Eighth Circuit: Bankruptcy Court Cannot Substantively Consolidate Debtor with Non-Debtor Non-Profit Entities

By Karl Johnson posted 08-02-2018 08:53

Karl Johnson, Hellmuth & Johnson, PLLC
Jeffrey Klobucar, Bassford Remele, P.A.

 Contributing Editor: Christopher (C.J.) Harayda, Faegre Baker Daniels LLP

In The Official Committee of Unsecured Creditors v. The Archdiocese of St. Paul and Minneapolis, et al. (In re The Archdiocese of St. Paul and Minneapolis), No. 17-1079 (8th Cir. Apr. 26, 2018), the Eighth Circuit affirmed denial of the Creditors’ Committee’s motion seeking substantive consolidation of more than 200 affiliated non-profit non-debtor entities with the debtor because, among other reasons, substantive consolidation would have required the commencement of involuntary bankruptcy proceedings.

The Committee, representing more than 400 clergy sexual abuse victims, argued that the non-debtor entities should be consolidated because they were directly controlled and supervised “in all material aspects” by the debtor, including “the oversight of financial and property-related decision-making.” Consolidation would have allowed the Committee to combine the debtor’s and the non-debtor entities’ assets to satisfy creditors. The Committee’s asserted legal basis for substantive consolidation was 11 U.S.C. § 105(a), which gives bankruptcy courts the power to “carry out the provisions of the Bankruptcy Code.” The Eighth Circuit noted that it has previously recognized the bankruptcy courts’ authority to substantively consolidate debtor entities, as have other circuit courts, though it is an “extraordinary remedy.” It continued, however, to point out that only the Ninth Circuit has ever permitted substantive consolidation of debtor and non-debtor entities. Further, it emphasized that no court has ever consolidated a debtor and a non-profit non-debtor entity, “let alone a debtor and over 200 non-profit non-debtors.”

The Eighth Circuit then examined § 303(a)’s prohibition of involuntary bankruptcy proceedings involving non-profit entities. The court found that permitting the involuntary proceeding for the non-debtor entities under § 105(a) would be in direct contravention of § 303 of the Bankruptcy Code, precluding such relief. The court affirmed the denial of the Committee’s motion for substantive consolidation.