Union Savings Bank v. Augie/Restivo Baking Co.
860 F.2d 515 (1988)
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Rule of Law:
Substantive consolidation of debtor entities in bankruptcy is only permissible when (i) creditors dealt with the entities as a single economic unit and did not rely on their separate identities when extending credit, or (ii) the entities' affairs are so hopelessly entangled that the benefit to all creditors from consolidation outweighs the harm to any individual creditor.
Facts:
- Between July 1983 and September 1984, Union Savings Bank ('Union') loaned Augie’s Baking Company ('Augie’s') approximately $2.1 million, secured by a mortgage on Augie’s real property.
- In November 1984, Union loaned Augie’s an additional $300,000, secured by its inventory and accounts receivable. At this time, Union was unaware that Augie’s was negotiating with Restivo Brothers Bakers ('Restivo').
- On November 27, 1984, Augie’s and Restivo agreed that Restivo would acquire all of Augie's stock in exchange for 50% of Restivo's stock.
- Following the stock exchange on January 1, 1985, Restivo changed its name to Augie/Restivo Baking Company ('Augie/Restivo') and moved its operations to Augie's plant, maintaining a single set of books.
- Augie's was never legally dissolved, and no legal transfer of its real property or equipment to Restivo or Augie/Restivo ever occurred.
- From January 1985, Manufacturers Hanover Trust Company ('MHTC') extended credit to the combined entity, Augie/Restivo.
- MHTC obtained a guarantee from Augie’s for Augie/Restivo’s debts, including a subordinated mortgage on Augie’s real property, indicating MHTC's awareness of the separate corporate structures.
Procedural Posture:
- Augie/Restivo and Augie’s filed for bankruptcy protection.
- The debtors moved in the bankruptcy court for substantive consolidation of their two bankruptcy cases.
- Union Savings Bank, a creditor of Augie's, opposed the motion.
- The bankruptcy court granted the debtors' motion for substantive consolidation.
- Union appealed the bankruptcy court's order to the U.S. District Court.
- The District Court affirmed the bankruptcy court's decision.
- Union, as appellant, appealed the district court's affirmance to the U.S. Court of Appeals for the Second Circuit, with the debtors and MHTC as appellees.
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Issue:
Does the equitable remedy of substantive consolidation permit the pooling of assets and liabilities of two debtor corporations when doing so would impair the rights of a pre-acquisition creditor who relied on the separate credit of one debtor, and where the debtors' assets are not hopelessly commingled?
Opinions:
Majority - Winter, Circuit Judge
No. Substantive consolidation is an equitable remedy to be used sparingly and cannot be ordered where it would unfairly prejudice a creditor who relied on the separate existence of one of the debtors. The court identified two critical factors for determining when consolidation is appropriate: (i) whether creditors dealt with the entities as a single economic unit and did not rely on their separate identity in extending credit, or (ii) whether the debtors' affairs are so entangled that consolidation will benefit all creditors. In this case, neither factor was met. Union extended credit to Augie's alone, based solely on Augie's financial condition, before any relationship with Restivo existed. Furthermore, MHTC, the primary beneficiary of consolidation, also recognized the separate corporate structures by requiring a guarantee from Augie's for loans made to Augie/Restivo. The court also found that the debtors' affairs were not so hopelessly entangled as to make unscrambling them impossible or prohibitively expensive, as Augie's assets remained traceable. Finally, the court held that the potential benefits of a reorganization plan cannot, by themselves, justify a consolidation that would sacrifice the substantive rights of a creditor like Union.
Analysis:
This decision significantly clarifies the standard for substantive consolidation in the Second Circuit, establishing a creditor-rights-focused, two-part test. It solidifies the principle that consolidation is an extraordinary remedy, not a mere tool for administrative convenience or to facilitate a reorganization plan. By emphasizing the protection of creditors' expectations, especially those who relied on separate corporate forms, the ruling curtails the power of bankruptcy courts to merge debtors over the objections of creditors who would be harmed. The case sets a high bar for consolidation, requiring either universal creditor treatment of the debtors as a single unit or a level of asset commingling so severe that separation is practically impossible.
