Leveraging Substantive Consolidation, Piercing the Veil

Leveraging Substantive Consolidation,

Piercing the Veil, and Alter Ego

in Bankruptcy Proceedings Maximizing Creditor Recovery From or Asset Protection

for Debtor's Shareholders and Related Entities

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TUESDAY, AUGUST 5, 2014

Presenting a live 90-minute webinar with interactive Q&A

Gary M. Kaplan, Partner, Farella Braun + Martel, San Francisco

Benjamin G. Lombard, Shareholder, Reinhart Boerner Van Deuren, Milwaukee

Ariel Weissberg, Managing Partner, Weissberg and Associates, Chicago

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Leveraging Substantive Consolidation, Piercing the

Veil, and Alter Ego in Bankruptcy Proceedings

GARY M. KAPLAN, Farella Braun + Martel LLP

[email protected]

415.954.4940

August 5 2014

Alter Ego Doctrine & Elements

• "The alter ego doctrine arises when a plaintiff comes into

court claiming that an opposing party is using the corporate

form unjustly and in derogation of the plaintiff's interests. In

certain circumstances the court will disregard the corporate

entity and will hold the individual shareholders liable for the

actions of the corporation.” Mesler v. Bragg Mgmt. Co., 39

Cal.3d 290, 300 (1985)

• Alter ego claim generally requires: (1) unity of interest and

ownership such that separate personalities of corporation and

shareholder no longer exist, and (2) if acts are treated as

those of corporation alone, an inequitable result will follow."

Mesler, 39 Cal.3d at 300

5


• Factors courts consider in alter ego analysis:

• Commingling of funds and assets

• Identical ownership (direct or indirect) of the

entities

• Use of the same offices and employees

• Disregard of corporate formalities

• Identical directors and officers

• Corporation is mere shell or conduit for affairs of

the individual or other entity

6


• While California case law has applied alter ego doctrine to

corporations, a member of an LLC can be held personally

liable for obligations of LLC under comparable circumstances

pursuant to a California statute.

• Cal. Corp. Code §17101(b): “A member of a limited liability

company shall be subject to liability under the common law

governing alter ego liability, and shall also be personally

liable under a judgment of a court or for any debt, obligation,

or liability of the limited liability company, whether that liability

or obligation arises in contract, tort, or otherwise, under the

same or similar circumstances and to the same extent as a

shareholder of a corporation may be personally liable for any

debt, obligation, or liability of the corporation . . .”

7

Pursuit Of Alter Ego Claims By

Bankruptcy Trustee Or Creditor

• Bankruptcy trustee stands in shoes of bankrupt

corporation and has standing to bring any suit that

debtor could have brought had it not filed

bankruptcy. When trustee has standing to assert a

claim, such standing is exclusive and divests all

creditors of power to bring same claim

• Recent 9th Circuit case addressing rights of trustee

and creditors to assert alter ego claims: Ahcom

Ltd. v. Smeding, 623 F.3d 1248 (9th Cir. 2010)

8



• Ahcom holding: individual creditor of corporation in

bankruptcy has standing to assert claim against

sole shareholder on alter ego theory

• Overruled cases holding alter ego claim is property

of estate that only trustee (rather than creditor) can

assert if it alleges injury to corporation (e.g., CBS,

Inc. v. Folks (In re Folks), 211 B.R. 378 (B.A.P. 9th

Cir. 1997) & In re Davey Roofing, Inc., 167 B.R.

604 (Bankr. C.D. Cal. 1994))

9



• Ahcom: "California law does not recognize an alter ego claim

or cause of action that will allow a corporation and its

shareholders to be treated as alter egos for purposes of all

the corporation’s debts." 623 F.3d at 1250.

• 9th Circuit relied on California Supreme Court decision in

Mesler v. Bragg Mgmt. Co., 39 Cal.3d 290 (1985) for this

finding

• However, Ahcom court recognized that trustee can bring

action on behalf of debtor where company injured due to

conduct by shareholders typical of that alleged in alter ego

claims (e.g., action for conversion, fraudulent transfer) without

utilizing alter ego remedy

10



• Case law suggesting alter ego claims can be

pursued for creditors collectively under Chapter 11

plan of reorganization

• In re Tribune Co., 2011 Westlaw 514220 (Bankr. D.

