Fraudulent Transfer Litigation - The Eleventh Circuit Court of Appeals Deals a Blow to Lenders

 A highly significant ruling involving fraudulent transfers recently decided by the Eleventh Circuit could have a far-reaching impact on distressed lending and investing.   In Senior Transeastern Lenders v. Official Committee of Unsecured Creditors (In re TOUSA, Inc.), 2012 WL 1673901 (11th Cir. May 15, 2012), the Eleventh Circuit Court of Appeals reversed the district court and upheld the bankruptcy court’s ruling that liens granted by TOUSA’s subsidiaries to lenders constituted fraudulent transfers. In general terms, a fraudulent transfer is a conveyance by a debtor of property to a third party to place intentionally that asset out of reach of a creditor or creditors, or a conveyance made by the debtor to a third party for less than reasonably equivalent value, which conveyance was made while the debtor was insolvent or caused the debtor to become insolvent.  

TOUSA, a Florida company, and its subsidiaries were once one of the largest homebuilders in the country. TOUSA had borrowed large amounts of money during the boom years prior to the collapse in the housing market. TOUSA defaulted on its loans to its original lenders, with whom TOUSA reached a settlement with those lenders in the amount of $421 million. TOUSA borrowed $500 million of new money to pay the $421 million settlement. In conjunction with the new $500 million loan, certain of TOUSA’s subsidiaries guaranteed the new loans and provided security interests in their assets. None of those subsidiaries, however, received any of the proceeds from the new loans.

Less than six months after the new loans, TOUSA and most of its subsidiaries filed for protection under Chapter 11 of the Bankruptcy Code. The Unsecured Creditors Committee in those cases filed a lawsuit to avoid the liens and guarantees made by TOUSA’s subsidiaries, arguing that the subsidiaries’ guarantees and liens provided to the new lenders constituted fraudulent transfers because the subsidiaries did not receive reasonably equivalent value in exchange. In ruling for the Creditors’ Committee that the subsidiary liens and guarantees should be avoided, the Eleventh Circuit rejected the argument of the lenders that the subsidiaries received indirect value from providing the liens and guarantees because the new loans enabled the subsidiaries to avoid defaulting on bond and bank obligations. 

The Eleventh Circuit's decision in TOUSA could have serious implications in the distressed financing industry.  Transactions involving debtors with subsidiaries will need to be structured to avoid the TOUSA fraudulent transfer problems.  TOUSA could chill the availability of rescue financing for distressed entitities, although the full implications of the decision will not be known for some time.


A Receiver's Authority to Sell Property Free and Clear of Liens and Encumbrances Gaining Momentum in Ohio

            As the filing of Chapter 11 cases continues to be rare, state court alternatives for liquidation of assets continue to grow in popularity. State court alternatives typically provide a more expeditious and less expensive forum for secured lenders to direct the liquidation of their collateral—for example, state court receivership sales avoid the United States Trustee fees and unsecured creditors’ committees that add layers of expense to bankruptcy asset sales. In the past, secured creditors frequently sought the bankruptcy court as a forum for debtors to sell their assets, in large part because Section 363 of the Bankruptcy Code offered a powerful incentive: the sale of assets free and clear of liens and encumbrances. The sale of assets free and clear is critical for the efficient liquidation of collateral, because it attracts buyers who know with certainty that they are buying unencumbered assets. Until fairly recently, secured creditors in Ohio cases have been concerned whether state courts can provide similar assurances, because there is no statutory law in Ohio expressly authorizing the sale of assets free and clear.


            Nevertheless, the current trend is that a receiver can sell assets free and clear of liens and encumbrances. In recent cases, the Ohio state courts have been upholding a receiver’s right to sell assets free and clear. At least one case, decided in 2010, even authorized such a sale in the face of the objection of a junior lienholder. We are aware of only one cited case in which the receiver was not authorized to sell the assets free and clear, but the receiver in that case never sent the holder of a judicial lien notice of the sale. Accordingly, Ohio courts are not providing an impediment to sales of assets free and clear outside the realm of the bankruptcy courts.


