HONORABLE WILLIAM H. GINDIN,
U.S.B.J. PROCEDURAL HISTORY
Presently before the court is a cross-motion for substantive
consolidation and/or extension filed by the plaintiff / creditor
Dominion Financial Corporation.
1On or about April 17, 1996 the debtor, Andonis Morfesis (Morfesis)
filed a petition for bankruptcy under Chapter 7 of the Bankruptcy Code.
The plaintiff, Dominion Financial Corporation commenced the instant
adversary proceeding on or about July 22, 1996. In the adversary
proceeding, Dominion seeks to have certain debts of the debtor declared
non-dischargeable pursuant to 11 U.S.C. § 523(a).
Dominion filed the instant cross-motion for extension and/or
substantive consolidation onAugust 15, 2001. This court heard oral
argument on the motion on August 22, 2001 and reserved decision.
At the hearing, Morfesis, as well as his ex-wife, Maria Morfesis
objected to the motion. The trustee was not present and filed no
opposition or support of the plaintiff’s motion.
The court permitted the parties to file supplemental briefs. Counsel
for the debtor, Andonis Morfesis, counsel for the debtor’s ex-wife,
Maria Morfesis and counsel for the plaintiff/credit or filed
supplemental briefs with the court. JURISDICTION This court has
jurisdiction over the instant matter pursuant to 28 U.S.C. § 1334 and
28U.S.C. § 157. The instant motion is a core matter as defined in 28
U.S.C. § 157(b)(2)(I). Venue
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3is proper in this District pursuant to 287 U.S.C. § 1408.
Additionally, the court has jurisdiction over Maria Morfesis based on
28 U.S.C. § 1334, and 28 U.S.C. §157; coupled with the court’sancillary
and pendant jurisdiction.
To the extent that this court is found to have no jurisdiction asto
any matter, this opinion shall constitute a report and recommendation
pursuant to 28 U.S.C. §157(c)(1). FACTS The plaintiff, Dominion
Financial Company is in the business of lending money to bothbusinesses
and individuals and is a New York corporation. The debtor, Andonis
Morfesis ownsseveral properties in both New York and New Jersey.
Dominion lent money to Morfesis inreturn for a security interest in the
properties and business entities owned and/or operated by Morfesis.
Andonis and Maria Morfesis were married for a period of time, but
divorced sometime in1981. Since that time, they have resided together
at 26 John Street, Englewood Cliffs, NewJersey. Morfesis procured loans
for his business entities through Dominion.
In exchange for each loan, Morfes is executed a note and a mortgage
on a property owned by each respective business entity. In its
complaint, Dominion alleges that Morfesis either entered into the
initial loan agreements with Dominion with the intent to defraud
Dominion by not paying on his obligationsto the plaintiffs, or he
conducted his business entities in such a way as to defraud Dominion.
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Dominion alleges that one such instance of Morfesis attempted fraud was
to have his ex-wife,Maria Morfesis sign guarantees on monies lent by
Dominion to Morfesis. In another instance,Dominion alleges that
Morfesis transferred property to Maria Morfesis, in an attempt to place
the property outside the reach of creditors. Dominion alleges that
Morfesis gave false informationon loan applications, thereby obtaining
loans falsely, and that he used Maria Morfesis as aninstrumentality to
procure loans and defraud the lender. Dominion alleges that Maria
Morfesiswas involved in Morfesis’ alleged acts of fraud, and as such,
Dominion requests that Morfesis ’ bankruptcy estate be extended or
substantively consolidated to include the assets of MariaMorfesis.
DISCUSSIONSubstantive ConsolidationAlthough not specifically mentioned
in the bankruptcy code, substantive consolidation is a tool within the
equitable powers of the bankruptcy court. In re United Stairs, 176 B.R.
359,368 (Bankr. D. N.J. 1995). Pursuant to 11 U.S.C. § 105(a) the
bankruptcy court is afforded equitable powers to carry out the
provisions of the Code and to prevent abuses. Id. at 368. Substantive
consolidation results in the pooling of the assets of, and claims
against two ormore entities, thereby satisfying liabilities from the
resultant common fund, eliminating duplicate claims, and combining the
creditors of the two entities for purposes of voting on reorganization
plans. In re Genesis Health Ventures, Inc., 266 B.R. 591, 655 (Bankr.
