07/27/2011 – Defendant’s Reply in Further Support of Its Motion to Dismiss with Prejudice filed in the Sunset Aviation, Inc. Adversary Proceedings by Shorenstein Company LLC before Judge Walsh in the District of Delaware filed by  Cross & Simon LLC (Wilmington, Delaware) attorney Michael J. Joyce; and Morrison & Foerster LLP (New York, New York) attorneys Melissa A. Hager John A. Pintarelli. Defendant Shorenstein Company LLC’s reply takes apart every aspect of the Chapter 7 Trustee’s position that substantive consolidation order shifted the date for calculating the preference period to the earliest debtor petition date. However, what makes this reply especially noteworthy is (1) its retort to the Trustee’s “equity of creditors” rhetoric; (2) its discussion of the Third Circuit’s approach to substantive consolidation; and (3) its argument that, if the Court is inclined to give nunc pro tunc effect, it should be to the petition date of the last filing debtor.

The Trustee’s response to Defendant’s motion to dismiss was heavy on “equity of creditors” rhetoric. Defendant takes no prisoners in its rebuttal:

Plaintiffs arguments are mere smokescreens designed to divert the Court’s attention away from the fact that the Substantive Consolidation Motion never sought nunc pro tune or retroactive effect of the resulting order. Only now, one year after the fact and in response to the Motion, is Plaintiff trying to make arguments that such relief should be deemed to have occurred. Acquiescing to such a contrivance will do nothing to further equity. In fact, equity will be turned on its head. Unsuspecting creditors who might have had a say about the Substantive Consolidation Motion had Plaintiffs new-found intent been stated then, and who may have organized their post-consolidation affairs without fear of being sued, will effectively be treated as insiders. This means that certain pre-petition transfers could now be treated as possible unauthorized post-petition transfers, taking away potential defenses to recovery. Creditors were never put on notice of this potential effect of the Substantive Consolidation Motion, intentionally or otherwise.

Moreover, it is Plaintiffs special counsel, retained on a contingency basis, who stands to benefit most from the very interpretation of the Substantive Consolidation Order Plaintiff seeks, not Shorenstein nor the consolidated estates. Contrary to Plaintiffs assertions, the only estate with “assets” for distribution is the Sunset Aviation estate. Proceeds from the sale of substantially all of the assets of the Regal Jets estate were distributed to secured creditors pursuant to the sale order. Accordingly, the only additional assets that may be available for distribution to creditors of the substantively consolidated estates will come from Plaintiffs recovery of purported “preferential transfers” from creditors of Jet Direct, but only if Plaintiff can utilize the earlier petition date of Regal Jets. Even then, the majority of such recoveries will likely be distributed to the Debtors’ secured creditors on account of their deficiency claims or priority creditors, without any meaningful benefit to be conferred on the general unsecured creditors of any of the Debtors.

Defendant’s discussion of the Third Circuit standard for granting substantive consolidation also is insightful.

A.         Because The Substantive Consolidation Order Was Entered Without Objection It Should Not Be Inferred That Plaintiff Made A Prima Fade Case For Substantive Consolidation.

The Third Circuit summarized its approach to substantive consolidation as follows:

In our Court what must be proven (absent consent) concerning the entities for whom substantive consolidation is sought is that (i) prepetition they disregarded separateness so significantly their creditors relied on the breakdown of entity borders and treated them as one legal entity, or (ii) postpetition their assets and liabilities are so scrambled that separating them is prohibitive and hurts all creditors.

In re Owens Corning, 419 F.3d 195, 211 (3d Cir. 2005) (emphasis added).

Plaintiff argues that based upon its prima facie showing of a case for consolidation (i.e., a substantial identity between the entities to be consolidated and that consolidation is necessary to avoid some harm or to realize some benefit) the burden would then shift to Shorenstein to suggest that it relied on the separate credit of one of the entities and that it would be prejudiced by consolidation. That assumes Plaintiff has made a prima facie case for consolidation under Owens Corning. Note that Shorenstein does not concede that Plaintiff has met its burden under Owens Corning because the Substantive Consolidation Order was entered without objection, and for obvious reasons. However, even if Plaintiff has made its prima facie case for consolidation, that does not support a finding that the order be deemed to have nunc pro tunc effect without proper notice to creditors.

Finally, Defendant makes the interesting argument that if found, any nunc pro tunc effect should be to the petition date of the last filing debtor.

The Substantive Consolidation Order failed to make specific findings with respect to (i) the issue of separateness between the Debtors and JetDirect Holdings where Plaintiff has alleged that JetDirect Holdings lacked any internal financial controls, (ii) IJS’ lack of internal financial controls and (iii) retroactive application of the order. Furthermore, the order states that the findings with respect to substantive consolidation were made solely with respect to the Debtors for purposes of facilitating the orderly (i.e., efficient and systematic) liquidation of the Debtors in these proceedings. However, if the Court were inclined to assign an earlier petition date for purposes of calculating the preference period, equity would dictate that the Court assign the Sunset Aviation petition date for purposes of this adversary proceeding.

Even if Shorenstein were not able to establish that it only relied on Jet Direct’s separate credit, the most Plaintiff could establish is that Shorenstein may have relied on the combined credit of Jet Direct, its 80% subsidiary, Sunset Aviation, and its non-debtor parent IJS. Thus, any nunc pro tunc application of the Substantive Consolidation Order would should utilize the Sunset Aviation petition date of March 6, 2009 for purposes of calculating the preference period. Accordingly, any payments received by Shorenstein would still fall outside the 90 day preference period.