May 18 (Reuters) - Unfortunately, there's all too often an
inverse relationship between a decision's significance and its
readability. That's been true at every stage of the
rollercoaster litigation between the bankrupt home builder Tousa
and the distressed debt hedge funds that bought up Tousa bonds.
The stakes are huge. The hedge funds claim that Tousa's $421
million pre-Chapter 11 deal with secured lenders was a
fraudulent conveyance, so the money belongs to them. The courts
that have considered the issue -- first a federal bankruptcy
judge, then a district court, and now the 11th Circuit Court of
Appeals -- all know they're setting important precedent on the
ability of bankruptcy trustees and creditors to void payments to
lenders by distressed companies in the run-up to Chapter 11. And
the litigation has been filled with drama, with the $421 million
swinging back and forth after each new ruling.
If only the whole thing weren't so complex.
Here's the story, which is really the only way to understand
the rulings, including this week's landmark 11th Circuit
opinion. Tousa was once the 13th-largest home builder in the
United States. It grew fast through highly leveraged
acquisitions, which meant that by July 2007 the company had $1.2
billion in debt, including money it borrowed for its attempted
2006 acquisition of the Florida home builder Transeastern
Properties. That deal went bad when the housing market dried up,
and Tousa defaulted on the Transeastern loans. In 2007 the
lenders sued, claiming $2 billion in damages.
In an effort to stave off bankruptcy, Tousa reached a $421million settlement of the case. It financed the settlement with
loans amounting to $500 million from Citigroup and other banks.
Those loans were guaranteed by Tousa subsidiaries that hadn't
previously been encumbered by obligations to lenders.
The settlement only bought Tousa a few months, and in
January 2008 the home builder filed for Chapter 11. Soon
thereafter the bondholders -- led by Aurelius Capital and its
lawyers at Robbins, Russell, Englert, Orseck, Untereiner &
Sauber -- sued to undo what they claimed was a fraudulent
transfer of the company's value to the banks. The hedge funds
argued that when Tousa took out that $500 million secured loan,
it put more of its creditors' money at risk than needed.
After a 13-day trial in 2009, U.S. Bankruptcy Judge John
Olson in Miami agreed. In a ruling that became the talk of the
vulture fund community -- with some using the words "troubling"
and "controversial" to describe it -- Olson concluded that Tousa
was already insolvent when it made the deal that essentially put
its subsidiaries in the grip of its bank lenders. The deal made
it "inevitable" that Tousa would file for bankruptcy, Olson
said, and the transaction "was still the more harmful option."
Because Tousa received no value for the deal, the judge ruled,
it was a fraudulent conveyance and the $421 million had to be
restored to the creditors.
The lenders appealed, and in February 2011 U.S. District
Judge Alan Gold in Miami reversed Olson in a decision that was
highly critical of the bankruptcy court. Gold said Olson had
narrowly defined "value" in a way that could be "inhibitory of
contemporary financing practices." Value could include indirect
benefits like avoiding bankruptcy, the district court wrote.
"Inherently, these benefits have immense economic value that
ensure the debtor's net worth has been preserved, and, based on
the entirety of this record, were not disproportionate between
what was given up and what was received," Gold concluded.
In its ruling on Tuesday, a three-judge panel of the 11th
Circuit ducked the question of whether avoiding bankruptcy
confers value on a company. But the appeals court reversed Gold
after determining that Olson "did not clearly err" in his
findings. Writing for a panel that also included Judges Gerald
Tjoflat and Peter Fay, Judge William Pryor said Olson held that
even if avoiding bankruptcy was a legitimate reason, "the almost
certain costs of the transaction of July 31 far outweighed any
perceived benefits." As for the lenders' contention that they
didn't need to investigate how Tousa was securing the loan,
Pryor wrote that "every creditor must exercise some diligence
when receiving payment from a struggling debtor."
How significant is the ruling? We've already received at
least three client alerts focusing on the risk to upstream
lenders in just the few days since the 11th Circuit decision.
Bondholder counsel Lawrence Robbins of Robbins, Russell
declined to comment. Andrew Leblanc of Milbank, Tweed, Hadley &
McCloy, who represented the lenders, did not respond to a
request for comment.
(Reporting by Nate Raymond)
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