Opinion
C/A No. 17-02989-HB Adv. Pro. No. 19-80017-HB Adv. Pro. No. 19-80018-hb
09-29-2020
IN RE, AUDITHEAD, LLC, Debtor(s). John K. Fort, as Chapter 7 Trustee, Plaintiff(s), v. Tryon Clear View Group, LLC, Laura Maryanne Terranova, Defendant(s).
Randy A. Skinner, Randy A. Skinner, Skinner Law Firm, LLC, Greenville, SC, for Debtor. Kristin Burnett, Shane Rogers, Shane W Rogers, Barber Johnson Smith Hibbard & Wildman Law Firm, Spartanburg, SC, for Plaintiff. Tryon Clear View Group, LLC, pro se. Laura Maryanne Terranova, pro se.
Randy A. Skinner, Randy A. Skinner, Skinner Law Firm, LLC, Greenville, SC, for Debtor.
Kristin Burnett, Shane Rogers, Shane W Rogers, Barber Johnson Smith Hibbard & Wildman Law Firm, Spartanburg, SC, for Plaintiff.
Tryon Clear View Group, LLC, pro se.
Laura Maryanne Terranova, pro se.
ORDER ON CROSS MOTIONS FOR SUMMARY JUDGMENT
THIS MATTER is before the Court for consideration of the Motion for Summary Judgment filed by Plaintiff John K. Fort, Chapter 7 Trustee, and the Motion for Summary Judgment filed by Defendants Tryon Clear View Group, LLC ("TCVG") and Laura Maryanne Terranova. Each party objected to the opposing Motion.
ECF Nos. 41 & 42, filed Aug. 17, 2020.
ECF Nos. 45 & 46, filed Sept. 2, 2020.
SUMMARY OF FACTS
John Taylor and Terranova have been married since 1987. In 2002, Taylor formed AuditHead, LLC and served as its President. The company was initially formed as a South Carolina limited liability company because it operated out of Taylor's South Carolina residence. When its operations moved to a leased location in Tryon, a North Carolina limited liability company was formed. For purposes of this proceeding, the entities are treated as one and collectively referred to as "AuditHead."
AuditHead provided cost-reduction services via audits of its clients' operational expenses in the telecommunications and utilities service areas. Its clients included hospitals, long-term care facilities, clinics, and colleges. AuditHead employed sales representatives who reported to Taylor and were a combination of employees and independent contractors, and auditors who were independent contractors.
Creditor Catherine Rotruck began working for AuditHead in 2003. Rotruck claims she realized in November 2007 that AuditHead underpaid her in both wages and unpaid commissions. Rotruck remained employed by AuditHead despite this. In June 2008, Rotruck and Taylor began a personal relationship. When Rotruck refused to continue this relationship, she claims Taylor harassed her, which caused a hostile work environment and forced Rotruck to resign in October 2009. When Rotruck resigned, Terranova joined AuditHead in administrative, marketing, and sales roles.
In 2010, Rotruck filed a lawsuit against AuditHead and Taylor in the Court of Common Pleas for Spartanburg County. Terranova and TCVG were not named as defendants in that action. The lawsuit asserted causes of action for sexual harassment and sex discrimination under Title VII, violation of the Wage Payment Act of South Carolina, S.C. Code Ann. § 41-1-10 et seq. , promissory estoppel/detrimental reliance, breach of contract, and fraud and misrepresentation. She also asserted a claim for intentional infliction of emotion distress/outrage against only Taylor. Correspondence from the North Carolina Department of Labor to Rotruck dated October 28, 2011 states it completed an investigation of AuditHead regarding Rotruck's wage claim and determined AuditHead owes her $52,841.00 in back wages. AuditHead refused to voluntarily pay this amount and the Department of Labor did not to pursue legal action on Rotruck's behalf.
Rotruck v. Taylor, et al. , C/A No. 2010-CP-42-05471.
These causes of action are asserted in the amended complaint filed in the state court action on June 28, 2013. A copy of this amended complaint is attached to Rotruck's proof of claim.
