IN RE IDA V. REIDER AND JAMES M. REIDER, DEBTORS. IDA V. REIDER, PLAINTIFF-APPELLANT,

v.

FEDERAL DEPOSIT INSURANCE CORPORATION, DEFENDANT-APPELLEE

In this case of first impression, we address the propriety of substantive consolidation of the estates of debtors who are spouses. This appeal arises from the district court’s affir-mance of the bankruptcy court’s order substantively consolidating estate of debtor Ida V. Reider with that of her husband. For the reasons that follow, we reverse the judgment of the district court.

II.

FACTS A corporation owned by Ida and James Reider operated a horse breeding business, Clermont Farms, Inc., using land owned by Ida Reider. The Reider’s primary stud, Mastercard, died, and James Reider entered into an agreement with Jack Johnson to buy a replacement stud, Magnum T.

I. Johnson arranged for Clermont Farms through its president James Reider to borrow $250,000 from Florida Center Bank (“FCB”).

James Reider personally guaranteed the loan. Johnson was involved in several bank fraud schemes with the president of FCB, Mr. Justice, and never paid his portion of the purchase price for the stud. The arrangement concerning the horse purchase apparently formed part of a larger agreement between Johnson and Reider because Reider relayed most of the funds from the loan to Johnson so that Johnson’s father’s horse farm, in which Johnson had some interest, could be improved as part of a cooperative venture with Clermont Farms. Without funds and without a horse, the Reiders on December 12, 1985, filed a joint Chapter¹¹ bankruptcy petition, which was subsequently converted to a Chapter 7 proceeding. FCB failed in April, 1986, and FDIC acquired the claim against James Reider in a purchase and assumption transaction. Forming the basis for the claim was the personal guarantee executed by James Reid-er the day that he signed the corporate loan papers. On the list of personal assets Reider tendered to bank officials was the farm land owned by Reider’s wife Ida who had inherited the property from her mother.

On May 23,1988, the farm was sold by the trustee for $400,000.

On July 13,1988, the FDIC filed a proof of claim for $320,978.58, to which the Trustee objected. In an initial adversary proceeding contesting the allowance of FDIC’s claim, James Reider asserted that he never executed the personal guarantee. A handwriting expert testified otherwise, and the bankruptcy court agreed. In that prior proceeding, three attacks were mounted against the FDIC’s claim: 1) late filing, FDIC having waited two years after taking over FCB before filing a claim; 2) absence of consideration due to fraud; and 3) no personal liability. The argument concerning the absence of personal liability centered on Reider’s testimony that he had not knowingly signed the guarantee. The bankruptcy court overruled the Trustee’s objection and allowed the FDIC’s claim on July 9, 1990.

The district court affirmed this decision on August 27, 1991. In a December 15, 1988, order relating to exemptions, the bankruptcy court held that the real estate was titled solely in the name of Mrs. Reider. In denying any exemption for Mr. Reider, the court held that his status as spouse and his assertion of financial contributions to the property were insufficient to create an enforceable equitable interest in the property.

The record on appeal in this case reflects that the first mention in this case of the concept of substantive consolidation came in October, 1990.

On September 25, 1990, the Reiders had filed an amendment to Schedule B-4, the purpose of which was to seek an increased exemption. In response thereto, FDIC on October¹¹, 1990, argued for the first time in this case that because the case had been filed as a joint case by two spouses, because the trustee had intermingled the funds, because the debtors had not affirmatively set out a breakdown of the separate assets and liabilities of each estate, and because the assets and liabilities of the two debtors were so intermingled that they could not be separated, a substantive consolidation had in fact resulted.

On October 25, 1990, debtors responded to FDIC’s attempt to gain distribution of the funds, arguing that any order of distribution would have to consider the funds of each of the individual estates, and that the estate of Mrs. Reider could be distributed only to the creditors of the estate of Mrs. Reider and not to any other parties.

On November⁵, 1990, the debtors filed a formal motion to require separate distribution of each estate, and the accompanying brief responded at length on the substantive consolidation issue.

On November 20, 1990, FDIC filed a further brief on the issue.

On January 28, 1991, the Reiders filed a further brief on the issue, and filed an amended schedule separating the assets and liabilities of the two estates. On Feb.⁵, 1991, the FDIC filed a final brief on the issue.

On December 20, 1991, the bankruptcy court issued an order substantively consolidating the two estates. The court also denied the motion to increase Ida Reider’s exemptions because she had already received the one exemption to which she was entitled. The court sua sponte reconsidered its prior order denying James Reider’s claim for exemption and allowed him a $5,400 exemption to be paid out of the proceeds of the property.

The district court affirmed both issues. Mrs. Reider appeals.

We reverse.

III.

STANDARD OF REVIEW Because the district court in reviewing the decision of a bankruptcy court functions as an appellate court, we are the second appellate court to consider this case. Capital Factors, Inc. v. Empire for Him, Inc., 1 F. 3d 1156, 1159 (11th Cir.1993).

Thus, this Court’s review with regard to determinations of law, whether made by the bankruptcy court or by the district court, is de novo. Equitable Life Assurance Soc. v. Sublett, 895 F. 2d 1381, 1383 (11th Cir.1990). The district court makes no independent factual findings; accordingly, we review solely the bankruptcy court’s factual determinations under the “clearly erroneous” standard. Rush v. JLJ Inc., 988 F. 2d 1112, 1116 (11th Cir.1993); Bankr.Rule 8013; Bankr.Rule 7052. Pursuant to Section 302(b) and Rule 1015(b), a bankruptcy court may in exercising its equitable discretion order substantive consolidation of eases involving two related debtors.¹¹ U.S.C. § 302(b); Rule 1015(b).

Thus, we review an order of substantive eon-sohdation for abuse of discretion.

In re Giller, 962 F. 2d 796, 799 (8th Cir.1992).

IV.

DISCUSSION A. Substantive Consolidation In arguing that the bankruptcy court erred in ordering substantive consolidation, appellant argues that joint administration should not alter the separate nature of the estates created by bankruptcy or constitute a factor for consideration in ordering substantive consolidation. For the reasons that follow, we conclude that the courts below applied incorrect legal standards and that it would be an abuse of discretion to order substantive consolidation on the record in this ease.

Section 302 of the Bankruptcy Code provides that spouses may file joint cases.¹¹ U.S.C. § 302(a). After the commencement of a joint case, the court shall determine the extent, if any, to which the debtors’ estates shall be consolidated.¹¹ U.S.C. § 302(b). Because this case presents an issue of first impression among the circuits and has been addressed by few bankruptcy decisions, we begin our analysis with an overview of the development of substantive consolidation case law.

1. