Reider, In re

Decision Date13 September 1994
Docket NumberNo. 93-8128,93-8128
Citation31 F.3d 1102
PartiesIn re Ida V. REIDER and James M. Reider, Debtors. Ida V. REIDER, Plaintiff-Appellant, v. FEDERAL DEPOSIT INSURANCE CORPORATION, Defendant-Appellee.
CourtU.S. Court of Appeals — Eleventh Circuit

Thomas Paty Stamps, Office of Thomas Paty Stamps, Heidi Hughes, Atlanta, GA, for appellant.

Thomas E. Prior, Prior & Buser, Atlanta, GA, O. Byron Meredith, III, Harmon T. Smith, Jr., Chapter 7 Trustee, Gainesville, GA, Kathryn R. Norcross, F.D.I.C., Washington, DC, for appellee.

Appeal from the United States District Court for the Northern District of Georgia.

Before ANDERSON and DUBINA, Circuit Judges, and ESCHBACH *, Senior Circuit Judge.

ANDERSON, Circuit Judge:

I. INTRODUCTION

In this case of first impression, we address the propriety of substantive consolidation of the estates of debtors who are spouses. This appeal arises from the district court's affirmance of the bankruptcy court's order substantively consolidating estate of debtor Ida V. Reider with that of her husband. For the reasons that follow, we reverse the judgment of the district court.

II. FACTS

A corporation owned by Ida and James Reider operated a horse breeding business, Clermont Farms, Inc., using land owned by Ida Reider. The Reider's primary stud, Mastercard, died, and James Reider entered into an agreement with Jack Johnson to buy a replacement stud, Magnum T.I. Johnson arranged for Clermont Farms through its president James Reider to borrow $250,000 from Florida Center Bank ("FCB"). James Reider personally guaranteed the loan. Johnson was involved in several bank fraud schemes with the president of FCB, Mr. Justice, and never paid his portion of the purchase price for the stud. The arrangement concerning the horse purchase apparently formed part of a larger agreement between Johnson and Reider because Reider relayed most of the funds from the loan to Johnson so that Johnson's father's horse farm, in which Johnson had some interest, could be improved as part of a cooperative venture with Clermont Farms. Without funds and without a horse, the Reiders on December 12, 1985, filed a joint Chapter 11 bankruptcy petition, which was subsequently converted to a Chapter 7 proceeding.

FCB failed in April, 1986, and FDIC acquired the claim against James Reider in a purchase and assumption transaction. Forming the basis for the claim was the personal guarantee executed by James Reider the day that he signed the corporate loan papers. On the list of personal assets Reider tendered to bank officials was the farm land owned by Reider's wife Ida who had inherited the property from her mother. On May 23, 1988, the farm was sold by the trustee for $400,000. On July 13, 1988, the FDIC filed a proof of claim for $320,978.58, to which the Trustee objected. In an initial adversary proceeding contesting the allowance of FDIC's claim, James Reider asserted that he never executed the personal guarantee. A handwriting expert testified otherwise, and the bankruptcy court agreed. In that prior proceeding, three attacks were mounted against the FDIC's claim: 1) late filing, FDIC having waited two years after taking over FCB before filing a claim; 2) absence of consideration due to fraud; and 3) no personal liability. The argument concerning the absence of personal liability centered on Reider's testimony that he had not knowingly signed the guarantee. The bankruptcy court overruled the Trustee's objection and allowed the FDIC's claim on July 9, 1990. The district court affirmed this decision on August 27, 1991.

In a December 15, 1988, order relating to exemptions, the bankruptcy court held that the real estate was titled solely in the name of Mrs. Reider. In denying any exemption for Mr. Reider, the court held that his status as spouse and his assertion of financial contributions to the property were insufficient to create an enforceable equitable interest in the property.

The record on appeal in this case reflects that the first mention in this case of the concept of substantive consolidation came in October, 1990. On September 25, 1990, the Reiders had filed an amendment to Schedule B-4, the purpose of which was to seek an increased exemption. In response thereto, FDIC on October 11, 1990, argued for the first time in this case that because the case had been filed as a joint case by two spouses, because the trustee had intermingled the funds, because the debtors had not affirmatively set out a breakdown of the separate assets and liabilities of each estate, and because the assets and liabilities of the two debtors were so intermingled that they could not be separated, a substantive consolidation had in fact resulted. On October 25, 1990, debtors responded to FDIC's attempt to gain distribution of the funds, arguing that any order of distribution would have to consider the funds of each of the individual estates, and that the estate of Mrs. Reider could be distributed only to the creditors of the estate of Mrs. Reider and not to any other parties. On November 5, 1990, the debtors filed a formal motion to require separate distribution of each estate, and the accompanying brief responded at length on the substantive consolidation issue. On November 20, 1990, FDIC filed a further brief on the issue. On January 28, 1991, the Reiders filed a further brief on the issue, and filed an amended schedule separating the assets and liabilities of the two estates. On Feb. 5, 1991, the FDIC filed a final brief on the issue.