A copy of this correspondence is attached to Rotruck's proof of claim.
In late 2011, AuditHead ceased operations by no longer offering new services or soliciting new clients. At that time, there were pending audits that took approximately four or five years for auditors to complete and generate a report. Taylor's role was limited to ensuring these pending audits were completed and billed to clients and to collecting receivables for prior work performed. Collected funds were deposited into AuditHead's bank account, which was eventually closed in 2017.
Using her experience at AuditHead and having discovered businesses certified as woman-owned have certain advantages, Terranova left AuditHead in 2011 to form TCVG. TCVG is a North Carolina limited liability company. Terranova is the sole member and serves as its Chief Executive Officer. TCVG began operations in November 2011 and there was no delay between when AuditHead ceased new business and TCVG began. Terranova was aware of Rotruck's lawsuit against AuditHead and Taylor prior to forming TCVG.
Terranova personally funded TCVG's startup costs and operating expenses. However, TCVG's sales representatives and auditors initially used AuditHead's office equipment and computers. This equipment was purchased by TCVG in December 2011 for $5,225.00, and the proceeds were deposited into AuditHead's bank account. TCVG also operated out of AuditHead's office location in Tryon for several months while AuditHead continued to pay the rent. There was no sublease between AuditHead and TCVG. TCVG moved to a new location in 2012. There is nothing in the record to indicate TCVG and/or Terranova did not keep adequate corporate books and records or otherwise adhere to corporate formalities.
Taylor joined TCVG shortly after it was formed. One year later he began serving the role of President of TCVG. Taylor is involved in TCVG's sales and operations. TCVG contracted with all of AuditHead's prior sales representatives and auditors. Thus, there appears to be a period when auditors were contracted by TCVG and working on completing pending audits for AuditHead. TCVG's sales representatives and auditors are independent contractors and paid according to the same compensation structure used at AuditHead. All sales representatives and auditors report to Taylor. Thus, Taylor serves in managerial and leadership capacities for TCVG, similar to those he held at AuditHead, and appears to be involved in both day-to-day operations as well as upper-level decision-making.
TCVG offers the same audit services that AuditHead offered, but to different clientele because TCVG is a certified woman-owned small business. With this certification, TCVG markets itself to businesses in need of diversity vendors pursuant to internal or governmental requirements. Although TCVG provides services to some of AuditHead's former clients, AuditHead and TCVG did not compete for business. TCVG's clients include hospitals, health systems, companies, and government entities. TCVG hired auditors from AuditHead to perform audits for the telecommunications service area, which comprises 80-95% of TCVG's business. TCVG also hired new auditors for its additional service areas of waste, managed print, document storage, mailing equipment, equipment maintenance, credit card fees, and staffing.
AuditHead filed a voluntary petition for Chapter 7 relief in June 2017. Rotruck filed the only proof of claim, in the amount of $1,677,841.00, claiming back wages and other damages asserted in her lawsuit. The statement attached to Rotruck's proof of claim categorizes her claim as follows: $52,841.00 for back wages owed; $115,000.00 for commissions owed prior to termination as an employee of AuditHead; $1,500,000.00 for commissions owed after termination by AuditHead ($300,000.00 per year for 5 years); and $10,000.00 for stress-related medical expenses.
In this action, the Trustee asserts TCVG was created by Terranova for the sole purpose of continuing AuditHead's business while avoiding Rotruck's claim. The Complaint cites 11 U.S.C. §§ 548 and 550, the Federal Uniform Declaratory Judgment Act, 28 U.S.C. § 2201, et seq. , and the South Carolina Uniform Declaratory Judgment Act, S.C. Code Ann. § 15-53-10, et seq. However, it asserts only the following causes of action: successor liability, alter ego, piercing the corporate veil, and substantive consolidation. The Complaint does not discern whether each cause of action is asserted against TCVG, Terranova, or both Defendants. Taylor is not a party to this lawsuit.