Del 2011): Even though bankruptcy trustee cannot

pursue claims belonging to individual creditors,

Plan may appoint litigation trustee to prosecute

alter ego claims on their behalf

11



• Ahcom arguably misconstrues California law in

stating "no California court has recognized a free-

standing general alter ego claim," as that is what

California Supreme Court did in Mesler

• Mesler actually reversed lower court and ruled

plaintiff should have been allowed to proceed on

alter ego claim: "In the case at bar the court should

have permitted plaintiff to plead the alter ego

issue." (39 Cal. 3d at 297)

12



• Following Mesler and progeny, California courts continue to

recognize alter ego claims. E.g., Zoran v. Chen, 185

Cal.App. 4th 799 (2010) (reversing summary judgment for

defendant on alter ego claims based on genuine factual

issues regarding whether defendant's domination and control

of corporation gave rise to unity of interest); Doney v. TRW,

33 Cal.App 4th 345 (1995) (relying on Mesler and recognizing

viability of alter ego claims against parent company for acts of

subsidiary)

• Alternative strategy: Trustee assertion of alter ego claim in

state court (if state law allows such claims) because Ahcom is

federal court decision not binding on state courts

13



• Recent California Court of Appeals decision

generally following Ahcom: Shaoxing County

Huayue Import & Export v. Bhaumik, 191 Cal.App.

4th 1189 (Jan. 18, 2011)

• Holding: individual creditor of corporation in

bankruptcy could pursue alter ego claims against

shareholder, rather than such claims only being

assertable by bankruptcy trustee

14



• However, California Court of Appeal recognized

bankruptcy trustee's right to pursue alter ego

theories on behalf of company based on

shareholder's injury to the corporation:

• "The trustee of a bankrupt corporation can maintain

an action against a defendant based on an alter

ego theory if there is some allegation of injury to

the corporation that gives the corporation a right of

action against the defendant."

15



• Strategy to avoid dismissal of alter ego claim based on

Shaoxing court finding that “no California court has

recognized a freestanding general alter ego claim that would

require a shareholder to be liable for all of a company’s

debts” (quoting Ahcom): plead as declaratory relief claim

• Alternative: Frame alter ego claim against shareholder under

trustee’s Bankruptcy Code §544(b) “strong arm” powers

(allowing trustee to step into shoes of creditor who could

avoid debtor’s transfer of property or incurrence of obligation)

• E.g., assert claim for fraudulent transfer (under Bankruptcy

Code or state law), if can establish either actual intent to

hinder, delay or defraud creditors or lack of reasonably

equivalent value exchanged and insolvency at time of transfer

16



• Alternative: Trustee claim for breach of fiduciary duty based on facts giving rise to alter ego claim, in view of case law (e.g., Berg & Berg Enterprises, LLC v. Boyle, et al., 178 Cal.App.4th 1020 (2009); North American Catholic Educ. Programming Found. Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007)) holding that creditors have no direct claims for breach of fiduciary duty but that such derivative claims instead belong to corporation (assertable by trustee)

• Alternative: Trustee can seek to substantively consolidate assets of shareholder (even if not in bankruptcy) with those of corporate debtor (pursuant to 9th Circuit’s decision in U.S. Bancorp Mortg. Co. v. Bonner Mall Partnership, 2 F.3d 899 (9th Cir. 1993) and comparable authority), as facts giving rise to alter ego claim frequently overlap elements for substantive consolidation (e.g., commingling of assets and liabilities)

17

Contact Information

Gary Kaplan

Partner, and Chair of Restructuring,

Insolvency & Creditors Rights Group

Farella Braun + Martel LLP

235 Montgomery Street, 17th Floor

San Francisco, CA 94104

[email protected]

415.954.4940

18

mailto:[email protected]

Strafford Webinars:

Piercing the Corporate

Veil in Bankruptcy Ariel Weissberg, Esq.

Weissberg and Associates, Ltd.

401 South LaSalle Street

Suite 403

Chicago, IL 60605

(312) 663-0004

[email protected]

www.weissberglaw.com

August 5, 2014

Introduction: Topics To Be

Discussed

• Bankruptcy Court Jurisdiction

• General Overview of Piercing the Corporate Veil Cause of Action

• Historical

• Elements

• Combination of Equitable and Legal Remedy

• Standing

• Chapter 7 Trustee or Chapter 11 Trustee

• Derivative Standing

• Jury Trial

• Burden of Proof

• Clear and Convincing or Preponderance of the Evidence

• Piercing the Corporate Veil: Factors

20

Bankruptcy Court Jurisdiction

• Article III of the U.S. Constitution

• 28 USC §157(b)(2)(C)

• Northern Pipeline Construction Co. v. Marathon Pipeline Co., 458 U.S. 50, 102 S. Ct. 2858, 73 L.

