Bankruptcy invalidating liens

Because the Conveying Subsidiaries granted the liens on their assets but the loan proceeds went to satisfy debts owed by the parent, the court easily concluded that the Conveying Subsidiaries did not receive any direct benefits.

Defendants also argued that the Conveying Subsidiaries received indirect benefits, including avoiding a parent company bankruptcy, which allowed the parent to continue to provide support services, and eliminating the adverse business overhang of the Transeastern litigation.

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Because the Conveying Subsidiaries were insolvent even before the July 31 Transaction and received no value from that transaction, the court determined that the liabilities and liens could not be enforced to any extent.

However, the court went a step further and in opined that even if the Conveying Subsidiaries had become insolvent only as a result of the July 31 Transaction, the savings clauses are unenforceable under section 541(c)(1)(B), which provides that an interest of the debtor in property becomes property of the estate, notwithstanding any “provision in an agreement” that is “conditioned on the insolvency or financial condition of the debtor” that “effects or gives an option to effect a forfeiture, modification or termination of the debtor’s interest in property.” The TOUSA court also determined that the savings clauses were unenforceable because they were an impermissible effort to contract around the core provisions of the Bankruptcy Code, and that the savings clauses before the court were inherently indefinite as a matter of contract law.

The court noted that section 548 requires consideration of whether “the debtor” was insolvent, not the debtor and its affiliates collectively, and that the Defendants had waived any claims of substantive consolidation, alter ego or veil piercing.

The court found that the Conveying Subsidiaries were insolvent under all three insolvency tests before the July 31 Transaction, and because the Conveying Subsidiaries had incurred substantial new debt without receiving any of the loan proceeds, the Conveying Subsidiaries were rendered more deeply insolvent as a result of the July 31 Transaction.

The TOUSA decision reinforces the need for lenders to carefully consider how they structure their loan transactions, especially when dealing with multiple borrowers, guarantors and/or pledgors.