What is Substantive Consolidation?

Mary McMahon
Mary McMahon

Substantive consolidation is a proceeding where a bankruptcy court orders the liabilities and assets of debtors with a close relationship to be pooled together and treated as a single entity. This is done when the debtors have an entangled legal relationship and are both moving through the bankruptcy court. It can speed the process of settling accounts with creditors, but can also carry some risks for creditors, and sometimes people may argue against it.

Substantive consolidation can speed up the process of settling accounts with creditors.
Substantive consolidation can speed up the process of settling accounts with creditors.

In a classic example of substantive consolidation, two or more subsidiaries of a parent company could fail. Their finances may be closely intertwined, as seen in cases where one company supplies another or when the same personnel oversee both companies and fail to keep them clearly separated. Sometimes, creditors themselves tend to blur the lines between the companies they do business with, and this can make it hard to determine which company owes what money, and to whom.

On reviewing the cases, a judge in a bankruptcy court may determine that substantive consolidation is the best option. The liabilities of both companies are cataloged and combined, as are any available assets. Creditors are provided with compensation on the basis of the type of debt involved. It may not always be possible to completely repay debt, as seen when companies do not have enough assets to cover their debt. Higher-ranking creditors will be repaid first, followed by lesser obligations.

There is a potential with substantive consolidation that some creditors may lose out. The intermingled assets must pay for the liabilities for both companies. Creditors who might have gotten a bigger percentage of their monies must share with more creditors and may not receive full payment as a result. Judges must consider this issue when deciding whether to pool the assets and liabilities of two companies. Also under consideration is whether companies are asking for bankruptcy protection to reorganize, or are actually liquidating.

If substantive consolidation is a possibility in a case, people may be provided with a chance to comment, allowing them to discuss concerns with the judge. People watching the proceedings tend to take careful note of moves like consolidation, as it may provide important information about how and when the case will be settled. If the company is high profile, it may be discussed in the mainstream media, as well as being covered in the financial news and examined by analysts who have an interest in the case.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

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