            Equally important, however, is whether a title company will issue a title policy, even with the comfort of a sale order signed by an Ohio state court judge. There are title companies in Ohio that are still not convinced that title can be washed clean outside of bankruptcy unless there is a foreclosure. Certain title companies will wait to write an owner’s policy until the time for appealing the sale order has lapsed. Other title companies want assurance that all the lienholders agree to the sale. Obtaining the agreement from the title companies is critical to a successful free and clear sale, because no buyer will agree to buy assets free and clear in a receivership if the buyer cannot obtain an owner’s policy insuring title.


            Accordingly, while the trend in Ohio strongly supports receivership sales free and clear of liens, the willingness of title companies in Ohio to write an owner’s title policy for the buyer is less clear. A buyer considering buying assets from an Ohio receivership should make sure to line up a title company willing to write an owner’s title policy before the buyer seeks to buy the assets.  

Single Asset Real Estate Chapter 11 Cases - The Sixth Circuit Bankruptcy Appellate Panel Gives a Victory to Undersecured Lenders

A recent case from the Sixth Circuit Bankruptcy Appellate Panel, In re Buttermilk Towne Center, LLC, 2010 Bankr. LEXIS 4563 (BAP 6th Cir. 2010), appears to have strengthened the undersecured lender’s hand in single asset real estate Chapter 11 cases. An undersecured lender is one whose collateral is worth less than the amount the debtor owes, a common scenario in today’s market. In the Buttermilk case, the Debtor defaulted on its obligation to repurchase bonds whose proceeds had funded a significant, multimillion dollar loan. The Debtor had borrowed the money to develop a commercial center in Crescent Springs, Kentucky.  The Debtor leased the center from Crescent Springs, and paid its lease payments with rents generated by subleases with the center’s tenants. 


The Debtor filed a single asset real estate Chapter 11 case after defaulting, and sought bankruptcy court authority to use the rents as cash collateral to pay the Debtor’s counsel’s attorney fees.  The Debtor offered the lender a replacement lien in the rents (which constituted substantially the Debtor’s sole income source) as adequate protection. The Sixth Circuit Bankruptcy Appellate Panel ruled that the replacement liens did not constitute adequate protection of the lender’s secured claim because there was no equity cushion in the collateral, i.e., the lender was undersecured, and because the lender already had a security interest in the rents. Accordingly, the Debtor was not allowed to use rents to pay professional fees without the lender’s consent.


            It seems apparent that the lender’s undersecured status is a key factor in the decision.  The single asset real estate debtor cannot reorganize if it cannot use the rents unless the lender consents or the debtor owns unencumbered assets, which is not the case if the secured creditor is undersecured. So a practice pointer from the lender’s standpoint is to be prepared immediately upon the filing of a Chapter 11 case by a single asset debtor to prove through a valuation hearing that the lender is undersecured. If the lender succeeds, it can either cause the case to be dismissed or can use its leverage to obtain highly favorable terms in any attempted reorganization by the debtor. The single asset real estate debtor, on the other hand, needs to realistically evaluate its options upon default. If there is no equity in the property, the debtor’s principals are probably better advised to consider non-bankruptcy alternatives to retaining control of the property. 

Cognovit Update

Ohio is one of the few remaining states that still enforce cognovit provisions in promissory notes and other loan documents. A cognovit provision allows a creditor to take judgment immediately against a borrower upon the borrower’s default without having to endure the time, expense, and risk of a lawsuit. Cognovit provisions are only enforceable in commercial transactions.

Recent Ohio case authority has addressed the problems that occur when a lender seeks to take a cognovit judgment for principal amounts owed under loan documents and attorney’s fees, when the attorney fees are not yet liquidated, i.e., established in a definite amount. In one recent case, the lender sought a cognovit judgment in the amount of the note plus "reasonable attorney fees." As is commonplace, the judgment debtor, who had guaranteed corporate obligations, challenged the cognovit judgment. 

In that case, the cognovit judgment was not a final, appealable order because it did not fix a figure for attorney fees. The judgment debtor would probably have been better off not forcing the issue by filing motions and appeals. Instead, they should have either sat still or challenged the lender to execute on the judgment, since Ohio law provides that a lender cannot execute on a judgment that is not a final order.


