8th Circuit Prohibits Substantive Consolidation of Archdiocese with Non-Profit Non-Debtors

Bankruptcy courts rely on Bankruptcy Code section 105(a) to grant the relief of substantive consolidation, which expands a debtor’s bankruptcy estate to include additional entities or assets under appropriate circumstances. The boundaries of this equitable power were tested in connection with not-for-profit entities in a recent Eighth Circuit ruling, In re Archdiocese of Saint Paul and Minneapolis,[1] whereby the court declined to extend the remedial power to non-profit, non-debtor entities.               On January 16, 2015, the Archdiocese of Saint Paul and Minneapolis (“Debtor”) filed chapter 11 bankruptcy in the United States Bankruptcy Court for the District of Minnesota likely to halt hundreds of claims of clergy sexual abuse. In May 2016, the Official Committee of Unsecured Creditors (the “Creditors’ Committee”), representing more than 400 clergy sexual abuse claimants, filed a motion to substantively consolidate the Debtor with over 200 affiliated non-profit, non-debtor entities (collectively, the “Targeted Entities”[2]).            In their motion for substantive consolidation, the Creditors’ Committee alleged that the test for substantive consolidation had been met because the Debtor had direct control and supervision in all material aspects of the Targeted Entities. The bankruptcy court denied the motion and on appeal, the district court affirmed.            On appeal, the Eighth Circuit determined that the bankruptcy court lacked authority to substantively consolidate the Targeted Entities with the Debtor as a result of the general rule that “a bankruptcy court may not contravene specific statutory provisions” of the Bankruptcy Code.[3] The contravening statutory provision was Bankruptcy Code section 303(a), which expressly excepts “a corporation that is not a moneyed, business, or commercial corporation” from involuntary chapter 7 or 11 bankruptcy. Because the Targeted Entities were considered “not a moneyed, business, or commercial corporation,” the court found that allowing for substantive consolidation of these “truly independent” non-profit entities with the Debtor would impermissibly force the Targeted Entities into involuntary bankruptcy.              Notably, the court left unresolved whether a non-profit, non-debtor entity that is the alter ego of the debtor can be substantively consolidated with the debtor’s estate. This decision is one of first impression on the issue of bankruptcy courts substantively consolidating a debtor’s estate with a non-profit, non-debtor entity.For further information, please contact a Thompson & Knight Bankruptcy and Restructuring Attorney.For more information on the Thompson & Knight Bankruptcy and Restructuring Practice, please click here. [1] 888 F.3d 944 (8th Cir. 2018).[2] The Targeted Entities were made up of “over 200 affiliated non-profit non-debtors.”  Specifically, the Targeted Entities were 187 parish corporations, several primary and secondary schools, the Catholic Community Foundation of Minnesota, the Francophone African and Gichitwaa Kateri Chaplaincies, Segrado Corizon de Jesus, the Newman Center and Chapel, the Catholic Cemeteries, and the Catholic Finance Corporation.[3]See Law v. Siegel, 571 U.S. 415 (2014) (holding that a bankruptcy court has “necessary or appropriate” authority to carry out provisions of the Bankruptcy Code, however, in exercising this authority, a bankruptcy court may not contravene specific statutory provisions of the Bankruptcy Code).