Part I United States, 4 Lessons from Lehman: Forcing A Settlement of Substantive Consolidation

Abstract

‘Substantive consolidation’ is the deemed merger of a bankrupt corporation with one or more other corporations, so that the assets of all the corporations are pooled and their value distributed to the creditors of all the entities. It penalizes creditors of more solvent debtors and rewards creditors of less solvent debtors. It is supposedly an ‘extraordinary remedy’ that is nevertheless frequently threatened in complex chapter 11 bankruptcy cases. This chapter describes the remedy of substantive consolidation, the facts in Lehman’s chapter 11 cases that made it the critical issue, and the threat of ‘involuntary settlement’ that avoided years of litigation and produced a fully consensual plan. The threat of an ‘involuntary settlement’ was a huge success in the Lehman case but the technique is very powerful and potentially very dangerous, as the chapter concludes.