The Trustee also asserted a cause of action seeking injunctive relief; however, he no longer intends to proceed with that claim. See ECF No. 45. There were no specific causes of action asserted under §§ 548 or 550.
DISCUSSION
This Court has jurisdiction over this proceeding pursuant to 28 U.S.C. § 1334(a) and (b), 28 U.S.C. § 157, and Local Civ. Rule 83.IX.01 (D.S.C.). This matter is a core proceeding under 28 U.S.C. § 157(b)(2)(A) and (O) and the parties have consented to this Court's entry of a final order.
Defendants assert North Carolina law applies here, whereas the Trustee asserts South Carolina law is appropriate. As set forth in detail below, the result would be the same regardless of which states' laws govern this action.
I. STANDARD OF REVIEW
Fed. R. Civ. P. 56(a) provides "[t]he court shall grant summary judgment if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." The burden of demonstrating the absence of a genuine issue of material fact rests on the party seeking summary judgment. Though the moving party bears this initial burden, the non-moving party must then produce "specific facts showing that there is a genuine issue for trial." Celotex Corp. v. Catrett , 477 U.S. 317, 323, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). A genuine dispute of material fact exists "if the evidence is such that a reasonable [trier of fact] could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc. , 477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986). "When faced with cross-motions for summary judgment, the court must review each motion separately on its own merits ‘to determine whether either of the parties deserves judgment as a matter of law.’ " Rossignol v. Voorhaar , 316 F.3d 516, 523 (4th Cir. 2003) (quoting Philip Morris Inc. v. Harshbarger , 122 F.3d 58, 62 n.4 (1st Cir. 1997) ). II. SUCCESSOR LIABILITY
Made applicable to this adversary proceeding by Fed. R. Bankr. P. 7056.
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In North and South Carolina, as in most states, a successor corporation is generally not liable for the debts and liabilities of its predecessor. See Nationwide Mut. Ins. Co. v. Eagle Window & Door, Inc. , 424 S.C. 256, 818 S.E.2d 447, 451 (2018) ("[C]orporate law generally favors the free transfer of assets and disfavors successor liability."). However, as relevant here, exceptions to this rule include if "the successor company was a mere continuation of the predecessor; or ... the transaction was entered into fraudulently for the purpose of wrongfully defeating creditors' claims." Id. (citing Brown v. American Ry. Express Co. , 128 S.C. 428, 123 S.E. 97 (1924) ); see also G.P. Publ'n, Inc. v. Quebecor Printing-St. Paul, Inc. , 125 N.C.App. 424, 481 S.E.2d 674, 683 (1997).
North and South Carolina courts have rejected the continuity of enterprise theory of successor liability, which examines the successor's use of the predecessor's business operation, assets, and personnel. Id. at 453 ; Collins v. First Fin. Servs., Inc. , C/A No. 7:14-CV-288-FL, 2016 WL 589688, at *22 (E.D.N.C. Feb. 10, 2016). Rather, in order for the "mere continuation" exception to apply, there generally must be commonality of ownership and management among the entities (e.g., shareholders, officers, and directors). Eagle Window & Door , 818 S.E.2d at 453. Although the mere continuation exception to successor liability is narrow, it is not restricted entirely:
While commonality of ownership is a keystone of the analysis and almost always sufficient to establish mere continuation when paired with common directors and officers, we stress control is an essential consideration as well. Typically, ownership and control are found in tandem; however, there may be instances where directors or officers – lacking ownership – exert such control and influence over a corporation that their continued presence after a corporate acquisition is sufficient to establish successor liability .
Eagle Window & Door , 818 S.E.2d at 454 (emphasis added).
