Substantive Consolidation

Posted in Blog, Business Law by on April 25th, 2017

By: Attorney Gerald S. Garnick| Associate

A case recently came down from the U S Bankruptcy Court that will have far reaching consequences for business owners. In Re: Cameron Construction & Roofing Co., Inc. (Cameron) the court held that the assets of a limited liability company, Cameron Construction LLC (LLC) related to a construction business (Cameron) in Chapter 7 bankruptcy could be reached to satisfy the claims of the creditors of the bankruptcy estate. Cameron conducted the business and the LLC held the real estate assets.

The decision resulted from an adversary complaint filed by the bankruptcy trustee to disregard the corporate form of the LLC for the benefit of the creditors. The judge did not agree with Cameron’s argument that the corporation was a separate entity from the LLC. Instead she held that the trustee was entitled to the equitable remedy of “substantive consolidation”. The decision found that the level of interaction between Cameron and the LLC constituted one entity. Because of the consequences of these types of findings the decisions to find that the two entities are one will always be fact – intensive. In this case the Court found evidence that both entities had been controlled by the same individual, there was a commingling of assets, and the two entities observed only “minimal” corporate formalities. These are not unusual behaviors by business owners who separate their assets from their businesses by creating two separate entities. But the Court found these facts in this case were significant enough to rule in favor of the Trustee and rule the two entities were one.

The Court Held that the consolidation was necessary: “to realize a benefit to the Debtor’s bankruptcy estate, particularly where it is unlikely that any creditor of the Defendant, LLC would be prejudiced and the benefits of consolidation heavily outweigh the harm”. Very concerning language for business owners who have two entities in order to separate their business from their assets.

As a result of this finding the creditors of Cameron will now be able to have their debts satisfied by reaching and applying the real estate assets owed by the LLC.

It is not unusual for business’ to have different entities whereby real estate is held in one entity and the business is conducted in another entity. When this occurs it is possible that the business owners are lax in making sure there is no commingling of the two businesses. The Cameron case is a reality check for all business owners to make sure that conduct and lines are drawn so as not to establish facts that a court will be able to conclude that there was “substantive consolidation” between the entities.

Business owners must keep separate books, not the same officers in the same positions in the business entities, a honest paper trail between the entities, no commingling of monies—these are but a few suggestions. If you have any questions or would like assistance from an experienced attorney, please call Wynn & Wynn, P.C. at 1.800.852.5211 or request a free consultation.

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