Substantive Consolidation in Bankruptcy

A creditor requesting that the bankruptcies of a parent and one or more subsidiaries be consolidated [called substantive consolidation] must prove two elements to the bankruptcy court's satisfaction:

1.  There is substantial identity between the two estates to be consolidated. The requesting party must present evidence that satisfy's the bankruptcy court that the two corporations were substantially the same entity and/or represented themselves as one and the same and/or commingled cash. 

2.  The requested consolidation will avoid harm or create some benefit for pre-petition creditors of one or both of the estates. One of the obvious benefits in a consolidation of a case is the cost savings and efficiency of administration that would be achieved with a single bankruptcy estate.

The bankruptcy court's authority to order substantive consolidation arises from its general equitable powers as established in the Bankruptcy Code. Because substantive consolidation affects the substantive rights of creditors and generally results in a redistribution of wealth, it is subject to a high level of judicial scrutiny. Courts are reluctant to allow substantive consolidation since the action must not only justify the benefit that one set of creditors receives, but also the harm that other creditors might suffer as a result.  In other words, for some creditors to win others creditors must lose. Bankruptcy courts are reluctant to grant requests for consolidation of cases involving a parent company and one or more subsidiaries.

Edited by Michael C. Dennis.   Mr. Dennis is the author of several books on credit risk management  including "The Credit and Collection Manager's Concise Desk Reference."