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  1. Bankruptcy Glossary
  2. Substantive Consolidation

What is a Substantive Consolidation?

Substantive consolidation most often occurs if the debtor's businesses are intertwined and trying to separate the business relationship may increase delays in the distribution of payment to the creditors.

Under some conditions bankruptcy courts have the authority, which is allowed under 105 of the Bankruptcy Code, to combine the assets and liabilities of two separate and distinct legally related entities together and pay the creditors as a single party.

Through substantive consolidation duplicate claims of payment against more than one debtor are eliminated and instead the payments for secured and unsecured claims are made against the consolidated debtor. If substantive consolidation occurs it is likely that certain creditors may benefit while others do not. Courts will review the substantive consolidation process to determine if the benefit which accrues to the majority of the creditors is greater than the damage done to any particular creditor.

The bankruptcy court will make their decision to allow a substantive consolidation by reviewing the following key points:

  • Do consolidated financial and business records exist?
  • Does the parent company own a majority of the subsidiaries capital stock?
  • Do one or more entities have inadequate capitalization?
  • Do common officers or directors exist?
  • Are subsidiary employees paid by the parent company?
  • Are funds transferred from one company to another easily and without formality?
  • Does the company provide intercompany guarantees?
  • How difficult will it be to separate business liabilities and assets?
  • Do the subsidiary and the parent company operate from the same location?
  • How are the functions and business assets comingled between all of the business entities?
  • Do the entities share accounting, management and other overhead expenses?
  • Does the subsidiary have any other business except with its parent or affiliates? Does the subsidiary have any other assets except those of the parent or the affiliate?

Bankruptcy courts will review each bankruptcy case and the damage or gain of creditors and shareholder prior to allowing substantive consolidation. All the bankruptcy case facts must be reviewed and the clients must have enough information to make a sound legal choice which is financially sound for their shareholders. Prior to agreeing to a substantive consolidation the following must be done by competent legal counsel: 1) complete a review of the financial affairs of the debtor 2) a thorough review of public and non-public documents 3) interviews with the debtor's legal and financial advisors.