The District Court held that there was no fraudulent transfer because the Conveying Subsidiaries received reasonably equivalent value in exchange for the liens they granted and the obligations they incurred. It rejected the Bankruptcy Court's view that reasonably equivalent value must be in the form of an enforceable entitlement to tangible or intangible property of a quantifiable value.

Instead, the District Court held that indirect, intangible, economic benefits, including the opportunity to avoid default, to aid in rehabilitation and to avoid bankruptcy, may be considered in determining reasonably equivalent value, even if not precisely quantifiable. This is the position taken by most courts confronting this issue. However, for purposes of its analysis, the District Court accepted the Bankruptcy Court's conclusion that the indirect benefits must be received by each debtor entity.

The District Court explained that the key is whether the transaction conferred reasonable commercial value on the debtor, as measured at the time of the transaction, and without the benefit of hindsight. It stated that the analysis is a fact-intensive inquiry, based on the totality of the circumstances at the time of the transfer. In its analysis, the District Court emphasized the financial interdependence of the TOUSA entities, noting that an adverse judgment in the TL Litigation and a bankruptcy filing by TOUSA would have triggered the Conveying Subsidiaries' guarantees and caused their own bankruptcy filings.

While the TOUSA entities ultimately filed for bankruptcy less than seven months later, this was largely due to the dramatic decline in the housing market rather than the increased debt burden. Therefore, their expectations concerning the economic benefits of the transactions (the ability to avoid default and bankruptcy) were legitimate and reasonable at the time of the transfers.

The District Court also stated that the Bankruptcy Court erred in failing to consider the "identity of interests" doctrine in analyzing reasonably equivalent value. Under this doctrine, if a group of closely-held corporate entities behaved as a single business enterprise, they should be treated as one borrowing unit even though each member of the enterprise is a separate entity. This would allow a court to find that a subsidiary guarantor received reasonably equivalent value even if did not receive the proceeds of a loan guaranteed for its parent.

For more information on indirect benefits as consideration for upstream guaranties and the identity of interests doctrine, see Practice Note, Fraudulent Conveyances: Issues and Strategies for Lenders and Private Equity Sponsors: Box, Other Consideration for Upstream and Cross-stream Guaranties.

The District Court held that the Bankruptcy Court erred in adopting an alternative theory of liability that the Transeastern Lenders were strictly liable as entities "for whose benefit" the transfer was made under section 550(a)(1) of the Bankruptcy Code. It reasoned that this liability only applies where the benefit flows immediately from the initial fraudulent transfer.

In this case the benefit received by the Transeastern Lenders was not a direct consequence of the initial transfer of the liens granted to the Lenders by the Conveying Subsidiaries. Instead, it was a benefit flowing from the manner in which TOUSA used the initial transfer of the loan proceeds (to fund the settlement payment to the Transeastern Lenders).

While the Transeastern Lenders ultimately benefited from the initial transfer, they received no direct benefit from it. The District Court explained that the transactions at issue (the granting of the liens by the Conveying Subsidiaries to the Lenders and the settlement payment to the Transeastern Lenders) could not be collapsed to impose beneficial transferee liability.

The Bankruptcy Court did not consider whether the Transeastern Lenders could be liable as subsequent transferees under section 550(a)(2) of the Bankruptcy Code. The District Court ruled this was an error because that precluded the Bankruptcy Court from considering whether the Transeastern Lenders had the benefit of the good faith defense for subsequent transferees under section 550(b) of the Bankruptcy Code. Section 550(b) of the Bankruptcy Code precludes recovery if a subsequent transferee took for value, including the satisfaction or securing of an antecedent debt, in good faith, and without knowledge of the voidability of the transfer avoided (see Practice Note, Fraudulent Conveyances in Bankruptcy: Overview: Future Good Faith Transferees).

The District Court held that the Transeastern Lenders satisfied these requirements because they took for value (the satisfaction of TOUSA's antecedent debt) and there was no evidence that they acted in bad faith or with knowledge of the possible voidability of the transfer (the granting of the liens by the Conveying Subsidiaries to the Lenders). In doing so, the District Court rejected the Bankruptcy Court's conclusion that the Transeastern Lenders acted in bad faith and were grossly negligent in accepting the settlement payment because they knew of or should have known of the precarious financial condition of TOUSA and the Conveying Subsidiaries on the basis of publicly available information. The District Court stated that this standard is "patently unreasonable and unworkable" and imposes "extraordinary duties of due diligence" on the part of creditors accepting repayment, which equal or exceed the duties imposed on lenders extending credit in the first place.

The District Court held that the Transeastern Lenders did not owe a duty of care to the Conveying Subsidiaries before agreeing to accept the settlement payment. Therefore, they were not required to investigate TOUSA's internal re-financing structure and ensure that the Conveying Subsidiaries received fair value from the settlement payment, or that TOUSA, on an enterprise basis, was not insolvent or precariously close to being insolvent.

For more information on the good faith defenses to a fraudulent transfer action, see Practice Note, Fraudulent Conveyances in Bankruptcy: Overview: Good Faith Defenses.

This decision is important because the Bankruptcy Court's decision called into question long-standing corporate lending practices and the taking of subsidiary guaranties to support corporate lending activity. The Bankruptcy Court's decision also expanded lenders' fraudulent transfer liability well past limits set by prior precedent. The possible implications for the corporate lending market if the decision had been upheld were of serious concern to loan market participants.

While the validity of savings clauses and solvency issues were not addressed by this litigation (but are the subject of separate lender appeals in the District Court), the District Court's opinion helps affirm that, assuming the two remaining appeals in this matter are decided similarly, lenders can continue to employ past lending practices based on credit support from subsidiary guarantors that had been temporarily upset by the Bankruptcy Court's decision.

In addition, the District Court's opinion affirms that lenders do not have to meet the heightened due diligence standard cited by the Bankruptcy Court to avoid a determination that they acted in bad faith, which would deny them the benefit of the good faith defense for subsequent transferees under section 550(b) of the Bankruptcy Code.

Further, while the outcomes of the two lender appeals pending before Judge Jordan in the District Court are not certain, it seems likely that those appeals will be decided similarly to the ruling by Judge Gold in this case. Judge Jordan issued an order on February 15, 2011 requesting interested parties in the Wells Fargo Bank appeal to file supplemental briefs by March 15, 2011 explaining how Judge Gold's opinion and reasoning, if adhered to, affects the issues in that appeal. Judge Gold stated that submitting parties "are not to argue whether Judge Gold's ruling is correct but instead are to assume the ruling is correct."