On October 16, 2014, the United States Court of Appeals for the Fifth Circuit entered an order requiring a real estate lender, First National Bank (the “Lender”), to refund certain mortgage payments it received from Protective Health Management (the “Debtor”), an affiliate of its borrower. Because the mortgage payments constituted actual fraudulent transfers, the Fifth Circuit held that the Lender could retain the payments only to the extent of the value of the Debtor’s continued use of the property. Like the Eleventh Circuit’s controversial ruling in the TOUSA bankruptcy, this case serves as an important reminder that lenders should monitor the source of debt payments.

Background -

In 2006 the Lender made a loan to Zeigler Enterprises III, LLC (the “Borrower”) (an entity owned by Robert Zeigler). The loan was secured by a first lien mortgage on an office building owned by the Borrower. The Debtor (a pain management clinic also owned by Mr. Zeigler) occupied the office building, but was neither a borrower nor a guarantor under the Lender’s loan. From February 2007 through March 2008, the Debtor made direct payments to the Lender on account of the loan totaling approximately $365,000; the Debtor’s tax returns described these payments as “rent.” Although the Borrower was in default, the Lender did not pursue collection efforts or a foreclosure while the Debtor made the payments.