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Note: Federalism in Bankruptcy: Relocating the Doctrine of Substantive Consolidation

By R. Benjamin Hanna. Full text here.

Substantive consolidation is a process in corporate bankruptcy in which the assets of related debtor entities are placed into a single vehicle subject to the undifferentiated claims of all the creditors. Doing so resolves inter-debtor claims and vindicates the interests of creditors who thought they were transacting with a unitary debtor, albeit at the expense of those who relied on a strict separation of entities. The Note argues that these functions would be more properly executed under a cause of action created by state law than under federal law. Part I of the Note examines the current law of substantive consolidation in the context of federal bankruptcy law and state corporate law. Part II analyzes the role and constitutionality of state law in bankruptcy remedies. It notes that states may create causes of action as corporate property, which can mirror the effects of substantive consolidation. Part II asserts that this does not violate the Bankruptcy Clause of the Constitution because the Supreme Court’s bankruptcy jurisprudence respects state characterizations of property. Part III sketches a range of possible implementations of state law actions for substantive consolidation. The Note argues these causes of action would yield greater deference to state policy decisions regarding corporate structure, give sophisticated debtors and creditors more flexibility in structuring their relationships, and promote more efficient bankruptcy through increased use of substantive consolidation.