United States Court of Appeals
Fifth Circuit
F I L E D
REVISED APRIL 5, 2006
IN THE UNITED STATES COURT OF APPEALS March 31, 2006
FOR THE FIFTH CIRCUIT Charles R. Fulbruge III
_____________________ Clerk
No. 04-20841
_____________________
In The Matter Of: AMCO INSURANCE; REHMAT PEERBHAI,
Debtors.
---------------------
WELLS FARGO BANK OF TEXAS N. A.,
Appellant,
versus
RONALD J. SOMMERS, Trustee
Appellee.
__________________________________________________________________
Appeal from the United States District Court
for the Southern District of Texas, Houston
USDC No. 4:04-CV-455
_________________________________________________________________
Before JOLLY, DENNIS, and OWEN, Circuit Judges.
E. GRADY JOLLY, Circuit Judge:
The significance of this bankruptcy case relates to the nunc
pro tunc substantive consolidation of the assets and liabilities of
a corporation in bankruptcy and its sole shareholder, not in
bankruptcy (until afterwards). Because the bankruptcy court’s nunc
pro tunc order was an abuse of discretion under the facts of this
case, we vacate the district court’s order and remand.
I
Rehmat A. Peerbhai, an entrepreneur in the automobile
industry, owned and managed AIG, a holding company in the
automobile insurance business, prior to 1992.1 On April 21, 1992,
Peerbhai incorporated a new company, AIA, which sells automobile
insurance. A parent-subsidiary relationship was formed between
AIG, as parent, and AIA, as subsidiary, with Peerbhai acting as the
sole owner of both companies. AIG, AIA, and Peerbhai are all
debtors in bankruptcy proceedings that are at issue in this appeal.
In September 2000, Peerbhai, in his individual capacity, and
AIG approached Wells Fargo for financing, and Wells Fargo agreed to
enter into loan transactions with both. However, Wells Fargo
required Peerbhai, AIG, and AIA to be independently audited by
PricewaterhouseCoopers and Belew Averitt LLP before granting the
loans. After reviewing the financial statements and audit reports,
Wells Fargo agreed to lend money to Peerbhai as an individual, and
to AIG. Wells Fargo extended a loan in the amount of $2.4 million
to Peerbhai and AIG as co-borrowers, and another loan in the amount
of $1.2 million to AIG. Wells Fargo required Peerbhai personally
to guarantee AIG’s corporate obligations, and Peerbhai executed a
Continuing Guaranty on September 21, 2000.
In December 2001, AIG breached a material loan covenant with
Wells Fargo. On January 10, 2002, Wells Fargo filed, in state
1
This recitation of the facts is taken largely from the
district court’s opinion.
2
court, an Original Petition and Restraining Order against AIG based
on this breach. AIA and AIG both filed petitions for bankruptcy
under Chapter 7 of the Bankruptcy Code on February 4, 2002. On
February 11, Wells Fargo filed a Motion to Lift Stay to Pursue
State Court Litigation in the AIG bankruptcy case. The bankruptcy
court entered an agreed order partially lifting the automatic stay
on March 14, expressly permitting Wells Fargo to pursue state court
remedies against Peerbhai individually. Wells Fargo began
collection activities against Peerbhai, and thereafter Peerbhai
requested that Wells Fargo forbear from exercising its legal and
contractual rights and remedies until April 9, 2003. Wells Fargo
and Peerbhai reached an agreement and executed a Limited
Forbearance Agreement dated April 10, 2002, and they filed an
Agreed Judgment settling the state court litigation. The state
court entered the Agreed State Court Judgment on April 25, 2002,
giving Wells Fargo a consensual lien on Peerhbai’s homestead, as
well as a judgment against Peerbhai pursuant to the terms of
Peerbhai’s Continuing Guaranty. The total amount of the Agreed
State Court Judgment against Peerbhai was $3,398,956.16.
II
On July 11, 2002, the Trustee for AIA, Ronald J. Sommers,
filed an Application for Substantive Consolidation (“Application”),
seeking to consolidate AIA and Peerbhai as a single debtor in
bankruptcy. At the time of the Application, Peerbhai was not in
bankruptcy, and the Application sought essentially to put him into
3
bankruptcy and relate his filing date back to AIA’s February 4,
2002 filing date under the theories of “single economic unit” and
“single business enterprise.” Wells Fargo objected to the
Application. On December 11, 2002, Peerbhai filed a Chapter 11
bankruptcy petition, which he later converted into a Chapter 7
petition.
The United States Bankruptcy Court for the Southern District
of Texas held evidentiary hearings on the Application on May 2 and
May 23, 2003. Sommers argued that Peerbhai and AIA were not
separate legal entities, and that the finances of AIA and AIG were
commingled by Peerbhai so that substantively consolidating all of
Peerbhai’s personal assets with the assets of AIA and AIG was the
only way to ensure equitable distribution of the assets to the
creditors of AIA and AIG.
