According to the Seventh Circuit, the value of a forbearance arrangement can be counted along with the amounts due on outstanding loans as part of the “reasonably equivalent value” given by a lender for a deed in lieu of foreclosure.
It is a common scenario. The borrower defaults on a real estate loan. The bank and the borrower enter into a series of forbearance agreements, including one requiring the borrower to put in escrow a deed to the mortgaged property, enabling the bank or its designee to take that deed in lieu of foreclosure upon the borrower’s next default. Default occurs, and the deed is recorded.
In a recently-decided Seventh Circuit case, the borrower then filed bankruptcy, and attacked the transfer, claiming that it was a “fraudulent transfer” – that the surrendered property was worth more than the outstanding debt, so the bank received a windfall. The borrower sought return of the property.
In 1756 W. Lake Street LLC v. American Charted Bank, Seventh Circuit Case No. 14-3435 decided May 15, 2015, the Seventh Circuit held that the value to the borrower of the forbearances exceeded any value of the property in excess of the amounts owed. So the transfer was for a reasonably equivalent value, and the borrower’s fraudulent transfer claim failed.
Prior to its bankruptcy, borrower Lake Street owed the bank $1.5 million on various loans. From 2009 through 2013, Lake Street negotiated no fewer than eleven forbearance agreements with the bank. Those agreements kept Lake Street out of bankruptcy for four years. The agreements extended loan maturity dates, reduced monthly payments and interest rates, and also provided additional loans to Lake Street’s affiliates of $650,000. In exchange, the bank received besides the deed other consideration to assure repayment. The other consideration included a perfected security interest in certain assignments of rent, the listing of an affiliate’s property for sale, the requirement that all bank accounts of borrower and its affiliates be maintained at the bank, borrower’s agreement to pay all mortgage and tax-related liabilities before paying its own operating expenses, additional guarantees and a blanket release in favor of the bank. These are common provisions of a forbearance agreement.
During the four years that the borrower continued to operate, the borrower reported gross income per its bankruptcy schedules (which contained information for only three of the four years) in excess of $435,746. The alleged “windfall” received by virtue of the deed in lieu was only $200,000, based upon borrower’s appraisal, which put the value of the property at $1.7 million (compared to the $1.5 million debt to the bank). Consequently, between the debt and the four years of continued revenues, there was more value given by the bank than the mortgaged property was worth, even by the borrower’s reckoning.
Other courts have considered whether forbearance arrangements can constitute “value” in the fraudulent transfer context (see, e.g., In re Tousa, Inc., 680 F.3d 1298 (11th Cir. 2012); In re Propex Inc., 415 B.R. 321 (Bankr. E.D. Tenn. 2009); In re Positive Health Management, Inc. 769 F.3d 899 (5th Cir. 2014)). Some of those decisions measure such “value” in ways different from the Seventh Circuit. For example, the Fifth Circuit in the In re Positive Health Management case looked at what the lender had given up, not what the debtor received. In this developing area, the Seventh Circuit’s 1756 W. Lake Street LLC decision provides guidance for how the value of forbearance arrangements can be measured to successfully defeat a fraudulent transfer claim.