With respect to the exception allowing successor liability if the transaction was entered into fraudulently for the purpose of wrongfully defeating creditors' claims, "the general rule is that a successor must knowingly participate in a fraudulent asset transfer." Walton v. Mazda of Rock Hill , 376 S.C. 301, 657 S.E.2d 67, 70 (S.C. Ct. App. 2008) (citation omitted). "Proving such knowledge is difficult, and a few courts have advocated expanding the fraud exception to include reviewing the successor's actual or constructive knowledge." Id. (citation omitted); see also Lattimore & Assocs., LLC v. Steaksauce, Inc. , No. 10 CVS 14744, 2012 WL 1925729, at *15 (N.C. Super. May 25, 2012) ("The market for substantial asset purchases encourages the efficient allocation of business assets away from failing entities and into the hands of stronger or better capitalized competitors. Absent plausible evidence of irresponsible dealings, fraud or wrongful advantage, to impose successor liability on a transaction conducted pursuant to a due diligence inquiry, and circumscribed by clearly defined contractual terms, would unnecessarily discourage good-faith asset purchases of substantially all assets of a corporation.")
The Trustee seeks judgment in his favor that TCVG is liable for the debts and obligations of AuditHead because it is a mere continuation of AuditHead. TCVG seeks a contrary judgment. Although there is no commonality of ownership among AuditHead and TCVG, there is commonality of management in that Taylor has served as President for and is involved in the leadership and operations of both companies. Taylor is involved in sales for TCVG as he was AuditHead, and the auditors and sales representatives of both companies reported to him. He is also married to Terranova, who is the owner of TCVG, and TCVG was formed and aided early on with the use of AuditHead's property lease and equipment. The Court must weigh these facts and the credibility of the witnesses to determine whether Taylor exerted such control and influence that, despite cessation of operations and new ownership, AuditHead's presence continued through TCVG. Therefore, summary judgment in favor of the Trustee or TCVG as to this theory of liability is not appropriate. For reasons discussed below, this is the only theory of recovery that survives this Order.
The Trustee also seeks judgment in his favor that TCVG is liable for the debts and obligations of AuditHead because it was created fraudulently for the wrongful purpose of defeating AuditHead's creditors. TCVG seeks a summary judgment finding that it is not liable. The fraud exception to successor liability generally applies to transfers of a company's assets. There were some transfers from AuditHead to TCVG and some consideration was paid. While the timing of events and relationship among the parties may be noteworthy, they are not conclusive. Regardless, the record indicates that AuditHead elected – as a corporation may – to cease doing business and sell whatever assets it had available. Although Rotruck's claim may remain unpaid by AuditHead, viewing the facts in the light most favorable to the Trustee, he has failed to call the Court's attention to parts of the record that support a finding that the transfer of assets to TCVG or creation of TCVG was fraudulent and for the purpose of wrongfully defeating Rotruck's claim. Therefore, judgment should be entered in favor of TCVG regarding this theory of successor liability.
To the extent the Trustee asserts claims for successor liability against Terranova, his Motion is denied. The Trustee fails to allege or provide any factual or legal basis to hold Terranova personally liable for the debts and obligations of AuditHead under a successor liability theory. Viewing the facts in the light most favorable to the Trustee, there is no evidence that Terranova, personally, was a continuation of AuditHead, that she was involved with the leadership and management of AuditHead, or that she held an ownership interest in AuditHead prior to forming TCVG to provide a foundation for a mere continuation theory of successor liability. While TCVG purchased certain assets of AuditHead, there is no evidence that Terranova participated in a fraudulent asset transfer in an individual capacity. Accordingly, Terranova's Motion for Summary Judgment should be granted as to this cause of action.
III. ALTER EGO
Alter ego describes a theory of procedural relief. Drury Dev. Corp. v. Found. Ins. Co. , 380 S.C. 97, 668 S.E.2d 798, 800 n. 1 (2008). "[T]he alter ego doctrine is merely a means of piercing the corporate veil." Jones ex rel. Jones v. Enter. Leasing Co.-Se. , 383 S.C. 259, 678 S.E.2d 819, 823 (S.C. Ct. App. 2009). "Under this theory, when a parent company controls the business decisions and actions of its subsidiary, the subsidiary becomes an instrument or alter ego of the parent." Id. (citing Peoples Fed. Sav. & Loan Ass'n v. Myrtle Beach Golf & Yacht Club , 310 S.C. 132, 425 S.E.2d 764, 774 (S.C. Ct. App. 1992) ).
