Clark’s Crystal Springs Ranch LLC v. Gugino (In re Clark), — B.R. — (9th Cir. BAP March 2016)
Issue: Was substantive consolidation of the debtor, his LLC and trust into a single chapter 7 appropriate under the facts here?
Holding: Yes. creditors dealt with the entities as a single economic unit and did not rely on their separate identity in extending credit [and] the affairs of the debtor are so entangled that consolidation will benefit all creditors.
Judge Terry Myers, Idaho
Jury, Kirscher, Faris
Opinion by Jury
The chapter 12 debtor operated a family farm which was purportedly owned and managed by an LLC which was, in turn, purportedly owned by a trust. The case was converted to chapter 7 because there was “a showing that the debtor has committed fraud in connection with the case.” The trustee filed a complaint seeking substantive consolidation of the individual, the LLC and the trust. The bankruptcy court held a two day trial and granted the motion nunc pro tunc.
The BAP affirmed. The rule comes from a case called In re Bonham. “[W]hether creditors dealt with the entities as a single economic unit and did not rely on their separate identity in extending credit or whether the affairs of the debtor are so entangled that consolidation will benefit all creditors.” Both factors were pretty obviously present here. The sloppiness was everywhere. The trust had provisions which contradicted other provisions, the debtor called himself the manager of the LLC and took a draw even though the docs said the trust was the manager. The bankruptcy schedules even listed assets which the debtor argued later were actually owned by the LLC. The debtor on the petition was “Jay P. Clark, DBA Crystal Springs Ranch.” This case has a nice summary of substantive consolidation.
The debtor argued on appeal that the court was required to use state law and since the trust had a spendthrift clause, that was binding on the court here. He also argued that alter ego with respect to an LLC under Idaho law must be followed. But the BAP said, “the law of substantive consolidation is federal bankruptcy law and is not dependent upon state law concepts.”
The BAP wrote: “Substantive consolidation is an uncodified, equitable doctrine allowing the bankruptcy court, for purposes of the bankruptcy, to ‘combine the assets and liabilities of separate and distinct – but related – legal entities into a single pool and treat them as though they belong to a single entity.’ The doctrine ‘enables a bankruptcy court to disregard separate corporate entities, to pierce their corporate veils in the usual metaphor, in order to reach assets for the satisfaction of debts of a related corporation.’ The essential purpose behind the doctrine is one of fairness to all creditors, but it is a doctrine to be used sparingly.”