Friday, October 3, 2014

More on Beads and Steads; Bankruptcy Court Denies Amended Complaint Asserting Substantive Consolidation


More on Beads and Steads; Bankruptcy Court Denies Amended Complaint Asserting Substantive Consolidation

 

        In an earlier decision, the Bankruptcy Court denied an effort by the bankruptcy trustee to utilize the alternative doctrines of inside an outside reverse piercing  in order to, in effect, render the assets of one LLC liable on the debts of another.  That prior decision was reviewed CLICK HERE.  As then noted, even as the Bankruptcy Court rejected the theories based upon reverse piercing, it did afford the trustee the opportunity to file an amended complaint setting forth a theory based upon substantive consolidation.  Spradlin v. Beads and Steeds Inns, LLC (In re Howland), Case No. 12-51251, Adv. No. 14-5019 (October 2, 2014).
 
            Thereafter, the trustee did file that amended complaint asserting claims based upon substantive consolidation.  Filing is not, however, the same as acceptance.  In this instance, the Bankruptcy Court denied the motion to amend the complaint, finding it would be futile.
 
Discussing the nature of substantive consolidation, the Court wrote:
 
     Substantive consolidation is an extreme remedy that is used only where there are no other adequate remedies, “particularly where the entity sought to be consolidated is not itself already a debtor in bankruptcy.”  American Camshaft, 410 B.R. at 787.  Substantive consolidation of the Prospective Defendants requires proof that:  “(1) prepetition they disregarded separateness so significantly their creditors relied on the breakdown of entity borders and treated them as one legal entity; and (2) postpetition their assets and liabilities are so scrambled that separating them is prohibitive and hurts all creditors.”  See In re Owens Corning, 419 F.3d 195, 205 (3d Cir. 2005).  The Trustee’s Amended Complaint falls short. Slip op. at 5.
 
            Explaining why substantive consolidation would not be in this case permitted, among other basis, the Court observed:
 
The amended Complaint contains no facts regarding how the Debtors and Meadow Lake handled their financial statements or bank accounts.  Specific factual allegations about the Prospective Defendants’ financial statements and bank accounts may have supported an inference that the assets and liabilities are hopelessly scrambled.  Further, facts about how the Debtors and Meadow Lake disseminated this information to creditors, or facts regarding their specific interactions with creditors, could have led to reasonable inferences that creditors have suffered, and will suffer, harm without substantive consolidation.
 
The lack of this sort of information is more glaring considering the Trustee had two years before the Complaint was filed to review financial statements, bank account details and other proof addressing the Debtors’ and Meadow Lake’s interaction with creditors.  This is the Trustee’s second chance to state a claim for relief.  A conclusory allegation that the “assets and liabilities are so scrambled that separating them is prohibitive and hurts all creditors” is not enough to conclude the Trustee has pled a prima facie claim for such an extreme remedy. Slip op. at 7.

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