The South Carolina Supreme Court has held that "[a]n alter-ego theory requires a showing of (1) total domination and control of one entity by another and (2) inequitable consequences caused thereby." Oskin v. Johnson , 400 S.C. 390, 735 S.E.2d 459, 465 (2012) (citing Colleton Cnty. Taxpayers Ass'n v. Sch. Dist. of Colleton Cnty. , 371 S.C. 224, 638 S.E.2d 685, 692 (2006) ). "Control may be shown where the subservient entity manifests no separate interest of its own and functions solely to achieve the goals of the dominant entity." Colleton Cnty. , 638 S.E.2d at 692. "Common officers and/or directors and public identification of one corporation as the other's subsidiary do not, without more, support the conclusion the subsidiary is its parent's alter ego or agent for the transaction of its business." Yarborough & Co. v. Schoolfield Furniture Indus., Inc., 275 S.C. 151, 268 S.E.2d 42, 44 (1980) (citations omitted). "[O]ne must show that the retention of separate corporate personalities would promote fraud, wrong or injustice, or would contravene public policy." Mid-S. Mgt. Co. Inc. v. Sherwood Dev. Corp. , 374 S.C. 588, 649 S.E.2d 135, 143 (S.C. Ct. App. 2007) (citing Colleton Cnty. , 638 S.E.2d at 692 ).
To prove an alter ego relationship between corporate entities under North Carolina law, the following must be established:
(1) Control, not mere majority or complete stock control, but complete domination, not only of finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction had at the time no separate mind, will or existence of its own; and
(2) Such control must have been used by the defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or a dishonest and unjust act in contravention of plaintiff's legal rights; and
(3) The aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of.
Estate of Rivas by & through Soto v. Fred Smith Constr., Inc. , 258 N.C.App. 13, 812 S.E.2d 867, 870 (2018) (citing Fischer Inv. Capital, Inc. v. Catawba Dev. Corp. , 200 N.C.App. 644, 689 S.E.2d 143, 147 (2009) ).
Although the elements needed to prove an alter ego relationship differ superficially between North and South Carolina, they are substantively the same. Both require a showing of control of the entity by a dominant shareholder or member and an inequitable result and injury to a third party caused by such control.
The Trustee has failed to demonstrate what fraud, wrong, or injustice would result if TCVG is not considered the alter ego of AuditHead. While Rotruck's claim may remain unpaid, the fact that one entity stopped its business without paying all claims and another started is insufficient to hold the latter liable under this theory of recovery and his Motion must be denied. Further, even if Taylor or AuditHead continued to exercise control over the business and decisions of TCVG, viewing the record in the light most favorable to the Trustee, he has failed to point to anything in the record indicating that TCVG was created in order to promote fraud, wrong or injustice, or to contravene public policy. Therefore, judgment should be entered in favor of TCVG regarding this alter ego claim.
The Trustee's Motion must be also denied and summary judgment granted in favor of Terranova as to this claim because the Trustee fails to allege or provide any factual or legal basis to hold Terranova personally liable for the debts and obligations of AuditHead under an alter ego theory. There is no evidence that Terranova, individually, was in a management or decision-making position at AuditHead that would allow her to exercise control over TCVG through that role. Rather, the record indicates Terranova left her employee position at AuditHead and then separately formed TCVG.
IV. PIERCING THE CORPORATE VEIL
Under South Carolina law, unless certain exclusions apply:
the debts, obligations, and liabilities of a limited liability company, whether arising in contract, tort, or otherwise, are solely the debts, obligations, and liabilities of the company. A member or manager is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manager.
S.C. Code Ann. § 33-44-303(a). Moreover, the "failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company." S.C. Code Ann. § 33-44-303(b). Likewise, the North Carolina Limited Liability Company Act provides that LLC members and managers are not liable for the debts and obligations of the LLC solely by reason of being a member or manager. N.C.G.S. § 57D-3-30.