On September 25, 2003, the bankruptcy court issued Findings of
Fact and Conclusions of Law. It determined that Peerbhai engaged
in a pattern of activity that was aimed at concealing AIA’s
proceeds from its creditors and from Peerbhai’s personal creditors,
that Peerbhai made no meaningful distinction between his funds and
those of AIA while AIA was a going concern, that substantial
identity between Peerbhai and AIA existed and AIA’s creditors dealt
with Peerbhai and AIA as a single economic unit and did not rely on
their separate identities in extending credit, that Peerbhai and
AIA did not observe the corporate formalities required by Texas
law, and that Peerbhai treated AIA as an alter ego of himself,
4
using the AIA corporate status to commit fraud against his and
AIA’s creditors. Based on these findings, the bankruptcy court
concluded that substantive consolidation was appropriate for
several reasons: first, substantive consolidation would benefit
all creditors, and not unfairly prejudice any creditor, because the
financial affairs of AIA and Peerbhai were so entangled that the
assets of each could not be segregated; second, substantive
consolidation would avoid the harm of AIA’s creditors receiving
virtually nothing in a bankruptcy that was caused primarily by
Peerbhai looting AIA; third, Wells Fargo would not be unfairly
harmed by substantive consolidation because of Wells Fargo’s
knowledge and the circumstances surrounding the execution of the
Limited Forbearance Agreement, and further that any prejudice Wells
Fargo may suffer from substantive consolidation is not unfair, and
is substantially outweighed by the benefits to other creditors;
fourth, the fact that AIA and Peerbhai were essentially a single
financial entity could not have been ignored by Wells Fargo or any
other reasonably diligent party extending credit to Peerbhai; and
fifth, substantive consolidation should be effective nunc pro tunc
to the petition date of February 4, 2002, because at all relevant
times, Peerbhai and AIA operated as one financial entity.
Wells Fargo appealed to the district court the bankruptcy
court’s November 17, 2003 Order Granting Substantive Consolidation.
In that appeal, Wells Fargo argued for the first time that the
Supreme Court of the United States effectively abrogated the
5
doctrine of substantive consolidation in Grupo Mexicano de
Desarrollo, S.A. v. Alliance Bond Fund, Inc., which held that a
preliminary injunction, issued prior to any judgment essentially to
prevent fraudulent transfer of assets, was an improper use of
equity powers. 527 U.S. 308, 332 (1999) (“[T]he equitable powers
conferred by the Judiciary Act of 1789 did not include the power to
create remedies previously unknown to equity jurisprudence. Even
when sitting as a court in equity, we have no authority to craft a
‘nuclear weapon’ of the law like the one advocated here.”). The
district court, however, determined that substantive consolidation
remains an available remedy despite the Grupo Mexicano holding,
reading Grupo Mexicano narrowly and noting that Grupo Mexicano did
not discuss the remedy of substantive consolidation.
Wells Fargo further argued that even if substantive
consolidation is an available remedy, the bankruptcy court should
not have applied it retrospectively to revoke Wells Fargo’s
interests in Peerbhai’s assets. The district court noted that
before a court may exercise its nunc pro tunc powers, that court
must make an inquiry to determine whether retroactivity is
necessary to achieve some benefit or avoid harm. The district
court determined that the bankruptcy court took the proper factors
into consideration in determining whether to apply substantive
consolidation retroactively, and thus its decision was appropriate.
Wells Fargo made a third argument to the effect that the
bankruptcy court’s alter ego conclusion was improper under Texas
6
law, which requires proof of actual fraud. Wells Fargo contended
that the bankruptcy court did not show that Peerbhai had the actual
intent necessary to prove actual fraud. The district court held
that based on the bankruptcy court’s findings, the actions of
Peerbhai prove that his intent to defraud was calculated, not
accidental, and thus the bankruptcy court’s decision regarding
alter ego was not erroneous.
Wells Fargo timely appeals the district court’s final
judgment.
III
Wells Fargo argues that the bankruptcy court did not have the
power to order substantive consolidation and, in the alternative,
that if the bankruptcy court had such power, it applied the wrong
standard to determine whether substantive consolidation was
appropriate. Further, Wells Fargo contends that substantive
consolidation was inappropriate in this case and, finally, that the
bankruptcy court erred in issuing the order to consolidate nunc pro
tunc.
This Court applies the same standard of review to the
bankruptcy court’s decision as applied by the district court.
