Recent Court Case Strengthens Consolidation Rules


A recent bankruptcy case decided in central California has strengthened the rules surrounding substantive consolidation in cases filed under Chapter 7 of the federal bankruptcy code. According to the decision, it is completely appropriate for bankruptcy courts to bring other businesses or individuals into a bankruptcy proceeding, even non-debtors, if the evidence suggests that the finances of the parties are heavily intermingled.

Substantive consolidation is the principle of consolidating all of the assets of the businesses and individuals involved in bankruptcy in order to create a fairer outcome for creditors facing substantial financial losses as a result of liquidation. The problem with substantive consolidation is that it has been interpreted by the courts differently in a variety of cases.

Some courts have held that non-debtors cannot be “roped in” to Chapter 7 bankruptcy proceedings involving corporations and other business entities because their personal finances are separate and private property. Other courts have affirmed that consolidation of individuals is necessary to prevent insulating assets by transferring them from a corporate entity to an individual.

Going after Lawbreakers

It remains to be seen how other courts across the country rule in light of the California decision. However, it appears as though the intent of the District Court of Central California’s decision could be construed to be specifically targeted at individuals who purposely undertake fraudulent activity with the intent to eventually declare Chapter 7 bankruptcy.

In this particular case, ten non-debtors were consolidated into a bankruptcy case between Bank of America and a real estate investment firm. The court found that the finances of the firm and the ten non-debtors were extensively intertwined through multiple bank accounts and property transactions that were impossible to untangle without bringing them all into the proceeding. The court determined that the non-debtors should be consolidated into the bankruptcy because they were directly involved through their investments.

Protect Yourself and Your Assets

In light of this ruling, it is advisable for anyone involved in any sort of business dealings to create and maintain a clear line of distinction between personal assets and business assets. Going forward there is less room than ever before for mixing assets in a series of transactions that could result in substantive consolidation in the event of a bankruptcy.

It is reasonable to assume future courts will look at the California decision for guidance in especially complex Chapter 7 cases. In light of that, it would be a shame for truly innocent parties to be consolidated into a bankruptcy simply because they did not exercise the proper caution in keeping things separate.

The unfortunate reality of bankruptcy is that there are no clear winners at the end of the day. Chapter 7 bankruptcies are especially troublesome in that creditors almost always suffer losses as a result. What the California court decided in its most recent ruling is a clear effort to protect the interests of creditors as much as possible, even at the expense of non-debtors who may not be able to prove their non-involvement.

The bankruptcy experts at Hayward Law Offices are here to assist you with either personal or corporate bankruptcies. Our team of attorneys can effectively represent you to ensure your best interests are protected throughout the proceedings. If you have any questions about substantive consolidation in light of a bankruptcy proceeding you are not currently part of, feel free to contact us for advice.

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