Many people believe that if they form separate companies to hold assets or operate businesses, that each entity will be responsible for its own debts but not the debts of related entities; this is not always the case. In some lawsuits courts are empowered to grant “fair” relief in addition to granting commonly known relief measures, such as damages. In the bankruptcy context, this includes a court’s ability to treat the assets and liabilities of two or more separate, but related entities, as a common pool of assets for the satisfaction of creditors’ claims. This remedy is referred to as “substantive consolidation.”
In Florida, the party seeking substantive consolidation must establish that (1) there is a substantial identity between the entities to be consolidated; and (2) consolidation is necessary to avoid some harm or to realize some benefit. If these elements are established, the burden then shifts to the parties opposing substantive consolidation to show that (1) the creditor relied on the separate credit of only one of the entities to be consolidated; and (2) they will be prejudiced by substantive consolidation.
A court will look to the facts and circumstances including: (1) whether financial statements are consolidated; (2) common ownership; (3) cross-corporate guarantees on loans; (4) how difficult it is to segregate the assets and liabilities; (5) transfers of assets withoutformal observance of corporate formalities; (6) commingling of assets and/or business functions; and (7) consolidation at a single location.
A court may also consider: (1) whether a parent company owns the majority of a subsidiary’s stock; (2) common officers or directors; (3) under-capitalization of a subsidiary; (4) transaction of business solely with a parent entity; and (5) disregard of corporate legal requirements.
Most substantive consolidation cases deal with two debtor entities. However, some cases have sought to consolidate non-debtor entities into a debtor entity; this tactic creates exposure for both creditors and debtors. From a debtor’s perspective, assets belonging to an entity not in bankruptcy may be subject to attack. From a creditor’s perspective, the ability to recover may be compromised in the event that a related non-borrowing entity goes into bankruptcy. If you have specific questions regarding substantive consolidation and what you can do to help protect your assets, one of our lawyers will be happy to assist you.