Total Minatome Corp. v. Jack/Wade Drilling, Inc. (In re Jack/Wade
Drilling, Inc.), 258 F.3d 385, 387 (5th Cir. 2001). The bankruptcy
court’s findings of fact are reviewed under a clear error standard,
while conclusions of law are reviewed de novo. Id. The
determination of which standard to apply in order to assess whether
7
substantive consolidation is appropriate is a question of law
reviewed de novo. As to the bankruptcy court’s decision to
consolidate, some courts suggest that we review such decision under
an abuse of discretion standard. See, e.g., Reider v. Fed. Deposit
Ins. Corp. (In re Reider), 31 F.3d 1102, 1105 (11th Cir. 1994)
(applying abuse of discretion standard to bankruptcy court’s
decision to consolidate estates of spouses, as explicitly
authorized under the Bankruptcy Code); First Nat’l Bank of El
Dorado v. Giller (In re Giller), 962 F.2d 796, 799 (8th Cir. 1992)
(stating that the abuse of discretion standard may be appropriate,
but declining to resolve the question). This Court has stated that
“substantive consolidation affects the substantive rights of the
parties and therefore is subject to heightened judicial scrutiny.”
Clyde Bergemann, Inc. v. Babcock & Wilcox Co. (In re Babcock &
Wilcox Co.), 250 F.3d 955, 959 n.6 (5th Cir. 2001). Furthermore,
we review the bankruptcy court’s decision to enter a nunc pro tunc
order for abuse of discretion. See Heartland Fed. Sav. & Loan
Ass’n v. Briscoe Enters., Ltd., II (In re Briscoe Enterprises,
Ltd., II), 994 F.2d 1160, 1170 (5th Cir. 1993); see also Pac.
Shores Dev., LLC v. At Home Corp. (In re At Home Corp.), 392 F.3d
1064, 1067 (9th Cir. 2004).
On March 14, 2002, the bankruptcy court entered an Agreed
Order Partially Lifting the Automatic Stay to Proceed in State
Court Litigation (“Agreed Order”). This order granted Wells
Fargo’s “Emergency Motion to Lift the Automatic Stay to proceed in
8
the lawsuit [in state court] ..., to maintain its temporary
injunction against [AIG] and pursue remedies against [] Peerbhai,
individually[.]” Sommers and Wells Fargo both consented to the
Agreed Order. The bankruptcy court, by granting the motion to lift
the stay, and Sommers, by agreeing to it, explicitly authorized and
consented to Wells Fargo’s pursuit of state court remedies against
Peerbhai. Because of this green light by the bankruptcy court,
Wells Fargo expended its time and money to pursue the state court
litigation until the suit concluded in the Limited Forbearance
Agreement. Yet, when Sommers later filed his motion for
substantive consolidation, which the bankruptcy court in turn
granted, he then sought to undo what he had earlier specifically
authorized by applying the consolidation of the estates nunc pro
tunc. In granting the motion, the bankruptcy court stated that
“[t]he avoidance of the liens granted to Wells Fargo by Peerbhai
pursuant to the Limited Forbearance Agreement would simply return
Wells Fargo to its position as of the petition date.” We think it
was a little late for this reversal of course.
The bankruptcy court, in granting Wells Fargo authorization to
pursue the state court litigation, and then invalidating its
authorization some twenty months later, and nineteen months after
the litigation had terminated in a settlement, cited Section 105(a)
of the Bankruptcy Code as its jurisdictional authority.2 However,
2
The provision granting the bankruptcy court its general
equitable powers states that:
9
“[a] court’s powers under § 105(a) are not unlimited[.]” Mirant
Corp. v. Potomac Elec. Power Co. (In re Mirant Corp.), 378 F.3d
511, 523 (5th Cir. 2004). Section 105(a) “does not permit []
courts to ‘act as roving commission[s] to do equity.’” Id.
(quoting In re Southmark Corp., 49 F.3d 1111, 1116 (5th Cir. 1995))
(second alteration in original).3 But even if the bankruptcy court
The court may issue any order, process, or
judgment that is necessary or appropriate to
carry out the provisions of this title. No
provision of this title providing for the
raising of an issue by a party in interest
shall be construed to preclude the court from,
sua sponte, taking any action or making any
determination necessary or appropriate to
enforce or implement court orders or rules, or
to prevent an abuse of process.
11 U.S.C. § 105(a) (2005).
3
We also note concerns regarding the consolidation of a non-
debtor with a debtor, which is the essence of what the nunc pro
tunc nature of the order granting substantive consolidation
achieved. “The courts are divided on whether they may order
consolidation of a debtor with a nondebtor.” 2 Collier on
Bankruptcy ¶ 105.09[1][c] (15th ed. rev. 2005). Some courts have
allowed such consolidation. See, e.g., Soviero v. Franklin Nat’l
Bank, 328 F.2d 446 (2d Cir. 1964); Walter E. Heller & Co. v.
