new debt savings clauses violate the policy of
”
lenders knew about Tousa’s the Bankruptcy Code as well as
dire financial condition but that public policy as an attempt to
Citigroup and other nullify Section 548.
participants were motivated in In a footnote to the opinion,
part by fees generated by the the Bankruptcy Court observed:
July, 2007 loan transactions “There is something inherently
including $15 million of loan distasteful about really clever
and advisory fees for Citigroup lawyers overreaching. Some
and $6.4 million for transaction problems cannot be drafted around.
and advisory fees for Lehman The fact that this sort of drafting
Brothers. was felt necessary by Citi ought to
3. The July, 2007 loans caused have given it pause that maybe this
Tousa to have a seventy (70) to deal was not possible. In any event,
thirty (30) debt to equity ratio Citi and the rest of the Defendants
when a 45% to 55% debt cap assumed the risk that the
had been recommended as the Transaction would be regarded by a
maximum sustainable debt reviewing court as a fraudulent
level. transfer.”
4. Tousa’s CEO was due an It is significant that the court
incentive bonus of $2.25 avoided as fraudulent conveyances
million as a result of a the July 2007 loan transactions
successful closing the July 2007 and the pay-off of the prior debt
loan. with the proceeds of the July 2007
5. Tousa agreed to pay its loan transactions. After concluding
11 in January 2008 in response to 2. Debtor was insolvent at the financial consultant Alix that the obligations and liens were
the real estate market crash, time of the transfers or the Partners $2 million for a avoided, the court ordered that
plummeting real estate values, and obligations are incurred, solvency opinion regarding almost $500 million in value be
a freeze of the credit markets. In 3. Debtor was left with Tousa to be used as support for disgorged from the lenders in the
the Chapter 11 proceeding, the “unreasonably small capital,” the July 2007 transaction, July 2007 loan transaction and also
unsecured creditors’ committee and which the Court found to be from the lenders who were paid
(comprised mainly of Tousa’s 4. Debtor was unable to pay its “seriously flawed”. A solvency off.
unsecured bondholders) filed an debts as they came due in the opinion is common in loan We note that the lenders have
adversary proceeding against the ordinary course of business. transactions as an attempt to appealed the Bankruptcy Court’s
lenders involved in the July 2007 In the Tousa case, the unsecured avoid a later claim that the loan ruling, thus there may be future
loan transactions and also the creditors’ committee asserted that caused the Debtor(s) to be appeals court rulings in the Tousa
lenders involved in the 2005 when the unrelated Tousa insolvent. case. The lender liability ruling in
Florida loans who were paid off subsidiaries took on $500 million 6. The July 2007 debt crippled the Tousa will provide guidance to
from the proceeds of the July 2007 of debt obligations, such Tousa subsidiaries in that they other US Bankruptcy Courts in
loan transaction. subsidiaries received virtually no became more deeply insolvent, scrutinising loans as the US real
The essence of the lawsuit was value or consideration for such unable to pay their debts in the estate market restructures, often in
that the loans and liens of the July debt. Rather, the loan proceeds ordinary course of business, a Chapter 11 proceeding.
2007 transactions and payments to were used primarily to pay off and significantly
satisfy the lenders of the 2005 prior debts of other entities. undercapitalised.
Florida loans were fraudulent Moreover, at the time and as a The defending lenders raised
conveyances under Section 548 of result of the new debt, the several defenses to the fraudulent
the Bankruptcy Code, which subsidiaries were rendered conveyance claims, mainly arguing
allows a debtor to avoid obligations insolvent, were left with insufficient that the loans were made in good
incurred and transfers or pledges working capital, and were unable faith and that the Tousa
of property if: to pay their debts in the ordinary subsidiaries did receive material
1. Debtor “receives less than a course of business. In its ruling, the value for the loans. In addition, the
reasonably equivalent value in Bankruptcy Court found that the lenders argued that the savings
exchange for such transfer or creditors’ committee had satisfied clauses in the loan agreements
obligation,” all of the elements of Section 548 prohibited avoidance of the loans.
Winter 2009/10 31