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57 another related debtor entity, 24 substantive consolidation will cause creditors of the former entity to receive a smaller distribution than they would have without consolidation and creditors of the latter entity to receive relatively more than they would have received in the absence of such consolidation. Furthermore, substantive consolidation eliminates the presence of multiple unsecured claims against corporate affiliates, so creditors will hold only one claim against the entire group (essentially negating the impact of any guarantees). Although there is no express statutory basis for substantive consolidation, courts applying this doctrine have derived their authority from their general equitable powers under Section 105(a) of the Bankruptcy Code. However, because of the dramatic alteration of creditors' rights and expectations that results from substantive consolidation, courts have uniformly held that it is to be used sparingly. Although different Circuits have developed varying tests for substantive consolidation, as a general matter, the tests focus on two main criteria—creditor expectations and a lack of corporate formalities. For example, the Third Circuit has ruled that to approve a request for substantive consolidation, a court must find that (i) prepetition, the entities proposed to be consolidated "disregarded separateness so significantly that their creditors relied on the breakdown of entity borders and treated them as one legal entity," or (ii) after the petition date, "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). 24 Although substantive consolidation is typically applied in situations involving related entities that are both debtors in bankruptcy, it has been applied less commonly in situations involving unrelated entities as well as situations involving a debtor and a nondebtor.

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