The Eighth Circuit Extends Substantive Consolidation by Affirming the Consolidation of a Separated Couple’s Bankruptcy Estates

By: Justin A. Klingenberg

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

            In Boellner v. Dowden,[1] the Eighth Circuit held that it is within the discretion of the bankruptcy court to order substantive consolidation of spouses’ bankruptcy estates when they file separate petitions for chapter 7 bankruptcy.[2]  In Boellner, the debtors, Samuel and Marilyn Boellner, who were married and living separately, each filed their own petition for chapter 7 bankruptcy on the same day.[3] James Dowden was assigned as trustee in their respective cases.  In addition to living apart and having individual credit card debt, the debtors “had separate insurance policies, separate interests in business, separate annuities, and separate IRAs….”[4]  However, the debtors shared a checking account, several credit cards, a leased car, and had jointly withdrawn funds from IRAs.[5]  Additionally, the debtors shared obligations for state and federal taxes and attorney’s fees from a previous civil case.[6]  The trustee filed a motion for joint administration and substantive consolidation, arguing that the debtors’ “assets, liabilities, and handling of financial affairs were substantially the same,” and permitting them to “maintain separate bankruptcy estates would prejudice the creditors.”[7]  The debtors disagreed and argued that they should be permitted to maintain separate bankruptcy estates because it would allow Samuel, the husband, to choose federal exemptions and Marilyn, the wife, to choose state exemptions.[8]  After comparing the schedules filed by each spouse, the bankruptcy court ruled in favor of the trustee, and ordered substantive consolidation.[9]  The debtors appealed to the Bankruptcy Appellate Panel and the trustee removed the appeal to the district court, which affirmed the bankruptcy court’s order.[10]  Subsequently, the debtors appealed to the Eighth Circuit, contending that the substantive consolidation order was an abuse of the bankruptcy court’s discretion.[11]  In determining whether substantive consolidation was appropriate, the Eighth Circuit adopted a two-prong factor test articulated by the Eleventh Circuit that considered “(1) whether there is a substantial identity between the assets, liabilities, and handling of financial affairs between the debtor spouses; and (2) whether harm will result from permitting or denying consolidation.”[12]  In assessing the first factor, the Eighth Circuit found that the bankruptcy court’s reliance on the debtor’s statements of financial affairs and bankruptcy schedules was appropriate.[13]  In concluding the first factor had been fulfilled and, thus, substantial identity had been established, the Eighth Circuit emphasized the bankruptcy court’s finding it peculiar that Marilyn claimed ownership of the home while Samuel claimed ownership of the household’s goods.[14]  In its analysis of the second factor, the Eight Circuit affirmed the bankruptcy court’s finding that the evidence was sufficient to establish harm to creditors, particularly because the debtor’s “separate estates would have significantly less value than if their cases were substantively consolidated and [they] were forced to choose either federal or state exemptions.”[15]  Ultimately, the Eighth Circuit held that, since substantial identity had been established and separate estates would greatly prejudice the debtor’s creditors, the bankruptcy court was within its discretion in ordering substantive consolidation.[16]

            In In re Reider, the Eleventh Circuit became the first court of appeals to recognize the equitable remedy of substantive consolidation outside of the corporate context.[17]  Prior to that case, only a handful of district court and bankruptcy court decisions had addressed substantive consolidation in a spousal context.[18]  Three of those cases held that “cases should be consolidated where the affairs of the husband and wife are so intermingled that their respective assets and liabilities cannot be separated.”[19]  The Eleventh Circuit recognized the legitimacy of that rule and incorporated it into its own inquiry, but concluded that it “should not be the sole test” and developed the two-prong inquiry later cited by the Eight Circuit in Boellner. [20]  In the twenty one years between In re Reider and Boellner, substantive consolidation outside of the corporate context has been recognized by four other Circuit Court decisions.[21]  However, none of those Circuit Courts articulated their own test or explicitly adopted the one implemented by In re Reider.

            Boellner v. Dowden represents the continued expansion of substantive consolidation into the non-corporate context.  The Eighth Circuit became the sixth Circuit Court to recognize the equitable power of bankruptcy courts to substantively consolidate the separate estates of debtor spouses.  However, the Eighth Circuit is the first Circuit Court to actually affirm an order substantively consolidating the separate estates of debtor spouses.[22]  In doing so, the court notably omitted a cautionary statement about substantive consolidation’s sparing use, a statement included in most substantive consolidation opinions.[23]  Furthermore, in contrast to debtor spouses in most of the other Circuit Court decisions that considered substantive consolidation, the debtor spouses in Boellner are separated and did not file for joint administration.  By affirming the substantive consolidation of two separate bankruptcy estates of debtor spouses that are separated and filed separately, the Eighth Circuit not only continued the remedy’s expansion into a non-corporate context, but also extended its application in a way that no Circuit Court has done before.