Last month, the Bankruptcy Court for the Southern District Of New York overruled an objection to proposed substantive consolidation provisions included in the plan of reorganization for Republic Airways Holdings Inc. See In re Republic Airways Holdings Inc., 565 B.R. 710 (Bankr S.D.N.Y. 2017). The bankruptcy court’s ruling provides a good refresher on the requirements of substantive consolidation in the Second Circuit. More importantly, the decision shows the importance that diligence plays not only at the time a lender/creditor enters into a transaction with its borrower, but also later on if both the borrower and the borrower’s guarantor end up in bankruptcy.

Substantive Consolidation Factors

Substantive consolidation has the effect of consolidating assets and liabilities of multiple entities and treating them as the assets and liabilities of a single entity. The result is that creditors with overlapping claims against more than one of the consolidated entities based on the same liability will “lose” all claims but one, entitling them to a single recovery against the consolidated asset pool.

Substantive consolidation is an equitable remedy, not specifically authorized by any section of the Bankruptcy Code. As noted by the Republic court, bankruptcy courts will traditionally consider various factors in determining whether substantive consolidation is appropriate in any particular case, including:

the presence or absence of consolidated financial statements; the unity of interest and ownership among the various corporate entities; the degree of difficulty in segregating and ascertaining individual assets and liabilities; the transfers of assets without formal observance of corporate formalities; the commingling of assets and business functions; the profitability of consolidation at a single physical location; and the disregard of legal formalities.

See In re Augie/Restivo Baking Co., 860 F.2d 515, 518 (2d Cir. 1988). After considering these factors, the Second Circuit has adopted the following tests in determining whether substantive consolidation is warranted: (1) whether creditors dealt with the entities as a single economic unit and did not rely on their separate identity in extending credit; or (2) whether the affairs of the entities are so entangled that consolidation will benefit all creditors. See id. Satisfaction of either test can justify substantive consolidation. Another key factor identified by the Republic court is whether substantive consolidation “will yield an equitable treatment of creditors without any undue prejudice to any particular group.” (citing In re Food Fair, Inc., 10 B.R. 123 (Bankr. S.D.N.Y. 1981).

The proponent of substantive consolidation bears the burden of demonstrating that consolidation is warranted under the tests noted above. In this case, Residco argued that the debtors had failed to satisfy either of the two Augie/Restivo test prongs.


As part of its reorganization efforts, Republic Airways, a holding company, and its subsidiaries proposed a plan that provides for the consolidation of assets and liabilities of certain “Consolidated Debtors.” The plan’s consolidation provisions in effect create one pot holding all the assets of the reorganizing debtors. Creditors holding claims against two of the Consolidated Debtors for the same obligation—such as a direct claim against a subsidiary and a related guarantee claim against its parent for that same debt—are treated as holding only one claim against the consolidated pot of assets.

Wells Fargo Bank Northwest, N.A. and ALF VI, Inc. (together referred to in the court’s opinion as “Residco”) were the owner trustee and owner participant of seven aircraft leases to the Debtors. In this role, Residco had both direct lease claims against Shuttle America Corporation and guarantee claims for those lease obligations against the holding company Republic Airways. Both Shuttle and Republic Airways are Consolidated Debtors under the plan, and Residco objected to the plan’s proposed consolidation provisions, asserting they were improper because they eliminated Residco’s guarantee claims against Republic Airways (which for various reasons Residco asserted could actually be more valuable than its direct claims under the leases with Shuttle).

The Importance of Diligence

Corporate Separateness. The first prong of the Augie/Restivo test is whether creditors dealt with the debtors as a single economic unit. Residco argued that it had relied on the corporate separateness of the entities in entering into the aircraft lease transactions, with one of its officers testifying that he had reviewed public filings and believed the holding company was separate from the various operating subsidiaries. He also argued that Residco would not have entered into the transactions with the debtors without the separate guarantee from the holdco Republic Airways. While these facts strongly undercut the “single economic unit” test described above, the bankruptcy court gave this testimony little weight. The court noted that the officer joined Residco only a couple months before the transaction closed, and the structure of the transaction was agreed before he joined the company. In addition, the court noted that the public filings reviewed by the officer did not actually support a finding of corporate separateness. The officer had only reviewed the consolidated financials of the debtors, not financial on a debtor-by-debtor basis, which made it “unclear” to the court how the officer could have relied on the corporate separateness of the debtors. The court found more credible the debtors’ testimony that the debtors operated as one economic unity that held itself out to the public simply as “Republic,” with no distinction in terms of management, overheads and common functions behind the scenes.

Entanglement of Entities. The second prong of the Augie/Restivo test is the level to which the affairs of the debtors are so entangled. In arguing that this test was not met, Residco noted that the debtors were able to separate the assets and liabilities of each individual debtor in preparing the schedules that were filed in connection with the bankruptcy cases. The court also gave this argument little weight, noting that the schedules included language referencing the debtors’ consolidated cash management and acknowledging that the debtors may have made payments on behalf of other entities. The schedules also stated explicitly that nothing therein should be viewed as a waiver on any issues involving substantive consolidation.  The court also found credible the debtors’ testimony that additional time and expenses would be necessary to untangle the assets of the consolidated debtors.

Prejudice. Failing to rule out substantive consolidation under either Augie/Restivo test, Residco then argued that it would be harmed by substantive consolidation if it were only permitted to retain its lease claims, as those claims were potentially worth less than the guarantee claims. The court rejected this argument as well, noting first that resolution of the value of those lease and guarantee claims would not be decided on the record before it but, in any event, Residco was not prejudiced because the debtors had proposed a carve-out allowing Residco to opt to have its claims treated as if substantive consolidation had not occurred. In other words, Residco could receive two classes of claims—its direct lease claims against one of the debtors and the guarantee claims against the parent debtor. Why didn’t this resolve Residco’s objection? Residco argued that it would be treated worse than other creditors because it might possibly receive less than other creditors who agreed to substantive consolidation (depending on the amount of assets that each of these two debtors was deemed to hold in the non-consolidated scenario). This argument was viewed as too greedy (think, “want to have my cake and eat it too”), and the court ultimately rejected this argument as well.


If a creditor or lender is relying on more than one entity for its recovery, such as the borrower project company and its parent, then it must ensure that it has done sufficient diligence on each company, on a stand-alone basis, to show that it is relying on each company’s separate credit-worthiness.  It should document and maintain evidence of this diligence. In addition, if the lender is also relying on parent support in connection with a loan, the related guarantee/support should be properly documented.  In finance transactions, lenders sometimes also ask for an opinion from borrower’s counsel opining that the borrower would not be substantively consolidated into the parent bankruptcy case. Such an opinion, while not always necessary, can also be very helpful in demonstrating the reliance on the companies as separate entities.

Finally, it’s worth noting that the creditor here did actually succeed in a way on its objection to substantive consolidation. When the creditor pressed its objection, the debtors agreed to carve the creditor’s claims out from the consolidation provisions if creditor so chose, allowing it to recover on both its direct claim and its guarantee claim. Ultimately, substantive consolidation was not its issue; the amount the creditor wanted to recover was.