D. Del. Sept. 12, 2001),citing, In re Augie/Restivo Baking Co., 860
F.2d 515, 518 (2d Cir. 1988).While the remedy of substantive
consolidation is more widely used to consolidate debtor
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estates already in bankruptcy, its scope has been held to reach
non-debtor entities, under theappropriate circumstances. See Sampsell
v. Imperial Paper & Color Corp., 313 U.S. 215, 85 L.Ed. 1293, 61 S.
Ct. 904 (1941); see also, In re 1438 Meridian Place N.W., Inc., 15
Bankr. 89(Bankr. D.D.C. 1981). The D.C. Circuit has developed a three
part test, whereby, the party requestingsubstantive consolidation must
show:(1) a substantial identity between the entities to be
consolidated;(2) that consolidation is necessary to avoid harm or to
achieve some benefit; and(3) in the event that the creditor shows harm,
that the benefits of consolidation “heavily” outweigh the harm.In re
Auto-Train Corp., 258 U.S. App. D.C. 151, 810 F.2d 270, 276 (D.C. Cir.
1987); see also, In re Genesis Health Ventures, Inc., 266 B.R. 591, 656
(Bankr. D. Del. Sept. 12, 2001).Additionally, this court has adopted a
balancing of the equities test, whereby “the courtmust weigh the
economic prejudice of continued debtor separateness against the
economicprejudice of substantive consolidation.” In re United Stairs,
176 B.R. at 369. Applying the first prong of the test, adopted by the
D.C. circuit in Auto Train andoutlined in Genesis, movant must show
that Maria Morfesis operated as an alter ego of the debtoror of the
debtor’s business entities. See, In re Auto-Train Corp., 258 U.S. App.
D.C. 151, 810F.2d 270, 276 (D.C. Cir. 1987); In re Genesis Health
Ventures, Inc., 266 B.R. 591, 657 (Bankr.D. Del. Sept. 12, 2001). In an
attempt to establish this relationship, movant alleges that
Morfesisused a series of entities, including Maria Morfesis to escape
his liabilities to his creditors,
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including Dominion. Ms. Morfesis testified under oath that she did sign
papers, when her ex-husband asked her to. Among the documents submitted
by counsel for Dominion, are two guarantees signed by Maria Morfesis
thereby guaranteeing loans made by Dominion to businessentities owned
by Morfesis. Two cases are instructive on the application of the first
prong.First, in In re Genesis Health Systems, 266 B.R. 591 (Bankr. D.
Del. Sept. 12, 2001), Judge Wizmur, sitting by designation, found that
the movants showed substantial identitybetween the parties sought to be
consolidated where, the entities operated as separate and integrated
business units without the formality of separate corporate entities.
Id. at 658. Additionally, the presence of a central cash management
system maintained for the entities through which revenues were received
and accounts were paid factored into Judge Wizmur’sdetermination. Id.
at 658. While Morfesis operated several business entities, he did so
without corporate formalities. At no time, however, could it be said
that Maria Morfesis operated any of thebusiness units. Ms. Morfesis
testified under oath that she had no interest in or no idea of
anyinterest she had in her ex-husband’s business entities. Although she
signed two guarantees to Dominion, these acts alone do not make her an
alter ego of Morfesis’ business entities. The relationship between the
parties is unusual in that they are no longer married, but living under
thesame roof. This might suggest a business relationship, but this
court finds that the testimony of Ms. Morfesis is credible and
concludes that she was truly ignorant of Morfesis’ business activities.
She claimed, and the court accepts the explanation that she was acting
to protect her family and to ensure its economic stability.