Ed.2d 598 (1982)

• Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub. L. No. 98-353, 98

Stat. 333 (“1984 Act”)

• Commodity Futures Trading Commission v. Schor, 478 U.S. 833, 106 S. Ct. 3245, 92 L. Ed.2d

675 (1986)

• Granfinanciera S.A. v. Nordberg, 492 U.S. 33, 109 S. Ct. 2782, 106 L. Ed. 2d 26 (1989)

• Stern v. Marshall, 564 U.S. 2, 131 S. Ct. 2594 (2011)

• Exec. Benefits Ins. Agency, Inc. v. Arkison, 702 F.3d 553 (9th Cir. 2012)

• Wellness International Network, Limited v. Sharif, 727 F.3d 751 (7th Cir. 2013)

• Exec. Benefits Ins. Agency, Inc. v. Arkinson, 573 U.S.__ (2014) 21

United States Supreme Court

Piecing the Corporate Veil Cases

• Dole Food Co. v. Patrickson, 538 U.S. 468 (2003)

• Pepper v. Litton, 308 U.S. 295, 60 S. Ct. 238, 84 L. Ed. 281

(1939)

• Bangor Punta Operations, Inc. v. Bangor & Aroostook R. Co.,

417 U.S. 703, 94 S. Ct. 2578, 41 L. Ed. 2d 418 (1974)

22

Predominant Business

Organizations

• Limited Liability Company

• Limited Liability Partnership

• Corporation

• General Partnership

• Limited Partnership (General Partner)

• Sole Partnership

• “Piercing Corporate Veil”

• Breach of Fiduciary Duty by Directors and Officers when Business Organization is insolvent

23

Standing

• Koch Ref. v. Farmers Union Cent. Exch., Inc., 831 F.2d 1339 (7th Cir. 1987)

• Official Committee v. RF Lafferty & Co., 267 F. 3d 340 (3d Cir. 2001)

• Steyr-Daimler-Puch of America Corp. v. Pappas, 852 F. 2d 132 (4th Cir. 1988)

• Lumpkin v. Envirodyne Industries, Inc., 933 F. 2d 449 ( 7th Cir. 1991)

• In re: Ozark Restaurant Equipment Co., Inc., 816 F. 2d 1222 (8th Cir. 1987)

• Kalb, Voorhis & Co. v. American Financial Corp., 8 F. 3d 130 (2d Cir. 1993) (Applying Texas Law)

• Board of Trustees of Teamsters v. Foodtown, Inc., 296 F. 3d 164 (3d Cir. 2002)

24

Derivative Standing

• Fogel v. Zell, 221 F.3d 955 (7th Cir. 2000)

• In re: Adelphia Communications Corp., 544 F.3d 420 (2d Cir. 2008)

• In re: Trailer Source, Inc., 555 F.3d 231 (6th Cir. 2009)

• In re: Lauer, 98 F.3d 378 (8th Cir. 1996)

• In re: Racing Services, Inc., 540 F.3d 892 (8th Cir. 2008)

• Official Committee of Unsecured Creditors of Cybergenics Corp. ex rel. Cybergenics Corp. v. Chinery, 330 F.3d 548 (3d Cir. 2003)

25

Jury Trial

• Granfinanciera S.A. v. Nordberg, 492 U.S. 33, 109 S. Ct.

2782, 106 L. Ed. 2d 26 (1989)

• Wm. Passalacqua Builders v. Resnick Developers, 933 F. 2d

131 (2d Cir. 1991)

• Koch Ref. v. Farmers Union Cent. Exch., Inc., 831 F.2d 1339

(7th Cir. 1987)

26

Burden of Proof: Clear and

Convincing or Preponderance of

the Evidence • Trustees, Nat. Elevator Industry Pension v. Lutyk, 332 F. 3d

188 (3d Cir. 2003)

27

Piercing the Corporate Veil

• An equitable remedy to disregard the corporate entity and

impose personal liability on a corporation’s shareholders.

• Van Dorn v. Future Chem. & Oil Corp (7th Cir.): Two prong

test: A corporation is pierceable when

• (1) There is such “unity of interest and ownership” that the

separate personalities of the individual and corporation cease to

exist, and

• (2) When adhering to the fiction of a separate corporation

existence would sanction a fraud or injustice.

28

Mere Instrumentality

• In Main Bank of Chicago v. Baker, the Illinois Supreme Court rephrased the second prong such the corporation must be “so controlled and its affairs so conducted that it is a mere instrumentality of another.”

