Affirming the bankruptcy court, a district court in Florida held that substantive consolidation may be obtained by motion. Because substantive consolidation may be pursued in a contested matter, District Judge Roy K. Altman of Fort Lauderdale, Fla., also held that issuance of a summons is not required.

A company filed a petition under Subchapter V of chapter 11. On motion, the bankruptcy court converted the case to chapter 7. The chapter 7 trustee filed a motion for substantive consolidation of the debtor with four other entities that were subject to common control by the individual who controlled the debtor.

In granting conversion to chapter 7, Bankruptcy Judge Peter D. Russin found that the debtor had commingled assets with the other four entities and had committed misconduct in dealings with the other entities. Judge Russin granted the motion for substantive consolidation, deciding that findings from the conversion order supplied the elements required for substantive consolidation by application of the doctrine of issue preclusion.

The debtor’s owner and the four entities appealed.

‘Sub Con’ by Motion Is Ok

In his 56-page opinion, District Judge Altman explained that substantive consolidation is not specifically authorized by the Bankruptcy Code but is a power arising from the court’s general equitable powers.

Primarily, the appellants argued on appeal that the bankruptcy court erred because substantive consolidation was not sought in an adversary proceeding under Bankruptcy Rule 7001(7). With exceptions that do not apply, the rule requires an adversary proceeding in “a proceeding to obtain an injunction or other equitable relief.”

“Although this is admittedly a close call,” Judge Altman said, “the Eleventh Circuit has suggested (albeit in dicta) that a trustee need not seek substantive consolidation only through adversary proceedings.” [Emphasis in original.]

Focusing on Rule 7001(7), Judge Altman explored the question of whether an adversary proceeding is required when any form of equitable relief is sought. He agreed with Judge Russin, who decided “that substantive consolidation falls outside the ambit of Rule 7001(7).” Citing cases, he said that “courts around the country appear to agree that Bankruptcy Rule 7001(7) does not cover all forms of injunctive or equitable relief.” [Emphasis in original.]

More particularly, Judge Altman found “a longstanding practice (in and out of our Circuit) of allowing consolidation by motion, rather than requiring substantive consolidation to proceed through an adversary proceeding.” He found only one case, from Tennessee in 1990, holding that substantive consolidation cannot proceed by motion. He noted that the decision has not been followed and has been criticized.

Affirming Judge Russin, Judge Altman held “that substantive consolidation need not occur in an adversary proceeding,” there being “a longstanding tradition among the federal courts — including in this Circuit — of allowing substantive consolidation by motion.”

No Constitutional Violations

The appellants argued that they were denied due process, on several grounds.

Even if substantive consolidation should have proceeded through an adversary proceeding, Judge Altman said that the “error was unambiguously harmless, since the Appellants received all the due process they were owed.”

The appellants contended that the bankruptcy court lacked personal jurisdiction over them because they were not served with a summons. Since the bankruptcy court was proceeding by contested matter, Judge Altman said that Judge Russin correctly found that it could exercise personal jurisdiction given that the motion and notice of a hearing were served by first class mail, the required form of service under Bankruptcy Rules 9014(b) and 7004(b).

The appellants argued that the bankruptcy court could not enter a final order. Judge Altman disagreed, holding that “substantive consolidation is unquestionably a core proceeding” where the bankruptcy court can issue final orders.

Judge Altman ended his lengthy opinion by deciding that issue preclusion permitted the bankruptcy court to find the required elements for substantive consolidation. He upheld Judge Russin’s order granting the motion for substantive consolidation.