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Substantive consolidation can have significant consequences for creditors. Assume, for example, that a
company in bankruptcy has liabilities that exceed its assets (which are significant) by a relatively small
amount, allowing for a payment of approximately 75% to unsecured creditors. Assume further that a re-
lated company has fewer assets and much larger liabilities, resulting in a potential payout of only 10% to
unsecured creditors. The merging or substantive consolidation of these two estates may therefore pro-
vide benefit to some creditors while diminishing the payout to others. If millions of dollars are at stake,
the hearings on substantive consolidation can be replete with accounting issues, most of which are vig-
orously contested. For a further illustration of the effect of substantive consolidation, see appendix D,
"Effects of Substantive Consolidation on Payments to Creditors: An Illustration."

The act of substantively consolidating assets and liabilities does not affect the rights of secured creditors.
A secured creditor retains its underlying security interest in a specified asset(s) regardless of the consol-
idation, except for situations in which the collateral is the stock of a related entity.

The Bankruptcy Code does not specifically authorize a bankruptcy court to consolidate the assets and li-
abilities of different debtors. The power to consolidate substantively derives instead from the court’s
general equitable powers, as set forth in Section 105 of the Bankruptcy Code, to issue "any order, pro-
cess, or judgment that is necessary or appropriate to carry out the provisions" of the code. The power to
consolidate "is one arising out of equity, enabling a bankruptcy court to disregard separate corporate en-
tities, to pierce their corporate veils in the usual metaphor, in order to reach assets for the satisfaction of
debts of a related corporation." See Continental Vending Machine Corp., 517 F.2d 997, 1000 (2nd Cir.
1975).

Substantive consolidation is most often used to consolidate the assets and liabilities of affiliated debtor
corporations — primarily of a parent and one or more of its subsidiaries — and most of this discussion
deals with that relationship. However, consolidation may be granted as to any variety of entities. For ex-
ample, the court can consolidate the assets and liabilities of an individual debtor and an affiliated corpo-
ration, as with assets and liabilities of an individual and one or more partnerships, affiliated partnerships,
and affiliated partnerships and corporations.

The number of plans providing for substantive consolidation has increased in recent years with the
growing frequency and complexity of parent–subsidiary relationships. Note that a subsidiary is not au-
tomatically insulated from the court’s control merely because it has not filed a bankruptcy petition. Of-
ten, the subsidiaries that did not enter the bankruptcy process have substantial assets that are tempting
for creditors of the bankrupt parent. Although it is not common, courts have allowed substantive consol-
idation of subsidiaries that did not originally file for bankruptcy. See, for example, Kapila v. S&G Fi-
nancial Services of South Florida LLC, 451 B.R. 573, 582 (Bankr. S.D. Fla. 2011) (permitting substan-
tive consolidation of nondebtor entity).

In most cases, a request for an order of substantive consolidation also includes a request to consider all
claims filed in each of the individual cases as if such claims were filed in the consolidated case. In par-
ticular, the request will call for the elimination of all duplicate claims for the same indebtedness filed in
more than one case or against more than one debtor, for the elimination and disallowance of all inter-
company claims, and all cross-corporate guarantees of the debtors.

Tests and Factors in the Substantive Consolidation Determination

In determining whether substantive consolidation is appropriate, courts have considered a variety of fac-
tors and applied several different tests. The primary factors courts have considered, as well as tests that
courts have applied during the past few years — many of which are accounting related — are set forth

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