The take away point is that it is better practice for the lender to split the fixed portion of the obligation (i.e. the promissory note or guaranty obligation) and the attorney fees into two separate orders, if the lender does not wish to assign a definite amount of attorney fees when the lender takes judgment. The judgment on the promissory note or guaranty should also state that there is no just reason for delay, per Ohio Civil Rule 54(B). The lender can then present the judgment entry for the attorney fee portion once the amount of the fees is fixed. Whether you are a borrower or a lender watch your cognovits and continue to police your loans !

Fannie Mae Partners With Cuyahoga County Landbank

The Cleveland Plain Dealer has reported that Fannie Mae, a player in the national secondary mortgage market and unwitting owner of numerous abandoned properties in the Greater Cleveland area, has reached a deal with the newly formed Cuyahoga County Land Reutilization Corporation to sell properties to it for $1 each.

Compared with our last report here, the deal represents a significant step forward for the Landbank which until now had acquired approximately 20 properties with 60 more under evaluation. The first set of transfers from Fannie Mae will consist of 25 properties, 24 of which have homes on them that will likely need to be demolished. Fannie Mae has agreed to pay up to $3500 of demolition costs on each property.  

Going forward, Fannie will essentially provide the Landbank with a purchase option on any foreclosed properties valued at under $25,000. The Landbank will have 30 days to evaluate the properties for acquisition prior to them being listed on the wider market. 


In other Landbank developments, the Board of Directors will consider authorizing a line of credit with KeyBank at its December 18, 2009 meeting. The credit line would go up to $7.5 million and would be a significant portion of the $15 million in financing the Landbank is looking to generate in 2010. 


Both the Fannie Mae deal and the Landbank’s new financing options demonstrate that the bank has substantive long-term plans to redevelop established Cleveland neighborhoods. The Landbank has already been cited by experts as a national model for addressing lingering problems from the foreclosure crisis. In the near future, once the influx of abandoned properties have gone through the demolition and cleanup process, there should be a substantial opportunity for investors and nonprofit organizations to take the lead in transforming once-residential space into new neighborhood uses.

Power(less?) of Attorney

One of my business law professors often started the class with an anecdote that had nothing to do with anything on our syllabus. One morning he entered the class and told of the frustrations he had in trying to execute a deed on behalf of his wife who was out of the country and for whom he held a perfectly drafted and executed power of attorney. Alas, the title company refused to accept the deed. 

I have had issues of power of attorney pop up in three different contexts of my practice recently. First, two underwriters refused to insure title to a property because the vesting deed was a transfer on death deed (ugh, see my prior comments about the dreaded transfer on death deed) executed by a power of attorney. Although there is no statutory prohibition with respect to the validity of such a transfer, initially, neither underwriter would insure title. One underwriter was swayed by the fact that the deceased’s will provided the same disposition for the property as the deed (although with the hassle of probate), the other underwriter was unmoved. 


Second, it is common for commercial leases to provide that if a tenant refuses to execute a tenant estoppel or a subordination agreement, then the landlord has a power of attorney to execute the documents on behalf of the tenant. When I represent tenants, I regularly strike this language. However, practically speaking, lenders will not accept documents executed by a power of attorney. With respect to estoppel certificates, the lenders already have the information from the lender—they want to hear directly from the tenant. With respect to the subordination, using a power of attorney leaves open too many openings for the tenant to push through in the event the subordination becomes an issue in the future. For example, a judge may find that the power of attorney should have been recorded when given or may refuse to enforce certain provisions for equitable reasons which the judge may have been more likely to enforce had the tenant been the party executing the subordination directly.    



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Losing Priority: The Risk of Noninsider Equitable Subordination

Following an era of relaxed standards for issuing loans, lenders must be aware of a bankruptcy court’s ability to subordinate liens for equitable reasons. On May 13, 2009, in In re Yellowstone Mountain Club, the Bankruptcy Court for the District of Montana issued an order subordinating the secured lender’s $232 million claim below the (i) debtor-in-possession financing; (ii) administrative fees; and (iii) the unsecured claims. Section 510(c) of the Bankruptcy Code authorizes a bankruptcy court to subordinate a claim for equitable purposes, but it provides little insight into the reasons that would justify this harsh remedy. For non-insider claimants like the senior lender in In re Yellowstone, subordinating a claim is a drastic measure that bankruptcy courts will rarely utilize. But the lender’s conduct, in issuing a $375 million syndicated loan with little financial due diligence and far in excess of the borrower’s ability to repay, “shocked the conscience of the Court.”

