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Collateral Granted by Subsidiaries to Secure Parent’s Debts is Avoided in Bankruptcy: A Cautionary Lesson for Lenders

November 28, 2012

By: Gary Kaleita

TOUSA was a homebuilder that invested in a joint venture known as Transeastern in 2005. Transeastern borrowed $560 million in a syndicated loan from certain lenders (“Transeastern Lenders”).  Later, Transeastern defaulted, and in an effort to settle the default, TOUSA borrowed $500 million from Citicorp.  In connection with the Citicorp loan, TOUSA’s subsidiaries (which were not liable to the Transeastern Lenders) pledged their assets to Citicorp.  The loan proceeds were used to pay the Transeastern Lenders.

Six months after closing, TOUSA and its subs filed bankruptcies, and the Creditors Committee sought to avoid the security interests by the subsidiaries as fraudulent transfers, as well as the payments to the Transeastern Lenders, alleging that TOUSA and its subsidiaries were insolvent at the time and the subs received no value for the transfers. The bankruptcy court had no difficulty finding that both TOUSA and the subsidiaries were insolvent at the time of the transaction.

The court found that the subsidiaries had not received reasonably equivalent value for their pledges, as is required to sustain the transfers under the fraudulent transfer law. The court rejected arguments that the subsidiaries had received various indirect benefits from the transaction. The court therefore ordered the Transeastern Lenders to return the payments they received.

The court also found that Citicorp had not acted in good faith because it knew that the debtors were insolvent. The court held that the security interests granted by the subsidiaries to Citicorp were therefore avoidable.  After subsequent published appeals, the Eleventh Circuit Court of Appeals upheld the bankruptcy court’s decision.

The decision ought to be a cautionary lesson for lenders relying on guaranties or pledges of third party assets. The TOUSA risks exist even when the third parties are in fact the borrower’s subsidiaries. In order to understand the nature of the risk, it is important for lenders to be represented and advised by competent legal counsel.

Lowndes, Drosdick, Doster, Kantor & Reed, P.A.’s Distressed Real Estate Solutions Group has a number of attorneys practicing in the area of transactional lending and bankruptcy who are acquainted with the decision in TOUSA, as well as a broad range of issues relating to the structuring and documentation of loans, and bankruptcy issues that affect those loans.

This article is informational only. You should consult an attorney before acting or failing to act. The law may change rapidly and no warranty is given. LOWNDES DISCLAIMS ALL IMPLIED WARRANTIES AND WITHOUT LIMITATION, ANY WARRANTY OF FITNESS FOR A PARTICULAR PURPOSE. ALL ARTICLES ARE PROVIDED AS IS AND WITH ALL FAULTS. Consult a Lowndes attorney if you wish to establish an attorney/client relationship.

With more than 30 years of experience in real estate law, including over 20 years as a Board-certified expert in the field, Gary Kaleita has acquired the ability to navigate the complexities of sophisticated real estate deals with relative ease.

Gary has a wide variety of experience in real estate development, finance and transactions, condominiums, property owners’ associations, commercial leasing, commercial lending, and title insurance.

Gary enjoys a reputation for anticipating and avoiding problems, rather than merely reacting to them. He has years of experience handling purchases, sales and financings of commercial and residential projects, including office, industrial, retail, multi-family, single-family, condominium, resort, hotel and golf course properties. Gary has prepared and negotiated contracts for sale and purchase, performed due diligence investigations, and handled all aspects of closings, including issuance of title insurance and legal opinions. He has also performed tax free exchanges (both forward and reverse) under Section 1031 of the Internal Revenue Code, and has handled closings for housing revenue bond financing transactions with the Florida Housing Finance Corporation and various local housing finance authorities.

In the area of real estate development, Gary has assisted developers in obtaining land use approvals, plat approvals and permits for various developments from a number of jurisdictions in Central Florida, including planned developments (PD’s) and Developments of Regional Impact (DRI’s). He has drafted and negotiated complex land use documents, including development agreements, cost-sharing agreements, declarations of covenants, conditions, restrictions and easements. He also has experience in mall and shopping center developments, including outparcels, and has assisted developers with the selection, formation and operation of business entities, including commercial and residential property owners associations. He has extensive experience with the formation and operation of both commercial and residential condominiums as well.

In addition, Gary has established somewhat of a boutique practice by acting as local counsel to help out-of-state lenders, investors and law firms navigate the complexities of Florida real estate law. He is frequently engaged by large national and international law firms needing assistance on a variety of issues for their clients doing business in Florida. Gary regularly provides advice on Florida law and custom pertaining to purchase and sale contracts as well as loan documents, addresses local due diligence issues, answers questions involving titles, surveys and title insurance, and provides Florida legal opinions.

Not just another real estate lawyer, before pursuing his career in law Gary served as a U.S. Naval officer on active duty for 4 years in the Mediterranean Sea, first with a patrol gunboat squadron in Italy and then at a communications station in Greece. During this period he traveled extensively throughout Europe, the Middle East and North Africa. He believes his military experience is the source of the practical approach he has developed to problem solving.

Gary also took the initiative, after a homeowner in his own neighborhood was mauled by a Florida black bear in 2013, of researching what his homeowners’ association could do to limit the likelihood of future attacks. In the process, he became an expert in the subject of “bear-wise” communities and drafted a policy that his own homeowners’ association adopted, thereby becoming the first residential community to be officially recognized as bear-wise by the Florida Fish and Wildlife Conservation Commission (FWC). He has since written and spoken extensively on this subject, serves on the FWC’s Central Bear Management Unit Stakeholder Group, and has become a resource for FWC to educate other communities on the importance of bear-wise practices in areas of Florida containing black bear habitat.

Gary focuses on finding pragmatic solutions to complex problems, recognizing that clients want sensible and realistic advice in a timely manner so they can go about their business.

Chambers USA (2015)* reports that Gary has substantial experience acting as lender’s counsel and is acclaimed by market sources as an “extremely responsive, very practical and reasonable” practitioner.

*We make no guarantees or promises that the reader will realize the same or similar results

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