• Mere Instrumentality

• Fontana v. TLD Builders (2nd Dist.):

• A corporation is a mere instrumentality when it is merely the alter ego or business conduit of another person or entity.

• For example, an entity or individual who uses a corporation as a method of conducting his or her business.

29

Badges of Fraud

BADGES OF FRAUD

• Inadequate capitalization;

• Failure to issue stock;

• Failure to observe corporate formalities;

• Nonpayment of dividends;

• Insolvency of the debtor corporation;

• Nonfunctioning of officers or directors;

• Absence of corporate records;

• Commingling of funds;

• Diversion of assets from the corporation by or to

a stockholder, or other person or entity to the

detriment of creditors;

• Failure to maintain arms’ length relationships

among related entities; and

• Whether the corporation was merely a façade for

the operation of the dominant stockholders.

• Used in the analysis of both prongs.

• Numerosity is not required.

• Fontana v. TLD Builders (2nd Dist.): The

Court will not base its decision on a single

factor, but examine several factors and the

totality of the circumstances

30

Undercapitalization

• Undercapitalization alone in not sufficient to pierce the corporate veil.

• Browning-Ferris Industries of Illinois v. Ter Maat, (7th Cir.) Undercapitalization is rarely if ever the sole factor in a decision to pierce the corporate veil.

• Fontana v. TLD Builders (2nd Dist.):

• Compare the amount of capital to the amount of business to be conducted and the obligations to be fulfilled.

• Held: Loans made by shareholders to the corporation and a $4 million line of credit with a bank did not show adequate capitalization, but rather, inadequacy of capitalization and an indication that the initial capitalization was insufficient to conduct the corporation’s affairs.

• Laborers' Pension Fund v. Lay-Com, Inc. et al., 580 F.3d 602 (7th Cir. 2009). Held: Adequate capitalization exists when a corporation has sufficient equity without considering loaned funds or encumbered assets.

31

Failure to Observe Corporate

Formalities

• Failure to observe corporate formalities is not a ground for imposing personal liability on an LLC member.

• For corporations, evidence of a failure to follow corporate formalities includes some of the badges of fraud:

• Commingling

• Absence of Corporate Records

• Other Badges

• Failure to issue stock (stock certificate)

• Nonpayment of Dividends

• Nonfunctioning of Officers or Directors

• No decision-making role

• Shareholder’s control over corporation/ Officers renders them nonfunctioning 32

Commingling

• Sea-Land Services, Inc. v, Pepper Source (7th Cir.): Commingling found when

shareholder used the bank accounts of all of these corporations to pay

personal expenses, including alimony, child support, education expenses

for his children, automobile maintenance, and healthcare for his pet.

• Jay Steinberg v. Helen Buczynski (7th Cir.): Funds were not commingled

where shareholders paid some of their personal expenses with checks

issued by the corporation. the shareholders “took no more than what

would have been a reasonable amount in salary, merely omitting the

formality of having salary checks issued to them and paying the personal

expenses in question by personal check.”

33

Absence of Corporate Records

• Particularly tricky in “one-man” corporations: corporations where one person is the sole shareholder, director, and manager.

• Jay Steinberg v. Helen Buczynski (7th Cir.): There was not a failure to follow corporate formalities despite the fact that the entity never held formal shareholder meetings or kept corporate minutes, and paid some of their personal expenses with checks issued by the corporation.

• Gallagher v. Recono Builders (1st Dist.): Defendant failed to follow corporate formalities because there were no corporate resolutions, meetings were undocumented, and the defendant failed to produce any corporate books

34

Reverse Piercing

• A variation of traditional veil piercing.

• Subjects the corporation to liability for the acts of its shareholders.

• Generally arises when a shareholder’s creditors try to reach the assets of the corporation.

• Scholes v. Lehmann (7th Cir.): Reverse piercing is ordinarily possible only in one-man corporations, since if there is more than one shareholder, seizing the corporation’s assets to pay a shareholder’s debts would be a wrong to the other shareholders.”

35

Reverse Piercing: The Test

• Reverse piercing is appropriate when

• (1) an insider owns all, or substantially all, of the stock, and

• (2) the insider treats the property as his or her own, and

• (3) no shareholder or creditor would be adversely affected.

36

Veil Piercing & LLCs

• Illinois LLCs are governed by the Limited Liability Company Act (“LLCA”).