Langenkamp (In re Tureaud), 59 B.R. 973 (N.D. Okla. 1986). Others
have cautioned that “as careful as the courts must be in allowing
substantive consolidation of debtors to occur ..., the caution must
be multiplied exponentially in a situation where a consolidation of
a debtor’s case with a non-debtor is attempted.” Morse Operations,
Inc. v. Robins Le-Cocq, Inc. (In re Lease-A-Fleet, Inc.), 141 B.R.
869, 872 (Bankr. E.D. Penn. 1992). Still others have held that the
bankruptcy court does not have subject matter jurisdiction over a
non-debtor, thus precluding substantive consolidation, as § 105 of
the Bankruptcy Code is not a jurisdictional grant, and further that
substantive consolidation should not be used to circumvent the
involuntary bankruptcy petition procedures of § 303 of the
Bankruptcy Code. Helena Chem. Co. v. Circle Land & Cattle Corp.
(In re Circle Land & Cattle Corp.), 213 B.R. 870, 876-77 (Bankr. D.
Kan. 1997).
10
had the jurisdictional authority, it abused its discretion in
exerting it. Furthermore, we think that the trustee, Sommers,
should have been more circumspect in requesting such an order given
his earlier approval of the litigation that resulted in settlement
terms that could not have been unexpected. Wells Fargo relied on
the agreement of the trustee and the approval of the court when it
lifted the stay, and Wells Fargo made investments of its time and
money because of this specific approval. Furthermore, nothing in
the record suggests that Sommers knew anything more at the later
date when he asked the court to grant substantive consolidation
than he could have reasonably known at the time the Agreed Order
was entered. This untimely withdrawal of approval might have been
understood if the litigation had produced some anomalous and
unexpected result, but it did not. On the other hand, the
abrogation of the earlier approval worked to the significant
prejudice of Wells Fargo.4
In this case, Peerbhai was a non-debtor on February 4, 2002,
the date to which the bankruptcy court determined in its nunc pro
tunc order that substantive consolidation relates. Peerbhai did
not file his own bankruptcy petition for another ten months after
the petition date of AIA and AIG, and five months after Sommers
filed the Application for Substantive Consolidation. Because
Peerbhai was a non-debtor for such a substantial amount of the
relevant time, special concerns exist. Substantive consolidation
should be ordered with more caution than normal, and jurisdictional
concerns may also be at issue.
4
This abrogation also seems to be in tension with Section
105(a), which allows the court to sua sponte take action to enforce
or implement its orders. In this case, the bankruptcy court
appears to use its Section 105(a) powers to contradict its previous
order.
11
Because we hold that the bankruptcy court erred in applying
substantive consolidation nunc pro tunc, and thus vacate and remand
for further proceedings, we decline to address Wells Fargo’s
arguments regarding the bankruptcy court’s power to grant
substantive consolidation and the proper standard for and
application of substantive consolidation.5 Given that the order of
substantive consolidation, in the absence of a nunc pro tunc order,
appears likely to be fruitless, there is the probability that the
issue will not arise on remand.
IV
5
Without deciding whether the bankruptcy court has the power
to order substantive consolidation, we do note that those
jurisdictions that have allowed it emphasize that substantive
consolidation should be used “sparingly.” In re Owens Corning, 419
F.3d 195, 208-09 (3d Cir. 2005); In re Bonham, 229 F.3d 750, 767
(9th Cir. 2000); Union Sav. Bank v. Augie/Restivo Baking Co. (In re
Augie/Restivo Baking Co.), 860 F.2d 515, 518 (2d Cir. 1988); 2
Collier on Bankruptcy ¶ 105.09[1][d] (15th ed. rev. 2005). It “is
an extreme and unusual remedy.” Gandy v. Gandy (In re Gandy), 299
F.3d 489, 499 (5th Cir. 2002). “Indeed, because substantive
consolidation is extreme ... and imprecise, this ‘rough justice’
remedy should be rare and, in any event, one of last resort after
considering and rejecting other remedies.” Owens Corning, 419 F.3d
at 211. Furthermore, it appears on the record before us that other
remedies, such as the doctrines of alter ego and fraudulent
conveyance, may have been available, and appropriate under the
circumstances, and the bankruptcy court should duly make such
considerations. Substantive consolidation should not be used as “a
‘free pass’ to spare [d]ebtors or any other group from proving
challenges, like fraudulent transfer claims, that are liberally
brandished to scare yet are hard to show.” Owens Corning, 419 F.3d
at 215. As the Owens Corning court noted, if the objectors to
substantive consolidation were as vulnerable to the fraudulent
transfer challenges as alleged, “then the game should be played to
the finish in that arena.” Id.
12
For the reasons stated, the judgment of the district court is
VACATED, and the case is REMANDED for further proceedings
consistent with this opinion.
VACATED and REMANDED.
13