Oct. 14 (Bloomberg) -- Citigroup Inc. and other lenders made fraudulent transfers when they gave Tousa Inc. secured loans six months before its bankruptcy filing, a judge ruled in a decision that may cost the banks more than $688 million. Tousa notes increased almost fivefold.

U.S. Bankruptcy Judge John K. Olson yesterday ordered the lenders, which include Wells Fargo & Co., Bank of America Corp. and CIT Group Inc., to pay $403 million to some Tousa units, plus interest, fees and expenses, and stripped them of a $207.3 million security interest in a tax-refund claim.

Tousa’s 9 percent notes due in 2010, which are in default, soared 42.5 cents to 53.5 cents on the dollar as of 4:09 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That’s the highest price since August 2008, Trace data show.

The notes have “gotten out ahead of themselves,” said Matthew Hamilton, a principal at Fulcrum Capital, an investment firm specializing in bankruptcy claims and other illiquid debt. “Absent a cash infusion from the fraudulent transfer actions, we estimate recoveries for the senior bonds won’t exceed 32 cents on the dollar.”

Bondholders could collect more than the debt is currently selling for because buyers will discount the price based on how long they have to wait for payment and the risk that the judge’s decision will be overruled, said Shawn Abboud, executive director of credit sales and trading for APS Financial Corporation.

“I would not be surprised to hear people talking about recovering as much as 75 cents” on the dollar, Abboud said.

‘Grossly Negligent’

Olson, in a 182-page ruling in Fort Lauderdale, Florida, said the lenders “did not act in good faith and were grossly negligent” when they made the loans. They “had more than sufficient knowledge to understand Tousa’s precarious situation,” Olson wrote.

The judge’s ruling favored Tousa’s creditors’ committee in a lawsuit filed in July 2008 that stemmed from the 2005 purchase of Transeastern Properties Inc.’s homebuilding business. Tousa, based in Hollywood, Florida, was the primary guarantor on $675 million in bank financing used to buy the business.

In July 2007, Tousa borrowed another $500 million to bail out and refinance the Transeastern joint venture. The creditors’ committee, representing mostly bondholders, argued that the new debt and the granting of liens were fraudulent transfers because the units that pledged their properties as collateral didn’t benefit from the loans.

‘Loss in Value’

Olson agreed, saying the loans can be voided and the units can recover their “loss in value,” in addition to fees and costs. Tousa must provide the court by Nov. 5 with an accounting of the value of assets owned by the units that were subject to the liens, Olson said.

The units “did not receive reasonably equivalent value in exchange for the liens,” were insolvent both before and after the July 2007 transaction and were left with “unreasonably small capital,” Olson wrote in his ruling.

“This is a vindication,” Daniel Golden, an attorney for the creditors’ committee, said today in an interview. The final award probably will be several hundred million dollars on top of the $403 million, giving unsecured creditors, who were set to receive little or nothing, a “sizable distribution,” he said.

Bank of America, based in Charlotte, North Carolina, disagrees with the ruling and plans to appeal, spokeswoman Shirley Norton said in a phone interview.

Alex Samuelson, a spokesman for New York-based Citigroup, declined to comment on the ruling.

“CIT does not comment on litigation,” Curtis Ritter, a spokesman for New York-based CIT Group, said in an e-mail. “CIT was not a lender on the deal and we have not been ordered to pay any money.”

The judge hasn’t decided on how to allocate the amount to be paid by each defendant, court papers show.

Lawrence Haeg, a spokesman for San Francisco-based Wells Fargo, didn’t return phone and e-mail messages.

Insolvency Warning

In April 2007, lawyers for Tousa investor Capital Research and Management Co. sent a letter to the board warning that the transaction might push the company close to insolvency. Tousa forwarded the letter to a Citigroup unit, Citicorp North America NA, which made a solvency opinion a condition of completing the July 31 transaction.

Olson called the solvency opinion from AlixPartners LLP “seriously flawed.” AlixPartners’ $2 million fee would have been only half as much had the valuation shown Tousa to be insolvent, the judge said, finding that the firm “blindly relied” on Tousa’s own “unsupportable financial projections.”

Tousa Chief Executive Officer Antonio Mon had a “strong personal incentive” to complete the loan because his $4.5 million target bonus was contingent on the deal, Olson wrote. Mon testified during a trial held in July and August that he knew the transaction might put Tousa at risk of insolvency.

‘Good Result’

Tim Yost, a spokesman for Southfield, Michigan-based AlixPartners, declined to comment. Jennifer Mercer, an outside spokeswoman for Tousa with Van Meter Consultants, said the company wouldn’t comment on the ruling.

Patricia Redmond, a Miami-based lawyer for the creditors’ committee, called the decision a “good result.” Redmond, from Stearns Weaver Miller Weissler Aldhadeff & Sitterson PA, said that the ruling will lead to a “substantially” higher recovery for unsecured creditors of the Tousa units.

Olson’s decision, if upheld on appeal, means that those creditors won’t be wiped out in bankruptcy by the claims of the parent company’s secured lenders. The award includes interest on the $403 million at a rate of 9 percent since July 31, 2007, or about $78 million.

The creditors’ committee also is entitled to recover attorneys’ fees spent on the lawsuit, Olson said. The lenders will lose their liens on the assets of Tousa’s units and will have secured claims only against the parent company.

Olson will later fix total damages. Including interest and fees, the judgment may exceed $700 million. The judge scheduled a status conference with the parties for Oct. 26.

Tousa filed for Chapter 11 bankruptcy protection on Jan. 29, 2008, listing assets of $2.3 billion and debt of $2.2 billion.

The bankruptcy case is In re Tousa Inc., 08-10928, U.S. Bankruptcy Court, Southern District of Florida (Fort Lauderdale).

To contact the reporter on this story: Dawn McCarty in Wilmington, Delaware, at dmccarty@bloomberg.net.

Last Updated: October 14, 2009 17:59 EDT