Substantive consolidation is an equitable remedy that permits a bankruptcy court to combine the assets and liabilities of separate and distinct—but related—legal entities into one and treat them as a single entity. The consolidated assets create a single fund from which all claims against the consolidated debtors are satisfied; the merged companies’ inter-company claims are extinguished, and the creditors of the consolidated entities are combined for purposes of voting on plans of reorganization. In the current age of mega-bankruptcy cases, substantive consolidation can become a hotly contested issue. Huge corporations have multiple businesses, many related entities as subsidiaries, and separate creditors for each, all of which are competing for a limited pool of assets. Substantive consolidation can cut through separate corporate structures and create a larger asset pool for distribution if certain complexities are overcome.

Historically, procedural problems such as the difficulties of combining entities with different accounting procedures or corporate forms made substantive consolidation rare. There is also potential harm to creditors whose claims normally would have priority but are subordinated under the consolidation. However, many jurisdictions recently have taken a more liberal view and adopted the remedy. This approach may be proscribed "whenever it will benefit the debtors’ estates without betraying legitimate expectations of the debtors and their respective creditors." In re Affiliated Foods, 249 B.R. 770 (Bankr. W.D. Miss. 2000). But skepticism remains. For instance, in the pending Owens Corning matter, the United States District Court for the Third Circuit is considering whether the bankruptcy court even has jurisdiction to decide substantive consolidation issues. No "bright line" rule regarding substantive consolidation has emerged.

The decision to substantively consolidate estates remains highly fact specific, and courts have delineated several tests to determine when substantive consolidation is appropriate. The analysis varies by jurisdiction and type of entities subject to consolidation. Courts generally focus on two areas of inquiry: (i) the harm or benefit to the debtor or its estate and (ii) the harm or benefit to the creditors of the entity and its affiliate. Typically, creditors of a poor estate are likely to seek consolidation in order to benefit from the pooling of assets with a more solvent related entity. Substantive consolidation also may be sought when related estates have accounting practices that make them difficult to separate.

Despite the inconsistencies of application, creditors should be aware that substantive consolidation may be a means to maximize recovery in the case of multiple related entity bankruptcies.