Revisiting Substantive Consolidation In Light Of Theory Of Asset Partitioning

The essential role of the corporate form is to provide affirmative asset partitioning,which is economically more significant than limited liability.It assigns to the corporation's unsecured creditors a prior claim on corporate assets with liquidation protection against shareholder's personal creditors.While this kind of priority generates benefits such as reducing information and monitoring costs for both unsecured creditors and shareholders,it also generates higher agency costs of debt and administrative costs when a corporation group fails.This paper argues that substantive consolidation would destroy this priority and thus the remedy is best viewed as a reaction to the costs of affirmative asset partitioning.However,Chinese courts mistakenly impose substantive consolidation for the purpose of discouraging debtor opportunism such as misappropriation risk,which leads to over-or under-compensate the injured creditors depending on the amount of the inequity and the relative solvency of the entities.The only justification to use substantive consolidation is minimizing administrative costs by simplifying bankruptcy proceedings rather than recompensing creditors for the loss generated by debtor opportunism.This paper has four main Parts and proceeds as follow:Part ? briefly reviews the theoretical work on asset partitioning by comparing the piercing the corporate veil and substantive consolidation It argues that the former destroys the limited liability,namely the defensive partitioning,while the latter disregards affirmative partitioning.It then catalogues the benefits and costs of affirmative asset partitioning and employs this catalogue to analyze the relative economics of asset partitioning within a corporate group.Part ? describes the evolution of substantive consolidation doctrine in Chinese law.Since the remedy is not granted by Chinese Bankruptcy Act and is entirely a creature of judge-made law,this paper suggests Bankruptcy Act shall explicates grants the courts substantive power to consolidate corporate groups.It then finds Chinese courts frequently justify consolidation on the basis including one entity as the alter ego of another,creditors' reliance on the collective credit of entities,the difficulties of disentanglement,likelihood of successful reorganization and the intentional evasion of legal obligations.Part ? examines the prevalent rationales mentioned above.It argues that debtor opportunism such as misappropriation of the assets by non arm-length transactions,the intention use of the subsidiary to evade obligations and the undercapitalization of entity alone can not justify the remedy.Fraudulent transfer law(provided in Article 71 of the Chinese Contract Law and Article 31 of the Bankruptcy Act)and even the rule of debtfollow-asset serve as a more appropriate remedy because both of them allow simple recovery of the unfair loss.It proposals the only justification to impose substantive consolidation is minimizing administrative costs on economic grounds in the Pareto and Kaldor-Hicks Scenario.The first scenario includes:(1)the extreme difficulties of disentanglement or(2)increased likelihood of successful reorganization.In the second scenario,it is important for the court to mirror a negotiated result by ordering partial consolidation with respect to a portion of the estate.Part ? discusses externalities of intragroup guarantees.Chinese courts has noticed the unfairness of double proof and scholars also proves intragroup guarantees dilute recoveries of the group's nonguaranteed creditors.However,the remedy of substantive consolidation makes problems even worse since it eliminates guarantees at the expense of ‘innocent' unsecured creditors.It argues that intragroup guarantees could be eliminated under Article 31 of the Bankruptcy Act on the grounds that intragroup guarantees lack reasonably equivalent value and objectively harm unsecured creditors.