The courts have nonetheless recognized that a "corporate fiction" may be disregarded in appropriate circumstances. Parker Peanut Co. v. Felder , 200 S.C. 203, 20 S.E.2d 716 (1942). However, piercing the corporate veil "is not a doctrine to be applied without substantial reflection." Baker v. Equitable Leasing Corp. , 275 S.C. 359, 271 S.E.2d 596, 600 (1980). Whether to pierce the corporate veil is governed by equitable principles, and the party seeking to do so bears the burden of proving it should be applied. Drury Dev. Corp. v. Found. Ins. Co. , 380 S.C. 97, 668 S.E.2d 798, 800 (2008).
South Carolina Courts have adopted a two-prong test. The first prong involves an eight-factor analysis that looks to the observance of corporate formalities. Sturkie v. Sifly , 280 S.C. 453, 313 S.E.2d 316, 318 (S.C. Ct. App. 1984) (citing DeWitt Truck Brokers, Inc. v. W. Ray Flemming Fruit Co. , 540 F.2d 681, 686-87 (4th Cir. 1976) ). The factors considered under the first prong are: (1) undercapitalization; (2) failure to pay dividends; (3) insolvency; (4) lack of corporate records; (5) siphoning off of corporate funds by dominant shareholders; (6) use of the corporation as a mere façade for operations of its dominant shareholders; (7) the non-functioning of other officers or directors; and (8) other failures to observe corporate formalities. DeWitt at 686-87. Some combination of these factors is required to meet the first prong of the piercing test, and no single factor alone will suffice. Id. at 687.
The second prong considers whether the party seeking to pierce the corporate veil would suffer injustice or fundamental unfairness if the acts of the corporation are not regarded as the acts of the individual shareholders. Sturkie , 313 S.E.2d at 318 (citing DeWitt , 540 F.2d at 686-87 ). "The burden of proving this fundamental unfairness requires the plaintiff to ‘establish that (1) the defendant was aware of the plaintiff's claim against the corporation, and (2) thereafter, the defendant acted in a self-serving manner with regard to the property of the corporation and in disregard of the plaintiff's claim in the property.’ " Id. (quoting Dumas v. InfoSafe Corp. , 320 S.C. 188, 463 S.E.2d 641, 644 (S.C. Ct. App. 1995) ). A defendant is "aware" of the plaintiff's claim against the company "if he has notice of facts which, if pursued with due diligence, would lead to knowledge of the claim." Multimedia Pub. Of S.C., Inc. v. Mullins , 314 S.C. 551, 431 S.E.2d 569, 572 (1993). Accordingly, a defendant does not need to have actual knowledge of the claim for purposes of the second prong. Id. at 571.
Similarly, North Carolina courts have found piercing the corporate veil is appropriate "when applying the corporate fiction would accomplish some fraudulent purpose, operate as a constructive fraud, or defeat some strong equitable claim." Green v. Freeman , 367 N.C. 136, 749 S.E.2d 262, 270 (2013) (citations omitted). In determining whether to pierce the corporate veil, North Carolina courts apply the "instrumentality rule," which provides:
[if] the corporation is so operated that it is a mere instrumentality or alter ego of the sole or dominant shareholder and a shield for his activities in violation of the declared public policy or statute of the State, the corporate entity will be disregarded and the corporation and the shareholder treated as one and the same person, it being immaterial whether the sole or dominant shareholder is an individual or another corporation.
Henderson v. Sec. Mortg. & Fin. Co. , 273 N.C. 253, 160 S.E.2d 39, 44 (1968).
Rotruck's pre-petition claim is against AuditHead and Taylor, not Terranova or TCVG. It appears the Trustee seeks to impose personal liability for that claim on Terranova as the member of TCVG by piercing the corporate veils of AuditHead and/or TCVG or otherwise melding them together. Viewing the record in the light most favorable to Terranova, the Trustee has failed to show how such relief can be granted on this record through summary judgment.
