Bankruptcy Scholars Challenge Judge's Ruling

A group of bankruptcy scholars have rallied together to challenge a recent ruling by a U.S. District Court judge which reversed a bankruptcy trustee’s decision that the homebuilder Tousa engaged in a fraudulent transfer which needed to be voided.

At issue are a series of transactions through which Tousa borrowed $500 million to fund a $420 million settlement. Its subsidiaries granted liens to lenders but received none of the proceeds from the loan.


Tousa’s bondholders, through the creditors committee, sued a group of lenders to wipe out the loan obligations and liens, arguing that the financing transactions were a so-called fraudulent transfer, which can be challenged under bankruptcy law. In bankruptcy proceedings, a judge can find certain loans to be fraudulent transfers if a company was insolvent when taking on new liabilities.

The bankruptcy trustee sided with the unsecured (subsidiaries) and voided the transaction.  But the bankruptcy trustee’s ruling was overturned by the District Court which argued that the unsecured creditors had received equivalent value in exchange for their loan guarantees. Furthermore the judge simply overturned the order instead of returning it to the bankruptcy court.

The scholars speaking out in this case are outraged because they think it sends the wrong message to corporate debtors.

“The District Court’s assumption that a debtor receives reasonably equivalent value for any transfer that decreases its odds of bankruptcy reflects a fundamental misunderstanding of the actual costs of the bankruptcy process,” the bankruptcy scholars wrote. “That misunderstanding, if left uncorrected by this court, may encourage financially distressed firms to engage in fraudulent transfers in the hope that they can justify the transfer by invoking an un-quantified ‘opportunity’ to avoid bankruptcy that the transfer purportedly created.”