The lender issued a $375 million loan to the Yellowstone Club, a high end development company controlled by Timothy Blixseth through Blixseth Group, Inc., the majority shareholder. The lender marketed its product as the equivalent of a home-equity loan, and Blixseth treated it that way, taking large distributions from Yellowstone that he never repaid. Although Yellowstone was unable to repay its debt, the lender benefited because it had obtained a $7.5 million fee for closing the loan and had unloaded portions of the loan to the other syndicates. The bankruptcy court, finding the practices tantamount to predatory lending, determined that equity dictated subordinating the loan.


Lenders should be mindful of a court’s power to subordinate claims, even if it is rarely used. Although the bankruptcy court withdrew this opinion because the parties had reached a settlement on the issue, this case is still instructive for creditors. It illustrates that bankruptcy courts can use their own discretion to determine whether a lender has indulged in unsavory lending practices, a troubling thought to secured creditors everywhere. Nonetheless, equitable subordination for non-insiders is rare (it almost never happens), and lenders that employ responsible lending practices are unlikely to ever encounter this problem. 

Protecting Tenants at Foreclosure

The rights of owners and tenants in post-foreclosure property have been dramatically altered by new legislation signed by President Obama. On May 20, 2009, President Obama signed the “Helping Families Save Their Home Act,” which contained provisions to aid renters whose landlords go through foreclosure. Title VII of the Helping Families Act (the “Act”) is entitled “Protecting Tenants at Foreclosure” and generally requires the immediate successor-in-interest on foreclosed property to recognize the lease rights of existing tenants on the property. 

The Act applies to any property where there has been a foreclosure on a “federally-related mortgage loan or on any dwelling or residential real property” after May 20. “Federally-related mortgage loan” is defined in RESPA as being limited to mortgages on property “designed principally for the occupancy of from one to four families.” Therefore, the Act’s requirements apply only to residential, and not commercial, property. 

If there are “bona-fide-tenants” on the property that signed leases prior to the foreclosure, the Act appears to require landlords to recognize the remaining term of the lease, although there is some ambiguity in the text of the Act regarding whether a landlord may choose instead to require existing tenants to vacate on ninety-days notice. “Bona-fide tenant” is a defined term essentially meaning that the tenant’s lease was the product of an arms-length transaction. 

There are two situations under the Act where it is clear a post-foreclosure owner may require a tenant to vacate upon ninety-days notice. First, if the new owner sells a tenant’s unit to a purchaser who will occupy it as a primary residence, the owner may require the tenant to vacate after expiration of the notice.  Second, a tenant who does not have a lease or whose lease is terminable at will must also receive a ninety-day notice before being required to vacate. The Act does not displace any federal or state requirements for terminating subsidized tenancies, or any state laws that offer greater protections to tenants. If not renewed, the Act will expire on December 31, 2012. 

It is especially important for lenders to be aware of this new law, as many are becoming owners of real property through foreclosure proceedings. Anyone acquiring property post-foreclosure must carefully examine existing tenancies to ensure it recognizes leases or gives appropriate notice as required by the Act. Hopefully, better guidance will be offered in the near future concerning when a landlord may terminate an existing tenancy after giving proper notice.

Landlord bankruptcy - is SNDA really that valuable?

A tenant always prefers an SNDA so that if the landlord's lender forecloses, the lender will have to respect the tenant's lease. But if the landlord files bankruptcy, or if the lender causes the landlord to file bankruptcy, the landlord can reject the tenant's lease anyway thereby subjecting the tenant to the very risk it was seeking to avoid.

In a currently ongoing bankruptcy case, the bankruptcy trustee went so far as to demand  the tenant to move out immediately because the trustee was shutting off utilities to save money for the estate.  In most cases, the lender does not want to avoid the lease because it wants the rental income. For the same reason, the trustee usually does not want to reject the lease. 