Even viewing the evidence in the light most favorable to the Trustee, no evidence was presented to indicate Terranova failed to observe the corporate formalities for TCVG to demonstrate any of the eight factors under the first prong of South Carolina's test. Equitable principles govern the second prong of South Carolina's corporate veil piercing analysis and most important is whether fraud or fundamental injustice will occur if the corporate entity is recognized. Although Terranova was aware of Rotruck's claim against AuditHead at the time TCVG was formed, there is no evidence in the record as to the injustice, fraud, or fundamental unfairness that may result if the acts of TCVG are not regarded as the acts of Terranova or the reverse. Likewise, under North Carolina law, the Trustee has failed to demonstrate from the record that TCVG is a mere instrumentality of Terranova or was created or operates to accomplish some fraudulent purpose or to defeat some strong equitable claim. The record fails to substantiate the grounds to pierce the corporate veil to hold Terranova personally liable here and, therefore, summary judgment as to this cause of action should be granted in her favor.
V. SUBSTANTIVE CONSOLIDATION
The Trustee seeks to substantively consolidate the Defendants into AuditHead's bankruptcy estate for a shared distribution of their assets to creditors. "Substantive consolidation is an equitable remedy, and the Court has broad discretion under 11 U.S.C. § 105 to determine whether substantive consolidation is appropriate." In re City Loft Hotel, LLC , 465 B.R. 428, 433 (Bankr. D.S.C. 2012) (citing In re Gyro-Trac (USA), Inc. , 441 B.R. 470, 487 (Bankr. D.S.C. 2010) ; In re Derivium Capital, LLC , 380 B.R. 407, 426 (Bankr. D.S.C. 2006) ). The foundation for substantive consolidation was established by the Supreme Court in Sampsell v. Imperial Paper Corp. , 313 U.S. 215, 61 S.Ct. 904, 85 L.Ed. 1293, reh'g denied, 313 U.S. 600, 61 S.Ct. 1107, 85 L.Ed. 1552 (1941), which affirmed the bankruptcy referee's decision that the property of a non-debtor corporation was property of the bankruptcy estate of its debtor principal shareholder. The corporation was formed simply to continue the debtor's business and the transfers made to the sham corporation were done to "hinder, delay, or defraud" the debtor's creditors. Id. As a result, the corporation could not assert against the trustee that "it was so separate and insulated from [the debtor's] other business affairs as to stand in an independent and adverse position." Id.
"This Court has previously adopted the test set forth in In re Augie/Restivo Baking Co. , 860 F.2d 515, 518 (2d Cir. 1988) to determine whether to substantively consolidate bankruptcy estates." City Loft Hotel , 465 B.R. at 443. In that case, Augie's Baking Co. and Restivo Brothers Bakery entered an agreement whereby Restivo acquired all of Augie's stock and changed its name to Augie/Restivo Baking Co., and Augie wound up its affairs but never dissolved. Both companies eventually filed for Chapter 11 relief and requested their cases be substantively consolidated, which was denied by the Second Circuit Court of Appeals. The Second Circuit applied the following test to determine whether substantive consolidation is appropriate: "1) [when] creditors dealt with the entities as a single economic unit and did not rely on separate identities in extending credit or 2) when the affairs of the debtor are so entangled that consolidation will benefit all creditors." 860 F.2d at 518.
"Substantive consolidation can significantly affect creditors' rights in a bankruptcy case; as a result, it should be used sparingly and should not be granted simply for purposes of procedural convenience." City Loft Hotel , 465 B.R. at 443 (citing Gyro-Trac, 441 B.R. at 487 ); In re R.H.N. Realty Corp. , 84 B.R. 356, 358 (Bankr. S.D.N.Y. 1988) ("The power to consolidate should be used sparingly because of the possibility of unfair treatment of creditors of a corporate debtor who have dealt solely with that debtor without the knowledge of the interrelationship with others.").