• Originally provided: a member of an LLC would not be liable for any act, debt, obligation, or liability of the LLC to the extent that a shareholder of an Illinois corporation would be liable under analogous circumstances.

• Amended to provide: “The debts, obligations, and liabilities of a limited liability company, whether arising in contract, tort, or otherwise, are solely the debts, obligations, and liabilities of the company. A member or manager is not personally liable for a debt, obligation, or liability of a company solely by reason of being or acting as a member or manager.”

• Specifically provides: An LLC’s failure to observe corporate formalities is not a ground for imposing personal liability on its members or managers

• Case law is sparse, but has resulted in two approaches: Pro-LLC piercing and Against LLC Piercing.

37

Non-Pierceable: The Puleo

Approach

• Puleo v. Topel

• Appellate Court for the First District of Illinois considered piercing the veil of an LLC that was administratively dissolved for failing to report.

• Held: an individual member or manager of an LLC was not personally liable for obligations incurred by the entity after it was dissolved relying on

• The amended LLCA providing for no personal liability, and on LLCA § 10-10(d), which provides that an LLC may assign personal liability to its members by including a provision to that effect in its articles of organization, or if a member consents to the imposition of such liability in writing

• Arguable that this protection goes beyond the protections enjoyed by shareholders of a corporation.

38

Pierceable

• Westmeyer v. Flynn (1st Dist.): The Court declined to

follow the First District’s reasoning in Puleo and noted

that § 10-10 of the LLCA “does not bar the other bases

for corporate veil piercing, including alter ego, fraud and

undercapitalization.”

• Several Bankruptcy Courts in the Northern District of

Illinois have followed this approach.

39

Leveraging Substantive Consolidation,

Piercing the Corporate Veil, and Alter

Ego in Bankruptcy Proceedings

Benjamin G. Lombard

Reinhart Boerner Van Deuren s.c.

1000 North Water Street, Suite 1700

Milwaukee, WI 53202

414-298-1000

[email protected]

©2014 All Rights Reserved

Reinhart Boerner Van Deuren s.c. 40

Substantive Consolidation

What is substantive consolidation?

• Substantive consolidation is an equitable doctrine in bankruptcy which permits the

consolidation of legally separate entities as if they were merged into a single survivor

with all of their assets and liabilities pooled.

• The Bankruptcy Code does not expressly authorize substantive consolidation. Instead,

the authority for a bankruptcy court to order substantive consolidation lies in its

general equitable powers under Section 105(a) of the Bankruptcy Code.

• Substantive consolidation has its origins in the state law concept of piercing the

corporate veil, although it has developed into a distinct doctrine under federal

bankruptcy law. As with piercing the corporate veil, a key consideration is whether

there is too much identity between separate entities and a failure to follow proper

formalities for each entity.




What is effect of substantive consolidation?

• In substantive consolidation, the assets of two or more affiliated entities are pooled,

intercompany claims are eliminated and creditors have claims against the pool of

assets in the bankruptcy estate.

• Substantive consolidation can be used to pull a solvent entity into the bankruptcy

estate of an affiliate.

• If an affiliated entity is consolidated with a debtor's bankruptcy estate, the automatic

stay and other provisions of bankruptcy law will apply.

• Creditors of the affiliated entity may also be left with an unsecured claim to the

estate's aggregate assets together with other creditors rather than a secured claim to

the affiliated entity's assets.

• Substantive consolation can result in a windfall to creditors of an insolvent entity and a

penalty to creditors of a solvent entity.




When may substantive consolidation apply?

• The risk of substantive consolidation should be considered anytime a creditor extends

credit to an entity relying on it to be separate from its affiliates.

• Substantive consolidation is relevant to securitization transactions and other structured

financing transaction involving the sale of receivables, consumer finance contracts

and other assets through special purpose vehicles (SPVs).

• It may also apply in more typical lending contexts, which is in fact where most of the

case law has arisen. Consider the basic facts of In re Owens Corning, 419 F.3d 195 (3rd

Cir. 2005).




When may substantive consolidation apply? (continued)

• Owens Corning and its subsidiaries were a multinational corporate group with

numerous related entities in different lines of business.

• A number of the Owens Corning entities faced continuing liability concerns due to

asbestos-related claims and litigation.

• A group of banks were willing to make a loan to Owens Corning despite the asbestos

risk, but only because of certain "credit enhancements."

• Most notably there were solvent entities in the corporate group without exposure to

asbestos claims. The banks required guarantees from these entities.