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Secondly, in United Stairs, 176 B.R. 359 (Bankr. D. N.J. 1995), this
court foundconsolidation warranted where the entities to be
consolidated were alter egos of one another. The court made an alter
ego finding on the grounds that there was a commingling of assets
between the entities. Id. at 369. In the present case, no evidence was
presented of commingledassets. Ms. Morfesis maintains her own checking
account, and has no right to use Morfesis’accounts.The second prong
aims to protect creditors from inequities. See In re Genesis
HealthSystems, 266B.R. 591 (Bankr. D. Del. Sept. 12, 2001). To prove
the second elementsuccessfully, Dominion needs to show that bringing
the assets of Ms. Morfesis into the estatewould benefit their recovery,
or prevent some harm caused by Morfesis alleged fraud. Id. at 656;see
also, In re United Stairs, 176 B.R. at 369. Ms. Morfesis testified that
her only asset is herhouse. No evidence was presented as to the value
of the home, any outstanding indebtedness onthe home and/or any equity
in the home over and above her exemption. Extending Morfesis’bankruptcy
estate to include Ms. Morfesis home does not result in Dominion
receiving a greaterrecovery on its claim. If consolidation were
granted, the estate is not greatly increased becauseMs. Morfesis’ only
asset is her home. Lastly, even if Dominion were able to establish the
first two elements, in no manner doesany benefit of consolidation
“heavily” outweigh the harm that would be done to Ms. Morfesis. In,
United Stairs, this court stated “substantive consolidation should be
considered with extremecaution and granted only in extraordinary
situations.” In re United Stairs, 176 B.R. at 68-69,
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citing, In re Lease-A-Fleet, Inc., v. Robins Le Cocq., Inc., 141 Bankr.
869, 872-73 (Bankr. E.D.Pa. 1992).The reason for caution stems from the
due process rights of the non-debtor. See In reAlpha & Omega
Realty, Inc., 36 B.R. 416 (Bankr. D. Id. 1984). “Consolidation is not
only rarelygranted, but requires strict attention to the concept of due
process.” Id. at 418, citing, Seligsonand Mandell, “Multi-Debtor
Petition– Consolidation of Debtors and Due Process of Law,” [NewYork]
Bankruptcy Bar Bulletin, Vol. 3, No. 2 (June 1968).Movant argues
further that this case is analogous to United Stairs, 176 B.R. 359
(Bankr.D. N.J. 1995), and after a balancing of the equities, Dominion
is entitled to substantiveconsolidation. Movant’s argument is
unavailing. In United Stairs, this court found that thecreditors would
be prejudiced if the entities were permitted to remain separate. Id. at
369. Asdiscussed above, Ms. Morfesis does not bring assets to the
estate of Mr. Morfesis that wouldresult in Dominion receiving a greater
recovery. Due to the very limited assets of Ms. Morfesis,any recovery
of Dominion would appear to have little impact with or without
consolidation.Additionally, in United Stairs, the entities to be
consolidated shared the same creditors.Id. at 369. Here, evidence of
Ms. Morfesis’ creditors, if any, was not submitted. The sole evidence
of Ms. Morfesis creditor’s is the presence of two guarantees she signed
in favor ofDominion. While Ms. Morfesis may be a guarantor of loans
made by Dominion to Mr. Morfesis,that is insufficient to reach a
conclusion that Ms. Morfesis and Mr. Morfesis have the samecreditors.
At the most, they have one creditor in common.
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Conclusion In conclusion, this court finds that movant failed to prove
that Maria Morfesis wassubstantially similar in identity to, or an
alter ago of Andonis Morfesis. Additionally, a balancingof the equities
shows no harm to Dominion absent consolidation, and no benefit to
Dominionwith consolidation. Movant has presented no evidence of any
benefits of consolidation thatwould outweigh Ms. Morfesis’ due process
rights. Based on the aforementioned reasons,movants’ cross motion for
substantive consolidation is denied. The claim for nondischargeability
will proceed to trial.Counsel for Ms. Morfesis shall submit an
appropriate order on notice within ten days ofthe date hereof.BY ORDER
OF THE COURT:DATEWILLIAM H. GINDINUNITED STATES BANKRUPTCY JUDGE
Read the hyperlinked original at
www.njb.uscourts.gov/chambers2/gindin/HENSLER.pdf
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