While the majority of courts recognize substantive consolidation of multiple bankruptcy cases ... courts are split on the issue of whether bankruptcy courts have the authority to substantively consolidate debtor and non-debtor entities. In fact, of the federal circuit courts, only the Ninth Circuit, in Bonham v. Compton (In re Bonham), 229 F.3d 750 (9th Cir. 2000), has held that a court may order substantive consolidation of debtor and non-debtor entities.
In re S & G Fin. Servs. of S. Fla., Inc. , 451 B.R. 573, 579 (Bankr. S.D. Fla. 2011) (footnote and citations omitted); see also 2 Collier on Bankruptcy ¶ 105.09 (16th ed. 2020) ("The courts are divided on whether they may order consolidation of a debtor with a nondebtor. Most decisions have permitted such consolidation. If the related corporations were mere fictions and were in fact the alter egos of the debtor parent, the court can justify the result on the theory that the subsidiary corporations were not really separate. In circumstances that would justify piercing the corporate veil, the courts have also substantively consolidated the assets and liabilities of the nondebtor shareholder with the estate of the debtor subsidiary where the misconduct has been sufficiently egregious. However, some courts have hesitated to consolidate a nondebtor with a debtor affiliate, reasoning that to do so would circumvent the procedures and protections of the requirements for commencing an involuntary bankruptcy case against the nondebtor entity."). "Substantive consolidation is essentially a complex turnover proceeding because the debtor is asking the nondebtor affiliated entity to bring into the estate assets in which the debtor asserts an unseparable interest." Matter of Munford, Inc. , 115 B.R. 390, 398 (Bankr. N.D. Ga. 1990). "A cause of action for substantive consolidation may be dismissed from a complaint if there are insufficient allegations of entanglement or creditor reliance." Derivium Capital , 380 B.R. at 426-27 (citing In re Verestar, Inc. , 343 B.R. 444, 462-63 (Bankr. S.D.N.Y. 2006) ). In Derivium Capital , the Chapter 7 trustee asserted twenty-three cause of action, including one for substantive consolidation, against the debtor's owners and another corporation that allegedly misappropriated funds received by the debtor. Id. at 414. When considering a motion to dismiss under Fed. R. Civ. P. 12(b)(6), the Court found the trustee properly pled a claim for substantive consolidation because he "sufficiently alleged a substantial pre-petition entanglement of Debtor's and [defendants'] financial interest so that substantive consolidation may be an appropriate remedy, if the allegations are true." Id. at 427. The trustee also made sufficient "allegations of alter ego behavior and intermingling of assets to show that substantive consolidation would be fair and just." Id. (citation omitted).
Even viewing the facts in the light most favorable to the Trustee, the record does not support a finding of commingling of funds or intermingling of assets within and among AuditHead, TCVG, and/or Terranova sufficient to support a claim for substantive consolidation. TCVG and AuditHead may have temporarily shared equipment and office space and used the same independent contractors marketing to similar clients. However, there is no evidence in the record to indicate creditors dealt with AuditHead, TCVG, and/or Terranova as a single economic unit and they did not rely on separate identities in extending credit, or that the parties' affairs are so entangled that consolidation will benefit all creditors. Accordingly, Trustee's Motion is denied and TCVG and Terranova are entitled to judgment as a matter of law as to this cause of action.
CONCLUSION
After careful consideration of the pleadings and exhibits attached thereto and even applying authorities in a manner most liberal to the Trustee, the Court finds the Trustee's Motion must be denied and Defendants' Motion should be granted in part. For the reasons stated above,
IT IS, HEREBY, ORDERED that Defendants' Motion for Summary Judgment is granted in part as follows:
1. all causes of action against Terranova are hereby dismissed; and
2. all causes of action against TCVG are hereby dismissed except for the Trustee's action for recovery under the mere continuation theory of successor liability.
IT IS FURTHER ORDERED that all remaining relief requested by Defendants is denied and the Trustee's Motion for Summary Judgment is also denied.