Death of the "Savings Clause" in U.S. Upstream Guarantees?
In October 2009, the United States Bankruptcy Court for the Southern District of Florida issued a decision that sent ripples of concern across the U.S. lending community.
The Decision
In Re TOUSA, Inc. involved a challenge of certain guarantees and liens granted by subsidiaries of Tousa, Inc., a Florida-based home builder. The guarantees and liens were provided in connection with US$500 million in loans made to Tousa about six months before it filed for Chapter 11 bankruptcy protection. The loans were made to finance a litigation settlement relating to a “disastrous” joint venture project. The relevant subsidiaries did not themselves receive any loan proceeds, nor were they liable under the litigation settlement (meaning they did not directly benefit from payment of the settlement from the proceeds of the loans).
"Savings Clauses" in Upstream Guarantees
Following the Official Committee of Unsecured Creditors’ challenge of the subsidiaries’ guarantees and liens, and the Bankruptcy Court disallowed such guarantees and liens as an avoidable fraudulent conveyance under U.S. federal bankruptcy law and State law. In so doing, the Bankruptcy Court imposed a number of relatively harsh remedies, effectively unwinding the loan transactions and settlement refinancing and imposing consequential damages on the lenders. But probably the most notable holding in the case was its rejection of so-called “savings” provisions in upstream guarantees.
Upstream (and sidestream) guarantees in the U.S. have long been acknowledged to be subject to fraudulent conveyance or fraudulent transfer risk – that is, the risk of invalidation on the basis that the guarantor was insolvent (or rendered insolvent) and did not receive reasonably equivalent value in exchange for providing its guarantee.
Traditionally, one of the most common methods of attempting to mitigate such risk has been to include a “savings” clause in the guarantee - i.e., a provision limiting the guarantor’s obligations to the maximum amount that would not give rise to a fraudulent conveyance. The Tousa Bankruptcy Court effectively held, in dictum, that “savings” clauses are per se unenforceable as attempts to contract around the protections of the Bankruptcy Code, and found that the multiple savings clauses at issue in this case were “inherently indeterminate” and “unenforceable as a matter of contract law”.
Concerns
Although not binding on other courts, Tousa is of obvious concern to lenders. The case is also of concern to borrowers, inasmuch as it may inhibit the availability and increase the cost of credit.
Many U.S. commentators believe Tousa was wrongly decided, and the case is currently on appeal. It is worth noting that the case involved certain “bad facts”, most notably a success fee-based solvency opinion. Pending the decision on appeal, Tousa has emboldened junior creditors to challenge or threaten to challenge upstream guarantees and liens provided to senior creditors, as was seen in the recent Tribune and Lyondell bankruptcies. Certain commentators have suggested that Tousa may lead to the inclusion of net worth or dollar caps in U.S. upstream guarantees. However, recent informal surveys of U.S. leveraged loan professionals have revealed that few practitioners have so far adopted such measures – although some commentators have indicated that Tousa may already have resulted in increased emphasis being placed on guarantors’ rights of cross-contribution.
Whether or not Tousa’s purported invalidation of U.S. “savings” provisions is ultimately followed, the risks inherent in upstream (and sidestream) guarantees in the U.S. stand in opposition to the situation in many leading Canadian jurisdictions -- where corporate statutes’ so-called “financial assistance” rules, which had traditionally called such guarantees into potential question, have in many cases been eliminated.
