© BIGSTOCK
Is the
Tide Turning
Against Secured Creditors?
By Carren Shulman
A
GIVEN for bankruptcy lawyers is that secured
creditors typically control the bankruptcy
process. Although bankruptcy courts
are a haven for debtors seeking relief, at least
temporarily, from secured and unsecured creditors
alike, a debtor with substantially all of its assets
encumbered by liens has little wiggle room.
A debtor is limited in its use of encumbered
cash (i.e., cash collateral) in bankruptcy to manage
its business and pay its professionals absent
approval of its secured creditors. A debtor is also
limited in obtaining additional credit, particularly
new credit that seeks to prime existing secured
claims, without a trial to determine a host of
issues, including whether the lender is adequately
protected (i.e., there is a cushion to ensure that
the lender’s collateral will not diminish in value
as a result of the extension of new credit). See,
e.g., §§363 and 364 of title 11, Chapter 11 of the
U.S. Code (Code).
However, bankruptcy judges wield tremendous
power in interpreting Code provisions in the
context of a court of equity where principles of
fairness are as important as principles of law.
This power was most evident in Official Comm.
of Unsecured Creditors of Tousa Inc. v. Citicorp N.
Am. Inc. (In re Tousa), 422 B.R. 783 (Bankr. S.D.
Fla. 2009), where a bankruptcy judge set aside as
fraudulent conveyances “transfers” of cash and
liens on property ostensibly made by certain
subsidiaries of Tousa Inc.
Even where the bankruptcy court acts
predictably, appellate courts sometimes rule
against the secured creditor, which happened in
In re Phila. Newspapers, LLC, 599 F.3d 298 (3d
Cir. 2010), where the Third Circuit rejected the
statutorily based argument that secured lenders
have the right to credit bid at an auction conducted
through a plan, and Clear Channel Outdoor Inc.
v. Knupfer (In re PW, LLC), 391 B.R. 25 (9th Cir.
BAP 2008), in which the Ninth Circuit Bankruptcy
Appellate Panel (BAP) signicantly weakened the
good faith purchaser protections in auction sales
pursuant to Code §363.
Is the tide turning against secured creditors
in response to the signicant decline in value of
property encumbered by their liens (prompted
by the economic crisis), and the apparent lack
of options for reorganization other than to turn
over property to secured creditors?
Taking ‘Tousa’ as an Example
The fraudulent transfers in Tousa were made
in connection with the settlement of a lawsuit
brought by certain lenders (the “Transeastern
Lenders”) against Tousa and one of its subsidiaries
(the “Original Borrowers”) for, inter alia, breach of
loan agreements and damages relating to Tousa’s
failing 2005 Transeastern Joint Venture. Tousa,
422 B.R. at 789. The settlement resulted in the
repayment of $421 million to the Transeastern
Lenders and the extension of new loans by some of
the Transeastern Lenders and some new lenders
(collectively, the “New Lenders”) secured by
rst and second liens on substantially all of the
assets of Tousa and its subsidiaries, all but one
of which were not Original Borrowers (the new
subsidiary borrowers are known as the “Conveying
Subsidiaries”). Id.
In a nearly 200 page decision, the bankruptcy
court held that the liens granted to the New
Lenders were fraudulent conveyances because,
inter alia, the Conveying Subsidiaries were
insolvent when the new loans were made, and
did not receive reasonably equivalent value or
any direct benet in exchange for the liens. Id.
at 844-48.
To return all parties to the positions they held
before the new loans closed, the bankruptcy court
ordered:
(i) the avoidance of the liens of the New
Lenders,
(ii) remittance by the New Lenders to the
Conveying Subsidiaries of
(a) the diminution in value of the collateral,
because the liens theoretically prevented the
Conveying Subsidiaries from selling assets
encumbered by the New Lenders,
(b) interest and attorneys fees paid to the
New Lenders, and
(c) attorneys fees, interest and costs of the
Conveying Subsidiaries,
(iii) disgorgement by the Transeastern Lenders
of $403 million (the payment to it that the court
attributed to the Conveying Subsidiaries), plus
prejudgment interest, into a fund, the proceeds
of which will pay the fees and costs due to the
Conveying Subsidiaries with the remainder to be
repaid to the New Lenders, and
(iv) the reinstatement of the Transeastern
Lenders’ unsecured claim against the Original
Borrowers. Id. at 884-87.
But the bankruptcy court went a step further in
stating that the standard “savings clause,” which
automatically reduces the debt of a borrower to
the extent that the debt would render the borrower
insolvent, did not allow any of the lenders to avoid
a nding of fraudulent transfer.
The court reasoned that savings clauses
impinge on the property rights of a debtor and
prevent the debtor from pursuing fraudulent
conveyance actions under Code §§541 and 548,
which the court found “inherently distasteful.” Id.
at 863-64 (“…savings clauses are a frontal assault
on the protections that section 548 provides to
other creditors. They are, in short, entirely too
cute to be enforced.”)
The length, tone and detail of the decision
reect the judge’s ire at the alleged “bad facts”
revealed during the 13 day trial, which included
a significant internal memo from Tousa’s
management to the company advising against
the new loan transactions, Tousa’s advisor’s
advice to le for bankruptcy protection rather
than entering into a rushed transaction in a down
market that would inevitably lead to bankruptcy in
the short term, and the lenders’ nancial advisor’s
solvency opinion rendered on a contingency fee
basis (with a signicant upside for a favorable
opinion) relying solely on data provided by the
company that an analysis of market conditions
revealed was awed.
Fortunately, the detail helps to distinguish this
case from future cases involving similar issues.
The Tousa decision, not surprisingly, was
appealed. See Senior Transeastern Lenders v.
Official Comm. of Unsecured Creditors, 0:10-cv-
A NEW YORK L AW JOURNAL SPECIAL SEC TION
www. NYLJ.com
Monday, June 28, 2010
Carren Shulman is a partner in the finance and
bankruptcy practice group in the New York office of
Sheppard Mullin Richter & Hampton. Tyler Baker, a
summer associate at the firm, assisted with the preparation
of this article.
Corporate Restructuring
And Bankruptcy
Corporate Restructuring
And Bankruptcy
