Ninth Circuit BAP Finds that the Equitable Power of Substantive Consolidation Survived Law v. Siegel.

Editor’s Note: This article was previously published in the August, 2016 edition of the American Bankruptcy Institute Journal.           

In In re Clark,[1] the Bankruptcy Appellate Panel for the Ninth Circuit affirmed a bankruptcy court’s determination to substantively consolidate an individual’s chapter 7 bankruptcy estate with the assets of a non-debtor limited liability company ranch and a trust that the debtor controlled.  Notably, after summarizing the law governing substantive consolidation in the Ninth Circuit, the BAP rejected the debtor’s argument that the Supreme Court’s ruling in Law v. Siegel took away the bankruptcy court’s equity power to substantively consolidate a non-debtor’s assets with the assets of a debtor.

In In re Clark, the chapter 7 trustee for an individual debtor filed an adversary complaint against a ranch and a family trust controlled by the debtor seeking, among other things, a judgment substantively consolidated the non-debtor defendants with the bankruptcy estate.  After a two-day trial, the bankruptcy court issued a decision finding that the requirements for substantive consolidation articulated in the governing Ninth Circuit opinion, In re Bonham, (i.e. whether creditors dealt with the entities as a single economic unit and did not rely on their separate identity in extending credit or whether the affairs of the debtor are so entangled that consolidation will benefit all creditors) were satisfied.[2]

Among other arguments, the defendants asserted for the first time on appeal that the bankruptcy court lacked the equitable power to substantively consolidated nondebtor estates with a debtor’s estate under Law v. Siegel.[3]  Because the issue was a purely legal one, the BAP considered the argument even though it had not been raised below.

In reaffirming a bankruptcy court’s equitable power to substantively consolidate, the BAP noted that the rule of law that “whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of the Bankruptcy Code” existed long before Law v. Siegel as a result of the Supreme Court’s prior ruling in Norwest v. Ahlers.[4]  The Ninth Circuit’s decision in Bonham (establishing the applicable standards for substantive consolidation in that circuit), the court found, was rendered after Norwest, and the court noted that there is no Ninth Circuit case suggesting that bankruptcy courts no longer have the authority to order substantive consolidation. 

The court held, “there is thus no basis to read broad new rules into Supreme Court rulings in order to specifically ignore Ninth Circuit precedent.”[5]   Noting that a bankruptcy court’s power to substantively consolidate entities has been considered part of the such courts’ general equitable powers since the passage of the Bankruptcy Act of 1898, the court affirmed the lower court’s determination to substantively consolidate the bankruptcy estate with the entities controlled by the debtor.