The Ninth Circuit has become the first circuit court to hold squarely that notice of a motion for substantive consolidation must be given to the creditors of a non-debtor.
The chapter 7 trustee for an individual prosecuted a fraudulent transfer suit against the debtor’s relatives. The bankruptcy court dismissed the suit because the trustee could not prove that the debtor was the transferor.
About the same time, and aiming to achieve fundamentally the same goals, the trustee filed a substantive consolidation motion against the relatives and a corporation. The bankruptcy court dismissed the consolidation motion, in part because the trustee had not given notice to the creditors of the non-debtors. The Ninth Circuit Bankruptcy Appellate Panel affirmed for the same reason, and so did the Ninth Circuit in an opinion by District Judge Michael H. Watson, sitting by designation from the Southern District of Ohio.
In his September 9 opinion, Judge Watson explained that substantive consolidation is not a remedy granted by the Bankruptcy Code “but is considered a general equitable power.”
While he said the “minority view” allows substantive consolidation without notice to the creditors of non-debtors, “most courts that have addressed the issue require giving notice to a non-debtor’s creditors prior to substantive consolidation.”
Judge Watson cited a slew of bankruptcy and district courts that require notice. Among those few that don’t, he cited a Seventh Circuit opinion where the issue was dealt with tangentially and perhaps in dicta. See Farmers & Traders State Bank of Meredosia v. Magill (In re Meredosia Harbor & Fleeting Serv. Inc.), 545 F.2d 583, 589 (7th Cir. 1976).
Beyond the persuasion provided by the majority of courts, Judge Watson saw the equitable nature of the proceedings as requiring notice to those “whose claims would be equitably distributed under the consolidation order.”
As a corollary, Judge Watson said, “it is logical to require that notice be given to actual parties whose substantive rights will be ‘seriously affected’ by the order so that they have an opportunity to be heard.”
The Ninth Circuit has become the first circuit court to hold squarely that notice of a motion for substantive consolidation must be given to the creditors of a non-debtor.
The chapter 7 trustee for an individual prosecuted a fraudulent transfer suit against the debtor’s relatives. The bankruptcy court dismissed the suit because the trustee could not prove that the debtor was the transferor.
About the same time, and aiming to achieve fundamentally the same goals, the trustee filed a substantive consolidation motion against the relatives and a corporation. The bankruptcy court dismissed the consolidation motion, in part because the trustee had not given notice to the creditors of the non-debtors. The Ninth Circuit Bankruptcy Appellate Panel affirmed for the same reason, and so did the Ninth Circuit in an opinion by District Judge Michael H. Watson, sitting by designation from the Southern District of Ohio.
In his September 9 opinion, Judge Watson explained that substantive consolidation is not a remedy granted by the Bankruptcy Code “but is considered a general equitable power.”
While he said the “minority view” allows substantive consolidation without notice to the creditors of non-debtors, “most courts that have addressed the issue require giving notice to a non-debtor’s creditors prior to substantive consolidation.”