• When Owens Corning filed for reorganization under Chapter 11 of the Bankruptcy

Code due to the asbestos-related liability, it proposed a plan predicated on

substantive consolidation of the solvent guarantors. Substantive consolidation would

"benefit" the bankruptcy estate by providing it with a larger pool of assets for the

reorganization.




What are the tests for substantive consolidation?

• Courts have developed multiple tests for substantive consolidation, and as a result

there is little uniformity in its application.

• Many courts state that substantive consolidation is an extraordinary remedy that

should be used sparingly, but other courts applying a "liberal trend" may more readily

apply substantive consolidation.

• Although there may be many differing details in the tests applied by the courts, courts

and commentators have increasingly referenced two main competing tests.




What are the tests for substantive consolidation? (continued)

• The Augie/Restivo Test. Stricter tests that truly apply substantive consolidation sparingly, and

generally reject substantive consolidation if any creditor relied on the separateness of the

entities. The seminal case for the stricter test is In re Augie/Restivo Baking Co., 860 F.2d 515

(2nd Cir. 1988). Owens Corning is a more recent case that critiques the competing tests and

adopts a stricter test.

• The Auto-Train Test. More liberal tests may apply substantive consolidation if the benefits of

consolidation outweigh (or "heavily outweigh") the harms, even if an objecting creditor relied

on the separateness of one of the entities and will be prejudiced. The "Auto-Train" test

reflects approach. Drabkin v. Midland Ross Corp. (In re Auto-Train Corp.), 810 F.2d 270

(D.C.Cir. 1987).

• Some courts following the liberal trend permit consolidation based on a list of factors relating

to separateness and do not necessarily take creditor reliance on separateness or prejudice

into account. E.g., In re Vecco Constr. Indus., Inc., 4 B.R. 407 (Bankr. E.D. Va. 1980).




What are the elements of the Auto-Train test?

• The proponent of substantive consolidation must show:

° "a substantial identity between the entities to be consolidated"; and

° "that consolidation is necessary to avoid some harm or realize some benefit".

• If the proponent makes such a showing, "a creditor can object on the grounds that it

relied on the separate credit of one of the entities and that it will be prejudiced by the

consolidation."

• If the creditor makes such a showing, the court may order consolidation only if it

determines that the demonstrated benefits of consolidation "heavily" outweigh the

harms.




What are the elements of the Augie/Restivo test?

• Whether creditors dealt with the entity as a single economic unit and did not rely on

their separate identity in extending credit.

° This factor is not satisfied if any creditor relied on the separateness of one of the

debtors, and thus would be prejudiced by the consolidation.

• Whether the affairs of the debtors are so entangled that consolidation will benefit all

creditors.

• As the Augio/Restivo test does not authorize a court to generally weigh the harm

versus the benefits of consolidation, it should be harder to satisfy than the Auto-Train

test.




Example of weighing an enumerated list of factors for substantive consolidation - In re Vecco

Constr. Indus., Inc., 4 B.R. 407, 410 (Bankr. E.D. Va. 1980), where the count listed the following factors:

• The degree of difficulty in segregating and ascertaining individual assets and liabilities.

• The presence or absence of consolidated financial statements.

• The profitability of consolidation at a single physical location.

• The commingling of assets and business functions.

• The unity of interest and ownerships between various corporate entities.

• The existence of parent and inter-corporate guaranties on loans; and

• the transfer of assets without formal observance of corporate formalities.




What are best practices to reduce the risk of substantive consolidation?

• Each entity should pay its own operating expenses from its own funds.

• Each entity should conduct business in its own name (including all of its business

correspondence, invoices, checks and other communications).

• Each entity should maintain its own separate books and records.

• Each entity should maintain separate bank accounts and not commingle funds.

• Each entity should maintain its assets separately in a manner that facilitates their

identification and segregation from those of the other party.

• Each entity should have its own directors and officers, observe corporate formalities in

its operations and obtain proper authorization for its actions.




What are best practices to reduce the risk of substantive consolidation? (continued)

• Each entity should compensate its own employees for services from its own funds.

• Each entity should maintain an arms' length relationship with the other, and properly

document all inter-company transactions.

• Each entity should not hold its credit or assets as being available to satisfy the

obligations of the others.

• Each entity should be adequately capitalized to engage in its business transactions.

• Each entity should prepare separate financial statements and ensure that any

consolidated financial statements have notes that clearly state that they are separate

entities and that their assets are available first and foremost to satisfy the claims of their

own creditors.



Documents

Leveraging Substantive Consolidation, Piercing the Veil