Ninth Circuit: No Consolidation Absent Notice to Creditors of Non-Debtors

Nelson Mullins Riley & Scarborough LLP

Nelson Mullins Riley & Scarborough LLP

In In re Mihranian, 2019 WL 4252115 (9th Cir. 2019), the Ninth Circuit Court of Appeals held, as a matter of first impression, that a party moving for substantive consolidation of the debtor's bankruptcy estate with the estate of a non-debtor must provide notice of the motion to the creditors of the putative consolidated non-debtor.

The Chapter 7 trustee appealed the bankruptcy court’s denial of a motion to substantively consolidate with the estates of various non-debtors because the trustee failed to serve the SubCon motion on the non-debtors’ creditors. After the Ninth Circuit BAP affirmed, the trustee then appealed to the Ninth Circuit, arguing that the law does not require a moving party to give notice of a SubCon motion to a putative consolidated non-debtor’s creditors and that, even if such notice is required, he provided the requisite notice.

The Ninth Circuit began its decision by observing that

Substantive consolidation is not provided for in the Bankruptcy Code but is considered a general equitable power of bankruptcy courts. We explained the concept and history of substantive consolidation in In re Bonham: ‘Orders of substantive consolidation combine the assets and liabilities of separate and distinct—but related—legal entities into a single pool and treat them as though they belong to a single entity. Substantive consolidation enables a bankruptcy court to disregard separate corporate entities … in order to reach assets for the satisfaction of debts of a related corporation. The consolidated assets create a single fund from which all claims against the consolidated debtors are satisfied … Without the check of substantive consolidation, debtors could insulate money through transfers among inter-company shell corporations with impunity.’ … Many courts, including this court, permit the substantive consolidation of both debtor and non-debtor entities. … The sole aim of substantive consolidation is ‘fairness to all creditors.’ … We have adopted the Second Circuit’s two-pronged test for substantive consolidation, but we have not yet determined whether a party moving for substantive consolidation must give notice of the motion to creditors of a putative consolidated non-debtor. Several considerations support such a notice requirement.

The Ninth Circuit further explained: “caselaw in this circuit regarding consolidation of two or more debtors’ estates supports extending a notice requirement to a putative consolidated non-debtor’s creditors, who should be afforded just as much—if not more—notice as a putative consolidated debtor’s creditors. In other circuits, most courts that have addressed this issue require giving notice to a non-debtor’s creditors prior to substantive consolidation.”

Accordingly, the Ninth Circuit held that “a party moving for substantive consolidation must provide notice of the motion to the creditors of a putative consolidated non-debtor,” and affirmed the BAP.

A minority of courts have permitted substantive consolidation without requiring separate notice to the punitive consolidated entities' creditors. See Matter of Meredosia Harbor & Fleeting Service, Inc., 545 F.2d 583, 589, 1977 A.M.C. 2646 (7th Cir. 1976); In re S & G Financial Services of South Florida, Inc., 451 B.R. 573 (Bankr. S.D. Fla. 2011). Even in those cases, however, the creditors were generally viewed as being functionally on notice by being present at the hearing or due process was eventually provided.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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