Garrison Keillor once said, “Sometimes I look reality straight in the eye and deny it.”[1] Being that the case arose in Minnesota, perhaps Circuit Judge Michael Melloy channeled Keillor, one of that state’s great humorists, when he authored the opinion in The Official Committee of Unsecured Creditors v. The Archdiocese of Saint Paul and Minneapolis et al. (In re: The Archdiocese of Saint Paul and Minneapolis) Case No. 17-1079 2018 WL 1954482 (8th Cir. April 26, 2018) [a link to the opinion is here].[2] Regardless, the quote must sum up the Appellant’s view of the outcome. The unsecured creditors that make up the Committee, most of whom were victims of clergy sexual abuse, will not obtain access to the value of over 200 non-profit entities affiliated with the Archdiocese of Saint Paul and Minneapolis to pay their claims.

In a concise opinion, the 8th Circuit held that a bankruptcy court’s authority to issue “necessary or appropriate” orders did not give it the power to substantively consolidate a Chapter 11 estate of a bankrupt nonprofit entity, the Archdiocese, with the estates of non-debtor parishes and parish schools that also qualified as nonprofit entities under Minnesota law. Despite the breadth 11 U.S.C. § 105(a), the Court looked past weighty equitable interests and instead relied on to state law, and on the plain language of the Section 303(a) of the Bankruptcy Code (which prohibits an involuntary filing against “a corporation that is not a moneyed, business, or commercial corporation”).

Background

The case arose from the 2013 passage of Minnesota’s Child Victims Act, which allowed previously time-barred sexual abuse claims to be brought. Hundreds of claims of clergy sexual abuse were filed against the Archdiocese. In 2015 the Archdiocese filed Chapter 11 bankruptcy. In May 2016, the Committee, representing more than 400 clergy sexual abuse claimants, filed a motion in the bankruptcy case to substantively consolidate Debtor with over 200 affiliated non-profit entities. The bankruptcy court applied Rule 7012 of the Federal Rules of Bankruptcy Procedure to the Committee’s motion, converting the motion to an adversary proceeding and allowing the responding parties to file motions to dismiss, which many did. The Bankruptcy Court dismissed the Committee’s Complaint and the District Court upheld that decision.

The 8th Circuit’s Decision

As the Court recognized, “[s]ubstantive consolidation allows the court, in appropriate situations, to expand the definition of the debtor’s bankruptcy estate to include assets also within debtor’s possession and control.”[3] Section 105 (a) of the Bankruptcy Code forms the basis for substantive consolidation; it provides the option in equity to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions.”[4]

What could be a more valid equitable consideration than providing relief to victims of sexual abuse? After all, Minnesota certainly wanted to provide relief when it passed legislation to overturn its own statute of limitations. Why would a bankruptcy court stand in the way of the victims’ recovery?

The answer, as stated by the 8th Circuit Panel, is simple. The Bankruptcy Code will not allow substantive consolidation?permissible only under the general powers of Section 105?given the more specific mandate of Section 303(a). In the words of the Panel, “the broad, catch-all equitable powers conferred under 11 U.S.C. § 105(a) do not allow a bankruptcy court to override explicit mandates of other sections of the Bankruptcy Code.” Section 303(a) details the parties who may (and may not) be subject to an involuntary bankruptcy petition. It states:

An involuntary case may be commenced only under chapter 7 or 11 of this title, and only against a person, except a farmer, family farmer, or a corporation that is not a moneyed, business, or commercial corporation, that may be a debtor under the chapter under which such case is commenced. (emphasis added).[5]

Per the Panel’s determination, “not a moneyed . . . corporation” is equivalent to the modern-day terms “not-for-profit” or “non-profit.” Further supporting this definition was Minn. Stat. Ann. § 315, under which the institutions in question were chartered. With this distinction, the Panel specifically found that the Bankruptcy Court did not have the legal authority to substantively consolidate Debtor and the “Targeted Entities,” all of which were non-profits under state law.[6]

III. A Deeper Look While the Panel’s reliance on Section 303’s prohibition seems straight forward, the quickness with which it reaches that legal conclusion may short change the circumstances of the case. The Committee’s motion detailed the centralized nature of the Archdiocese relationship with the Targeted Entities. According to the motion, the Bishop who heads the Archdiocese sits on the board of every Targeted Entity and wields control over almost every major decision. The Archdiocese requires prior approval before, among other financial transactions, the parishes:

[p]urchase any interest in real property; [t]ransfer or rezone any interest in real property; [e]nter into any loan; [g]rant any mortgage; [e]stablish any line of credit; [c]onsolidate or refinance any existing loan; [m]odify any existing mortgage, loan, or line of credit; [p]urchase personal property of $25,000 or more; [e]nter a lease of any kind for a term of longer than one year; … [g]rant contracts for deed; [b]uild any new structure on parish property; [r]enovate or restore any existing parish improvements; … [a]pprove construction change orders that increase costs by $5,000 or more; … [i]nitiate a capital fund campaign in which the total projected annual expenses exceed $25,000; [e]stablish any endowment.[7]

The decision also quotes a priest that says,

In my time as priest and a Parish Administrator, I never felt or believed that the parishes had control over their own assets and operations. The Bishop and Archbishop always maintained direct and ultimate control. It was as if the parishes were merely departments in the Diocese or Archdiocese organization….[8]

One wonders whether this variety of corporate control and centralized structure would doom a for profit entity in a similar situation. Would the Court have more closely followed its own ruling in In re Giller, 962 F.2d 796, 799 (8th Cir. 1992), where it affirmed a bankruptcy court’s decision to substantively consolidate six Chapter 11 debtors because that was the “only hope” of recovery for the unsecured creditors?

Or perhaps, the Giller example is not entirely applicable. After all, in Giller, all the parties that needed to be substantively combined were already in bankruptcy making it far less of a stretch to force them into a single case. As the Panel recognized, only the Ninth Circuit has directly addressed the substantive consolidation of debtors with non-debtors.[9] Even the Panel itself recognized the limitations of its decision, leaving for another day the issue of whether a non-debtor that is the alter ego, the agent of a non-debtor principal, or that is part of a Ponzi scheme, can be consolidated.[10] (Editor’s Note: Indeed, while second-guessing is never appreciated, The Bankruptcy Cave does wonder why instead of a motion for substantive consolidation was chosen as the procedural vehicle for such an important matter, the Committee didn’t instead file a complaint (or obtain standing and then file a complaint) seeking all of these other traditional state law remedies that debtors have against their affiliates?)

Three take-aways seem evident from the Case: 1) a bankruptcy court will not be afforded the opportunity to use its equitable powers to right a wrong where language in the Bankruptcy Code limits that power; 2) the corporate form offers protection, even in Bankruptcy, and 3) think carefully about how procedurally and substantively to go forward, and if in doubt, go with the more traditional approaches that allow for formal pleading and more relief.

In short, creditors beware. While the decision may not set the boundaries for substantive consolidation in every case, it provides needed insight into the level of scrutiny an appellate court will give efforts to bring non-bankrupt entities into a Chapter 11 case to serve as a means of recovery.