The real risk is where the property is to be redeveloped for a completely different use or is being held by a non-operator who wants no responsibility for operations whatsoever. In both cases, an SNDA may not suffice given the remedies available in bankruptcy.  

You Did What With My Money?!

               On November 26, 2008, LandAmerica Financial Group, Inc. (“LandAmerica”) and its affiliate, LandAmerica 1031 Exchange Services, Inc. (“LES”) filed for Chapter 11 protection from creditors.  LES abruptly ceased its 1031 exchange intermediary business two days prior to the bankruptcy filing and LandAmerica sold its Lawyers Title and Commonwealth Title underwriting subsidiaries to Fidelity Title and Chicago Title shortly after the petition date. 

Monday, April 6, was the deadline for creditors in each case to file their bankruptcy claims.  A review of the filed claims in each case tells quite a tale of woe, with the 1031 exchange customers of LES hit exponentially hard. 

As a 1031 intermediary, LES held proceeds from the sale of its customer’s “relinquished property” for 180 days or until “replacement property” was purchased if earlier.  For an extended period, LES had been investing its customer’s sales proceeds in auction rate securities (“ARS”), the market for which froze in February 2008.  By November, LandAmerica could no longer fund the cash needs for replacement property purchases and this led to the Chapter 11 filing.

Customers who were in the middle of their 180-day replacement period awoke to find that their cash proceeds were not only unavailable (and likely tied up long term in illiquid investments) but that they would not be able to obtain their planned tax deferral under Section 1031 of the Revenue Code.  If that was not injury enough, many of these customers already had replacement properties firmly under contract and suffered the insult of potential breach lawsuits by the sellers of those properties. 

One LES creditor’s claim is reflective of the many similarly situated customers.  Deblu Realty Corporation had almost $1.5 million deposited with LES from the sale of relinquished property, but its proof of claim was not only for that amount but for $373,000 in lost deferral of taxes (at capital gains rates), $3.7 million in potential lost profits on the thwarted acquisition of replacement property as well as yet to be determined amounts for alternate financing costs and legal fees. 


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A Guide to Dealing with Increased Delinquencies in Condominium and Homeowners' Associations

According to the Community Associations Institute, nearly 60 million people across the country live in association-governed communities. Many of these communities have been severely affected by the current economic downturn and increase in foreclosure rates. In a condominium or homeowners’ association, delinquencies and foreclosures create a ripple effect that impacts all owners. Once an owner ceases paying assessments, the association must either incur costs to collect the assessments, increase the amount of assessments to other owners, cut back on services, or some combination of the three. The problem is compounded when multiple owners become delinquent. 

The biggest mistake an association board can make is ignoring the problem and hoping that delinquent owners will eventually catch up. An association must have a properly enacted collection policy and adhere to it. For example, the policy may state that an owner whose payment is 30 days late will receive a reminder letter from the board. An owner who is 60 days late will receive a collection letter from the association’s attorney indicating that a lien will be filed if the past due amount is not paid promptly. At 90 days past due, the board should authorize the association’s attorney to file a lien to secure the delinquent assessments. Beyond 90 days, the matter should be reviewed by the board to determine if it is appropriate to file a foreclosure action. 


The decision to file a foreclosure action can be a difficult one and must be made on a case-by-case basis. The association’s lien is generally going to be lower in priority than the owner’s first mortgage, and possibly a second or third mortgage as well. This means that unless the property sells at sheriff’s sale for more than the total amount due under the mortgage or mortgages, the association will not receive payment. Additionally, the association will have to bear the costs associated with pursuing a foreclosure action. Nevertheless, it may be worthwhile for the association to file the foreclosure action because it may prompt the owner to pay the delinquent assessments. Even if the owner fails to pay, and the property is ultimately sold at sheriff’s sale without the association receiving any of the sale proceeds, the association may ultimately be much better off having a new owner who will (hopefully) be better about paying assessments. State law and the association’s declaration may permit the association to assess its costs of collection, such as attorneys’ fees and court costs, to the delinquent owner. The association should carefully track these expenses and consult with its attorney to determine if they can be recovered from the delinquent owner.    

