Two years after the U.S. Court of Appeals for the Eleventh Circuit issued its decision in Senior Transeastern Lenders v. Official Committee of Unsecured Creditors (In re TOUSA Inc.), 680 F.3d 1298 (11th Cir. 2012), lenders may still unwittingly be at risk when making revolving loans to multiple borrowers that utilize a central cash-management system.
TOUSA Inc. paid a settlement of $421 million to its senior Transeastern lenders with loan proceeds from its new lenders.[1] Six months after paying the settlement, TOUSA and its subsidiaries filed voluntary chapter 11 petitions.[2] Subsequently, in an adversary proceeding, the bankruptcy court inter alia avoided liens on the assets of certain of TOUSA’s subsidiaries (the “conveying subsidiaries”).[3] In particular, the bankruptcy court found that the conveying subsidiaries were unable to pay their debts when due, had an unreasonably small amount of capital, were insolvent before and after the transaction, and did not receive reasonably equivalent value.[4] Noting that “value” had to be either property or the satisfaction of antecedent debt, the bankruptcy court espoused that the conveying subsidiaries did not receive value unless they obtained some kind of enforceable entitlement to some tangible or intangible article.[5]
Based on the foregoing, the bankruptcy court analyzed the various items of “value” that the conveying subsidiaries received and concluded that the conveying subsidiaries had not received reasonably equivalent value because the conveying subsidiaries incurred $403 million in obligations (i.e., liens) in exchange for substantially less value, noting that the conveying subsidiaries had received no direct benefit because it was “undisputed that the Conveying Subsidiaries did not obtain the satisfaction of their own debts ...; rather, they satisfied an obligation of [their affiliates].”[6] The bankruptcy court similarly found that the conveying subsidiaries received no indirect value from the transaction, dismissing, among other things, the value of any corporate services provided by the conveying subsidiaries’ parent company.[7] On appeal to the U.S. Court of Appeals for the Eleventh Circuit, the bankruptcy court’s decision was ultimately affirmed.
While the TOUSA opinion was on everyone’s radar when it was rendered, two years later cash-management systems may still be putting lenders at risk when making revolving loans to multiple borrower groups. In a typical revolving loan to multiple borrowers, a lender will agree to make multiple revolving loans to multiple entities, each as a borrower. Each of the various borrowers then contributes its assets to a collective collateral pool. In turn, the lender will agree to make repeated and continuing revolving loans to the borrowers in amounts based on the varying value of the collective collateral pool — often accounts receivable, inventory or some other collateral with fluctuating value. Most often, if not always, the proceeds of each revolving loan are disbursed to a “borrower representative” who is in possession and control of a concentration account utilized in the borrowers’ cash-management system. From the concentration account, the proceeds of the revolving loans are disbursed amongst the borrowers as needed (as opposed to disbursements based on the contribution of collateral). Similarly, as part of the borrowers’ cash-management system, the proceeds of their collateral are typically funneled to a concentration account from which the lender is paid. Importantly, most often (if not always), the loan documents purport to make each borrower liable for the entire amount of funds disbursed by the lender.
In these types of loans, because the lender is disbursing funds to a centralized concentration account, the lender has no mechanism by which to monitor how proceeds of the revolving loans are being distributed by the “borrower representative.” Similarly, because the lender is being paid from a concentration account, the lender has little ability to monitor with any particularity which borrowers are paying and which borrowers are not. As a result, while one or more of the borrowers becomes balance-sheet insolvent as a result of the joint and several liability under the loan documents, within the group of borrowers, certain borrowers will become net winners while others will become net losers; i.e., some borrowers will receive more in value than the collateral contributed, and other borrowers will receive less in value than the collateral contributed. At the same time, the lender will continually receive payments from the borrower group, at which time the lender will continually disburse additional funds to the concentration account — in essence, repeatedly making new loans to the borrowers. The end result could look like this:
In the above example, because of the cash-management system, absent adequate reporting requirements the lender will continue making revolving loans in accordance with the governing loan documents, believing all the while that it has an equity cushion of approximately 20 percent. To the contrary, unbeknownst to the lender, each time it extends a “new” revolving loan in this scenario, the lender is continuing to expose itself to liability similar to that incurred by the lenders in TOUSA in the event that the borrowers end up in bankruptcy. In other words, notwithstanding the joint and several liability provisions invariably present in the loan documents, pursuant to § 548(a)(1)(B) of the Bankruptcy Code, the liens granted by Borrower A and Borrower C are potentially avoidable because neither borrower has received “reasonably equivalent value.” At the same time, the lender is also exposed to a cramdown with respect to Borrower B and Borrower D. Assuming a worst-case scenario, the lender in the above scenario could end up receiving a secured claim in the aggregate amount of only $10.3 million while having extended $15 million in loan proceeds.
Considering the foregoing, lenders making revolving loans to groups or borrowers should consider the inclusion of provisions in order to mitigate this type of scenario. In addition, in multiple-debtor bankruptcy cases, committees and debtors alike should closely analyze revolving loans made to the debtors as a group of borrowers for potential savings or recoveries for the benefit of all creditors.
[1] Id. at 1301.
[2] Id.
[3] Id.
[4] Id. at 1303.
[5] Id. at 1303-4.
[6] Official Comm. of Unsecured Creditors v. Citicorp N. Am. (In re TOUSA Inc.), 422 B.R. 783, 844 (Bankr. S.D. Fla. 2009).
[7] Id. at 845-48.