A Non-Profit Entity May Not Be Forced Into Bankruptcy Through Substantive Consolidation


By: Rachel Armely

St. John’s Law Student

American Bankruptcy Institute Law Review Staff     

          In January 2015, the Archdiocese of Saint Paul and Minneapolis (the “Debtor”) voluntarily filed a petition for relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”) with the United States Bankruptcy Court for the District of Minnesota.[1]In May 2016, the Official Committee of Unsecured Creditors (the “Committee”) filed a motion in bankruptcy court to substantively consolidate the Debtor with over 200 affiliated non-profit, non-debtor entities (the “Entities”).[2]According to the Committee, the Entities’ assets should be treated as assets of the Debtor because the Debtor exercises direct control over all material aspects of the Entities.[3]The bankruptcy court denied the motion for substantive consolidation because of the Entities’ non-profit status.[4]The United States District Court for the District of Minnesota affirmed.[5]On appeal, the United States Court of Appeals for the Eighth Circuit confirmed that because the Entities are non-profit organizations,[6]a court cannot substantively consolidate the non-debtors with the Debtor.  According to the Eighth Circuit, substantive consolidation is tantamount to a bankruptcy filing, and a court is prohibited from involuntarily forcing the Entities (non-profit organizations) into bankruptcy.[7]  

            Substantive consolidation is an equitable remedy that allows the court to expand a company’s bankruptcy estate to include assets and liabilities of another company.[8]Consequently, substantive consolidation would effectually involuntarily force non-debtor entities into bankruptcy.[9]As a result of the extreme nature of the remedy, courts generally set a high bar for granting the remedy.[10]Although there is no statutory authority specifically authorizing substantive consolidation, the power to grant the remedy is grounded in the broad powers of 11 U.S.C. § 105(a).[11]

          Under 11 U.S.C. § 303(a), an involuntary bankruptcy case may not be brought against a non-profit corporation or organization.[12]Although the statute does not define “non-profit,” legislative history indicates that the definition includes eleemosynary institutions such as churches, schools, and charitable organizations.[13]To determine whether an organization qualifies as non-profit, the court must rely on state law.[14]Under Minnesota law, the Entities are all non-profit organizations;[15]thus, they fall within the category of organizations that could not be the target of an involuntary bankruptcy.[16]Therefore, the Eighth Circuit concluded that a court was prohibited from granting the substantive consolidation of the Entities with the Debtor because doing so would allow the powers of § 105(a) to override the explicit protections of § 303(a).[17]

          The Eighth Circuit’s decision maintained unanimity with courts that have faced a similar question because none of those courts have recognized the substantive consolidation of a debtor with a non-profit organization.[18]In finding that a non-profit institution qualifies for exemption from involuntary bankruptcy,[19]the Eighth Circuit established that, absent unlawful activity, an institution that is classified as a non-profit entity under applicable state law may not involuntarily be brought into bankruptcy through the remedy of substantive consolidation.[20]

[1]In reThe Archdiocese of St. Paul & Minneapolis, 888 F.3d  944, 948 (8thCir. 2018); see alsoScott Neuman, Archdiocese of St. Paul-Minneapolis Files Chapter 11, National Public Radio, Inc. (Jan. 16, 2015, 1:03 PM), https://www.npr.org/sections/thetwo-way/2015/01/16/377732977/archdiocese... (highlighting the reasoning that led the Archdiocese to file for Chapter 11 bankruptcy).  

[2]See In reThe Archdiocese of St. Paul & Minneapolis, 888 F.3d at 948. The Committee represents more than 400 clergy sexual abuse claimants. Id.Several of the Entities include 187 parish corporations, primary and secondary schools, the Catholic Community Foundation of Minnesota, The Catholic Cemeteries, and the Catholic Finance Corporation. Id.

[3]See id.

[4]See id.

[5]See id.

[6]See id. 

[7]See id.at 952-53. 

[8]Id.at 951;see alsoIn reParkway Calabasas, Ltd., 89 B.R. 832, 836-37 (Bankr. C.D. Cal. 1988) (“In place of two or more debtors, substantive consolidation substitutes a single debtor, a single estate with a common fund of assets, and a single body of creditors.”) (internal citations omitted). The remedy combines all of the consolidated entities’ assets so that a larger pool of assets is available to satisfy a debtor’s creditors. See In reThe Archdiocese of St. Paul & Minneapolis, 888 F.3d at 951; see alsoCollier on Bankruptcy¶ 105.09[1][a] (16th ed. 2018) (“[C]ourts may consolidate the assets and liabilities of different legal entities so that the assets and liabilities are dealt with as if the assets were held by and the liabilities were owned by a single legal entity.”).

[9]2 Collier on Bankruptcy at ¶ 105.09[1][c] (“[S]ome courts have hesitated to consolidate a nondebtor with a debtor affiliate, reasoning that to do so would circumvent the procedures and protections of the requirements for commencing an involuntary bankruptcy case against the nondebtor entity.”).

[10]See In reThe Archdiocese of St. Paul & Minneapolis, 888 F.3d at 951; see alsoIn reAugie/Restivo Baking Co., Ltd., 860 F.2d 515, 518 (2d Cir. 1988) (emphasizing that substantive consolidation vitally affects substantive rights).

[11]11 U.S.C.A. §105(a) (2010) (allowing the court to issue any order, process, or judgment that is necessary to carry out the provisions on the Bankruptcy Code.); see also In reThe Archdiocese of St. Paul & Minneapolis, 888 F.3d at 948; 2 Collier on Bankruptcyat ¶ 105.09[1][b] (“There is no statutory authority specifically authorizing substantive consolidation . . . . Courts have generally found the source of this equitable power in section 105.”). 

[12]11 U.S.C.A. 303(a) (2016).

[13]S. Rep. No.95-989, at 32 (1978) (“Eleemosynary institutions, such as churches, schools, and charitable organizations and foundations . . . are exempt from involuntary bankruptcy.”).

[14]See, e.g.,In re Yehud-Monosson USA, Inc., 458 B.R. 750, 755 (B.A.P. 8th Cir.) (“[T]he test for whether a debtor is moneyed, business, or commercial corporation is determined by a consideration of ‘the classification of the corporation by the state; the powers conferred upon it; and the character and extent of its main activities.’”).  

[15]See Minn. Stat. Ann. § 315.15; see alsoIn reThe Archdiocese of St. Paul & Minneapolis, 888 F.3d at 953.

[16]See In reThe Archdiocese of St. Paul & Minneapolis, 888 F.3d at 953. The Court found that there was no dispute as to the religious organization and non-profit status of the Entities under Minnesota state law. Id.(citing Minn. Stat. Ann. § 315.15). 

[17]See In reThe Archdiocese of St. Paul & Minneapolis, 888 F.3d at 953.

[18]See id.at 951.

[19]See id.at 952 (citing S. Rep. No.95-989, at 32 (1978)).

[20]See id. at 952-53.