Bankruptcy Court Refuses to Modify Interest Rate on Ohio Tax Certificates

In In re Cortner, decided February 4, 2009, the Bankruptcy Court for the Southern District of Ohio held that an Ohio property tax certificate holder was entitled to receive the auction-established rate of interest on its certificate, rather than a reduced, court-determined rate. The creditor held several tax certificates, purchased at auction as described in the Ohio Revised Code, entitling it to payment of delinquent real estate taxes on the debtor’s property. The debtor and Chapter 13 trustee argued for the Court to modify the interest payable on the tax certificates to the “Till” rate of interest. In Till v. SCS Credit Corp., 541 U.S. 465 (2004), the Supreme Court applied a formula to determine the interest rate payable to a creditor receiving installment payments, factoring in the time value of money and risk. The Till rate presumably would have been considerably lower than the eighteen-percent rate the creditor was entitled to based on the auction sale. 

The Court rejected the opportunity to modify the tax certificate interest rate, although it noted it could do so because the tax certificates did not qualify as a protected “security interest” under the Bankruptcy Code. The Court based its decision on § 511 of the Code, which applies the interest rate “determined under applicable nonbankruptcy law” to all “tax claims.” Thus, if the certificates were classified as a “tax claim”, the creditor was entitled to the auction-established interest rate set forth under Ohio law. In determining that the certificate was a tax claim, the Court first noted that the certificate was not only a lien holder under Ohio law, but was entitled to the amount owed for delinquent taxes. Further, there is nothing in the Code limiting “tax claim” holders to governmental units. Finally, the certificate bears all the hallmarks of a real estate tax debt in Ohio – the holder receives a super-priority lien on the property and may foreclose if the debt is not paid. 

The Cortner decision should encourage investment in the Ohio property tax certificates. Since the debtors on tax certificates are very often financially troubled, any investor would be concerned about having its possible return on the tax certificates adjusted in bankruptcy. The Court here, however, offered a strong analysis of why these interest rates should not be adjusted in bankruptcy, thus protecting the investor’s interest and expected return. With statutory interest rates allowed as high as eighteen percent, the possible profit on a tax certificate is very high.



Policing Leasing

 It seems like every day another retailer files bankruptcy.  Many more have frozen new deals, cancelled scheduled openings and even closed open stores. A shopping center landlord must monitor tenant monthly gross sales reports and tenant public filings to anticipate which of its tenants are or could become problem tenants. The landlord should also act quickly to declare a default of a tenant which is not paying rent and other charges timely.  One strategy for a tenant is to withhold rent to build a war chest before it files bankruptcy. A landlord that terminates a lease prior to the tenant filing for bankruptcy protection has significantly improved its leverage.  A well drafted lease, including tight permitted use clauses, can also increase the landlord's bargaining power.

A relatively new development is "designation rights." A tenant with multiple locations files for bankruptcy. The tenant then has the right to accept or reject its leases. The tenant sells this right to a "designation rights acquirer."  The acquirer seeks a return on its investment by finding new tenants to purchase the leases. In a successful center, the landlord may become vulnerable to having the lease assigned to a party the landlord would prefer not to have in its center, or at rates less than the landlord could otherwise obtain. So another potential income stream to the designation rights acquirer is payment from the landlord  in exchange for the designation rights acquirer rejecting the lease because the landlord does not want to take the chance of having a bad assignment. As more and more retailers are stopping expansion plans, it is possible that designation rights will become less valuable because the designation rights acquirer will both have a smaller universe of potential assignees and because the landlord may be more willing to accept a larger universe of assignees.

The new Bankruptcy Code amendments to Section 365(d)(4) which effectively shortened the period for a tenant to accept or reject a lease was supposed to give the landlord more leverage (120 days/extenable to 210 days).  However, sticking to the rejection period and taking all of the other steps will do no good if there is no demand for the space. The economic reality may still cause the landlord to extend the rejection period and work with the designation rights acquirer. So the real question is whether there is simply too much retail space built and how do we absorb the existing space? One answer seems to be mixed use - adding office and residential into the retail center. In any event, it is clear we will see a shake up in the retail industry in 2009.