The Seventh Circuit is likely to split with the Second, Sixth, Eighth, Ninth and Tenth Circuits by ruling that a debtor cannot be substantively consolidated with nondebtors, in the judgment of Chief Bankruptcy Judge Pamela S. Hollis of Chicago.
The chapter 7 trustee for a corporate debtor sued several non-bankrupt corporate affiliates, seeking substantive consolidation. In her May 3 opinion, Judge Hollis dismissed the complaint, concluding “that non-debtor substantive consolidation is not an available remedy in the Seventh Circuit.”
Even if non-debtor substantive consolidation were available, Judge Hollis faulted the trustee for failing to give notice to all creditors of the nondebtor defendants.
Judge Hollis described substantive consolidation as a “judicially created remedy” that is “so extraordinary” because no provision in the Bankruptcy Code “provides for this relief.”
She said the Seventh Circuit “has shown a distinct lack of enthusiasm for a bankruptcy court’s use of [Section 105] and for creating rights based entirely on considerations of equity.” As authority, she cited, among other cases, In re Kmart Corp., 359 F.3d 866 (7th Cir. 2004), where the Seventh Circuit departed from other circuits by precluding chapter 11 debtors from obtaining so-called critical vendor orders.
On the other hand, she cited In re Caesars Entertainment Operating Co., 808 F.3d 1186, 1188 (7th Cir. 2015), as endorsing “the exercise of a court’s equitable powers when it serves one of the central objectives of the Bankruptcy Code.” Although Caesars is the most recent authority, Judge Hollis called it “an outlier in the universe of Seventh Circuit precedent covering the use of equity in bankruptcy courts.”
To bolster her conclusion, Judge Hollis said the trustee had other remedies, including an involuntary petition under the Bankruptcy Code or veil piercing under state law.
If presented with the issue, Judge Hollis therefore predicted that the Seventh Circuit would split with five other circuits and “not allow substantive consolidation of a bankruptcy debtor with entities that are not under the protection of the Bankruptcy Code.”
Judge Hollis found another defect to warrant dismissal. Citing the Ninth Circuit Bankruptcy Appellate Panel, among other courts, she said the trustee must serve the substantive consolidation complaint on all creditors of the nonbankrupt defendants.