Jessica D. Gabel, the Terrible Tousas: Opinions Test the Patience of Corporate Lending Practices

• Publication year: 2011

THE TERRIBLE TOUSAS:

OPINIONS TEST THE PATIENCE OF CORPORATE LENDING PRACTICES

Jessica D. Gabel*

INTRODUCTION

Another bankrupt company hardly makes news in this economy; a case built on liens, loans, and lawsuits does not strike a chord of the extraordinary. The bankruptcy case of troubled homebuilder TOUSA, Inc. (“TOUSA”)1, however, is not one for the mundane. The case itself is a testament to the economic crisis that has gripped the country since 2007. Indeed, the facts—

methodically analyzed under a judicial microscope—percolated from the unprecedented burst of the housing bubble. TOUSA (the parent corporation) entered into a rather complicated financing arrangement to fund a litigation settlement stemming from a failed joint venture.2 Under the settlement agreement, TOUSA agreed to pay the various joint-venture lenders more than

$421 million. In order to finance the settlement, TOUSA obtained a $200 million first-lien facility3 and a $300 million second-lien facility from a group of new lenders.4 TOUSA’s subsidiaries served as co-borrowers (with their parent) under the new loan agreements despite the fact that they were not

* Assistant Professor of Law, Georgia State University College of Law. J.D., University of Miami

School of Law; B.S., University of Central Florida. Clerk, the Honorable Peter T. Fay, Circuit Judge for the United States Court of Appeals for the Eleventh Circuit. The author would like to thank the dedicated students behind the Emory Bankruptcy Developments Journal for their patience and support in the completion of this “late-breaking” article. A great thanks also is owed to my colleague, J. Haskell Murray, for his ongoing advice as to the intricacies of Delaware corporate law. My research assistants, Andrew Fleischman and Kimberly Reeves, should be commended for their short-notice yet thorough research and editing. And last, my thanks to Stephen Andrade (J.D., 2011, University of Miami School of Law) for his extensive contribution in the research and development of the factual background and legal conclusions in the TOUSA bankruptcy court decision.

1 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) [hereinafter TOUSA I].

2 Id. at 786–87.

1. Typically, the first-lien debt facility is generally a working capital loan that consists of a revolving- loan facility, sometimes paired with a term loan. First-lien lenders generally require a first-priority lien on the

   borrower’s assets that puts them ahead of any other creditors on the borrower’s assets. Id. at 789. Second-lien lenders are next in line after the first-lien lenders. Id.

2. Id. at 789.

   
   

   defendants to the joint-venture litigation.5 TOUSA and the subsidiaries (the “Conveying Subsidiaries”) secured the new financing with a lien on substantially all of their assets, and the financing closed on July 31, 2007.6

   
   

   Had this been an ordinary company obtaining financing in ordinary times, probably little else would have come of this arrangement. But TOUSA was a homebuilder, and this massive transaction closed just weeks before the housing bubble began to implode in 2007. By January 2008, TOUSA and most of its

   subsidiaries had filed for bankruptcy.7 Shortly thereafter, the TOUSA

   Committee of Unsecured Creditors (the “Committee”) initiated a lawsuit to “claw back”8 the loan proceeds related to the joint-venture settlement. In July 2009, Judge John Olson presided over a thirteen-day trial in the bankruptcy court for the Southern District of Florida. In October 2009, he released his 182- page opinion, concluding that: (1) the Conveying Subsidiaries were insolvent

   both before and after the closing of the joint-venture settlement, which; (2) left the Conveying Subsidiaries with unreasonably small capital; and (3) did not provide those subsidiaries with reasonably equivalent value in exchange for incurring the obligations and granting the liens.9

   
   

   In addition, the court noted that a savings clause built into the financing agreement and aimed at insulating the lenders from subsequent fraudulent- transfer actions was invalid and provided no protection to the new lenders that had received first and second liens on the Conveying Subsidiaries’ assets (the

   “New Lenders”).10 The opinion also contained a meticulous discussion of the

   
   

3. Id. at 787.

4. Id. at 789.

5. Id. at 801. Although the cases were jointly administered for convenience, the bankruptcies of the individual entries were not substantively consolidated. See generally TOUSA I. Substantive consolidation

   “treats separate legal entities as if they were merged into a single survivor left with all the cumulative assets and liabilities.” In re Owens Corning, 419 F.3d 195, 205 (3d Cir. 2005).