On December 20, 1991, the bankruptcy court issued an order substantively consolidating the two estates. The court also denied the motion to increase Ida Reider's exemptions because she had already received the one exemption to which she was entitled. The court sua sponte reconsidered its prior order denying James Reider's claim for exemption and allowed him a $5,400 exemption to be paid out of the proceeds of the property. The district court affirmed both issues. Mrs. Reider appeals. We reverse.

III. STANDARD OF REVIEW

Because the district court in reviewing the decision of a bankruptcy court functions as an appellate court, we are the second appellate court to consider this case. Capital Factors, Inc. v. Empire for Him, Inc., 1 F.3d 1156, 1159 (11th Cir.1993). Thus, this Court's review with regard to determinations of law, whether made by the bankruptcy court or by the district court, is de novo. Equitable Life Assurance Soc. v. Sublett, 895 F.2d 1381, 1383 (11th Cir.1990). The district court makes no independent factual findings; accordingly, we review solely the bankruptcy court's factual determinations under the "clearly erroneous" standard. Rush v. JLJ Inc., 988 F.2d 1112, 1116 (11th Cir.1993); Bankr.Rule 8013; Bankr.Rule 7052. Pursuant to Section 302(b) and Rule 1015(b), a bankruptcy court may in exercising its equitable discretion order substantive consolidation of cases involving two related debtors. 11 U.S.C. Sec. 302(b); Rule 1015(b). Thus, we review an order of substantive consolidation for abuse of discretion. In re Giller, 962 F.2d 796, 799 (8th Cir.1992).

IV. DISCUSSION

A. Substantive Consolidation

In arguing that the bankruptcy court erred in ordering substantive consolidation, appellant argues that joint administration should not alter the separate nature of the estates created by bankruptcy or constitute a factor for consideration in ordering substantive consolidation. For the reasons that follow, we conclude that the courts below applied incorrect legal standards and that it would be an abuse of discretion to order substantive consolidation on the record in this case. 1

Section 302 2 of the Bankruptcy Code provides that spouses may file joint cases. 11 U.S.C. Sec. 302(a). After the commencement of a joint case, the court shall determine the extent, if any, to which the debtors' estates shall be consolidated. 11 U.S.C. Sec. 302(b). Because this case presents an issue of first impression among the circuits and has been addressed by few bankruptcy decisions, we begin our analysis with an overview of the development of substantive consolidation case law.

1. Historical background of the Eastgroup analysis

Substantive consolidation traces its roots to the Bankruptcy Act of 1898. The Act then contained no express statutory authorization for consolidation, either generally or in the case of spouses. 3 Instead, the authority to order substantive consolidation was implied from the bankruptcy court's general equitable powers. See Pepper v. Litton, 308 U.S. 295, 304, 60 S.Ct. 238, 244, 84 L.Ed. 281 (1939) ("courts of bankruptcy are essentially courts of equity, and their proceedings inherently proceedings in equity"). In 1940, the Supreme Court gave its tacit approval to this equitable power to substantively consolidate two estates. Sampsell v. Imperial Paper & Color Corp., 313 U.S. 215, 61 S.Ct. 904, 85 L.Ed. 1293 (1940). 4 Early decisions in the corporate context applied essentially an alter ego or pierce the corporate veil test in assessing the propriety of substantive consolidation. See, e.g., Fish v. East, 114 F.2d 177 (10th Cir.1940); Stone v. Eacho (In re Tip Top Tailors, Inc.), 127 F.2d 284 (4th Cir.), cert. denied, 317 U.S. 635, 63 S.Ct. 54, 87 L.Ed. 512 (1942); Maule Industries, Inc. v. Gerstel, 232 F.2d 294 (5th Cir.1956). Subsequently, a series of decisions from the Second Circuit articulated the contours of substantive consolidation which continue to guide current case law in this area. See In re Continental Vending Machine Corp., 517 F.2d 997 (2d Cir.1975); In re Flora Mir Candy Corp., 432 F.2d 1060 (2d Cir.1970); Chemical Bank New York Trust Co. v. Kheel, 369 F.2d 845 (2d Cir.1966); Soviero v Franklin National Bank of Long Island, 328 F.2d 446 (2d Cir.1964). Because of their continued importance, we examine each of these decisions in turn.

In Soviero v. Franklin National Bank of Long Island, 328 F.2d 446 (2d Cir.1964), the evidence established that...

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