Bankruptcy Substantive Consolidation and How it Works

Personal bankruptcy

At times, creditors must face the risk of bankruptcy substantive consolidation. This is when the bankruptcy allows the consolidation of separate entities. This means that the assets and liabilities of several different debtors are lumped in one single bankruptcy estate. This usually alters the rights of the creditors because each debtor tends to have a different ratio of assets to debt. When the court allows a bankruptcy substantive consolidation, the creditors with the highest ratio will lose out the most in that particular bankruptcy case. Bankruptcy issues like these can be a little complex but if you are filing for bankruptcy then you should have a lawyer or mediation services that can help you sort through these things.

Whenever a creditor lends money to someone, they have to take into consideration the possibility of bankruptcy substantive consolidation and the effect it could have on them, should the borrower end up in bankruptcy. For example, if a borrower has liabilities that are related to their past dealings, the lender might want someone else to guarantee the loan that doesn’t have any exposure the contingent liabilities. This way, if the main borrower ends up filing for bankruptcy, the guarantee is still responsible for the loan which protects the lender. However, there is still the possibility that the borrow could pull the affiliate into the bankruptcy substantive consolidation and lesson the value of the guarantee which once again, leaves the lender stranded.

Bankruptcy substantive consolidation also poses a risk when it comes to securitization or SPVs. This is a new entity that has no history and could possibly end up in liabilities. However, the good thing for creditors is that SPVs are usually made in such a way that they are not typically subject to a bankruptcy. An SPV is usually formed when a borrow needs to facilitate financing. An example of how an SPV is used is in a receivables agreement. In these situations, the originator sells the receivables to the SPV and they then sell them to the financing source which is usually a set of investors.

Courts usually have to issue a series of tests before determine whether or not a substantive consolidation should be approved. Many courts believe that it should only be used in extreme situations and reject the notion. However, other courts take a more liberal approach and take into consideration various different factors. If the benefits outweigh the harm for the most part, then it will likely be approved. Pooling the assets and liabilities of these entities in order to satisfy credit claims seems like it would be the answer to paying off debt but it actually can leave some creditors in the red so it is definitely not a welcome solution to all. The idea of the redistribution of wealth that this solution can imply makes them lose out a lot more than they gain. This is why most courts use this method sparingly.

If you do the research, you will find that there have been several cases where this method was approved and it ended in several different ways. Some creditors lost out, some didn’t. Equity is flexible based on different boundaries so depending on the case, things could turn out differently every time.

Because the whole idea is based wholly on equity, it’s important to understand the basis of equity jurisprudence and how the flexible descriptions change the methods. The courts have more power in bankruptcy substantive consolidation and bankruptcy courts particularly have more jurisdiction than a traditional court.

Filing for bankruptcy overall is a big decision and there are so many things involved with it. This is definitely not a decision that you want to make lightly and should be the very last resort. If you are considering bankruptcy then you will want to talk to a lawyer before making an rash decisions and make sure there are no other options. Bankruptcy cases can last a long time and once they are complete, can stay on your credit for seven to 10 years depending on the type of bankruptcy you filed for. Do not let this happen to you if it doesn’t have to unless it is absolutely the last case scenario.

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