6. Id. at 787. In bankruptcy cases, the power to recover property for the estate is vested in either the

   trustee or, in chapter 11 cases, the debtor-in-possession. 11 U.S.C. § 548 (2006). In chapter 11 business bankruptcies, the bankrupt company is referred to the debtor in possession as it attempts to reorganize its debts. Id. § 1101(1). Consequently, the debtor-in-possession (as represented by counsel) may initiate an avoidance action. The debtor-in-possession is not omnipotent, however. If the debtor-in-possession exhibits “fraud, dishonesty, incompetence, or gross management,” a trustee may be appointed to replace the debtor-in- possession. Id. § 1104(a)(1). Additionally, the bankruptcy court may allow the committee of unsecured creditors to pursue actions on behalf of the bankrupt estate since any recovery maximizes the amount of assets available to the general creditor pool. See, e.g., Official Comm. of Unsecured Creditors of Cybergenics Corp. ex rel. Cybergenics Corp. v. Chinery, 330 F.3d 548, 554 (3d Cir. 2003) (permitting the committee of creditors to pursue a derivative suit on behalf of the estate); see also11 U.S.C. §1109(b).

7. Id. at 786.

10 Id. at 863–64.

expert testimony in the case and the events surrounding the decline and near- epic failure of the real estate market during the time that the transaction took place.11 Consequently, the court avoided the obligations incurred and the liens granted by the Conveying Subsidiaries and required the joint-venture lenders

to return more than $400 million of the loan proceeds that they had received in the settlement of the joint-venture litigation.12

Various commentaries (from scholars and practitioners to a cadre of lending groups) cast the opinion as radical and overreaching in most, if not all, respects.13 Predictably, the old and New Lenders appealed to the District Court for Southern District of Florida.14 Because of the various defendants involved, and a voluminous record, the District Court split the issues among two judges and heard oral argument in a joint session. Judge Alan Gold handled the appeal relating to the old lenders (who were ordered to disgorge the $421 million in

joint-venture settlement proceeds), while another appeal (involving the New Lenders who financed the settlement) was directed to Judge Adalberto Jordan.15

While some expected Judges Jordan and Gold to issue their opinions simultaneously, in February 2011, Judge Gold released the first in what is likely to be a series of TOUSA appellate opinions. The result was nearly (if not equally) as shocking as TOUSA I. Judge Gold’s ruling (“TOUSA II”), reversed the bankruptcy court on every major issue, and, in a rather extraordinary procedural punch, quashed the bankruptcy court’s opinion instead of

11 Id. at 790–839.

1. Id. at 887.

2. Jo Ann J. Brighton, TOUSA: Do Lenders Have the Responsibility to Protect Borrowers From Their Own Bad Judgment?, 29 AM. BANKR. INST. J., 2010, at 18, 18; Arthur F. Coon and Kristin B. Peer, The

   TOUSA, Inc. Bankruptcy Decision: Anatomy and Implications of a Landmark Creditors Rights Case, 1, http:// www.clta.org/for-members/LegalCenter/article_tousa-MillerStarr_2010.pdf.

3. The Southern District of Florida takes a unique approach to bankruptcy appeals. The district court has

   limited the number of district court judges presiding over bankruptcy appeals to three judges. This approach effectively created a mini-Bankruptcy Appellate Panel to “ensure that the judge hearing the appeal will have some interest and experience in reviewing bankruptcy appeals.” Jessica D. Gabel and Samuel R. Maizel, Bankruptcy Appeals Manual: Winning Your Bankruptcy Appeal, Second Edition, AM. BANKR. INST., 2010, at I43.

4. Besides the fraudulent transfer claims, the Committee also brought claims against the first- and

   second-lien term lenders to avoid certain tax refunds as unlawful preferences under 11 U.S.C. § 547. All appeals relating to the first- and second-lien term lenders on appeal were before Judge Jordan. See In re TOUSA, Inc., No. 10-60017-CIV/GOLD, 2011 WL 522008, at *15 n.33 (S.D. Fla. Feb. 11, 2011) rev’g in

   part TOUSA I, 422 B.R. 783 (Bankr. S.D. Fla. 2009) [hereinafter TOUSA II]. A separate appeal from a different underlying bankruptcy proceeding was transferred to Judge Federico Moreno because it involves “distinct legal questions of Delaware law on the fiduciary duties of corporate officers and directors.” Id .at *3.

   remanding the case back to the bankruptcy court to enter new factual and legal findings consistent with the District Court opinion.16 In his ruling, Judge Gold also harshly criticized the bankruptcy court for adopting many of the Committee’s post-trial submissions in the TOUSA I opinion.17

   
   

   This Article examines the two decisions (TOUSA I and TOUSA II) for their legal analyses and macro-lending18 implications. It traces the factual background of the case, compares and contrasts the legal reasoning behind the opinions, and it also considers the case’s inevitable turn in the 11th Circuit.19

   
   

   1. FROM BOOM TO BUST TO BANKRUPTCY

      
      

      1. The Overview

         
         

         TOUSA and its subsidiaries designed, constructed, marketed, and sold residential real estate developments and the homes eventually built within those developments.20 The sequence of events that preceded TOUSA’s bankruptcy...