The Third Circuit Court of Appeals issued this decision yesterday in connection with the Owen Cornings chapter 11 case in which it reversed a bankruptcy court decision that substantively consolidated Owens Corning and its numerous units as one entity for purposes of confirming the company’s reorganization plan.
Substantive consolidation in large reorganization cases is a favored tactic of tort claimants (it was favored by asbestos claimants in the Owens Corning case) and creditors of a company’s unprofitable units that allows those creditors to share in distributions generated from the company’s more profitable units. Lenders to those profitable units generally balk at substantive consolidation because it dilutes the dividend that they would otherwise receive on their claims against the profitable unit by allowing the claims against the unprofitable units to share in distributions from the profitable unit. In the Owens Corning case, the Third Circuit’s decision is a victory for a group of banks led by Credit Suisse Group’s Credit Suisse First Boston that has hundreds of millions of dollars riding on the separation of Owens Corning from its more profitable units.

Owens Corning is a large manufacturer of building materials that filed a chapter 11 case in 2000 to resolve the risk of huge unliquidated asbestos-related personal-injury claims. However, some of Owens Corning’s most profitable units did not file their own chapter 11 case. Accordingly, the effect of the Third Circuit’s decision is that the lenders to those more profitable units will be able to claim superior distribution rights over those of tort claimants from the assets of the profitable subsidiaries, leaving the tort claimants and other creditors of the parent company to fight over the diminished assets of the parent.
Substantive consolidation was also recently used in the Enron Corp. chapter 11 case in connection with confirmation of the reorganization plan in that case. The tactic was opposed by creditors of certain of Enron’s more profitable units and, as I recall, the Bankruptcy Court’s decision overruling those objections was appealed. Thus, you can bet that the Third Circuit’s decision is being studied this morning by lawyers involved in the Enron case to determine the possible impact on the Enron reorganization plan.