District Judge J. Paul Oetken of Manhattan endorsed a structure for chapter 11 plans to allow substantive consolidation without running afoul of In re Augie/Restivo Baking Co., 860 F.2d 515 (2d Cir. 1988), where the Second Circuit ruled that substantive consolidation is only proper when (1) creditors dealt with affiliates as a single economic unit and did not rely on their separate corporate entities, and (2) the debtors’ affairs are so entwined that consolidation will benefit all creditors.
In his March 28 opinion, Judge Oetken cited the Second Circuit for saying that substantive consolidation must be used “sparingly” and cannot harm creditors, although there is no requirement that it benefit creditors.
The appeal involved a holding company and an airline subsidiary that confirmed a plan based on substantive consolidation. The appealing creditor was an aircraft lessor who had a lease claim against the airline and a guarantee claim against the holding company parent arising from rejection of an aircraft lease. As a result of peculiarities in state law, the lessor contended that the claim against the parent was more valuable.
Effectuating substantive consolidation, the plan eliminated all guarantee claims. To obviate objection, the plan allowed creditors to opt out of consolidation. By opting out, a creditor would retain both its lease and guarantee claims and would receive payments as though substantive consolidation had not occurred. The plan gave the debtors the burden of proving the distributions that the creditor would have received were there no consolidation.
Despite the opt-out offer, the creditor still objected and appealed the confirmation order. The debtor put money aside in case the creditor were to prevail on appeal.
The decision by Judge Oetken in substance endorses substantive consolidation plans with opt-out provisions designed to avoid Augie/Restivo infirmities. The judge said that the plan did not unfairly discriminate against the lessor under Section 1123(a)(4). He also held that the bankruptcy court properly analyzed the Augie/Restivo factors.
The opinion has an interesting wrinkle, however. Because the opt-out option “negated any prejudice,” Judge Oetken said that the lessor lacked standing to challenge substantive consolidation “because it suffered no harm from substantive consolidation.”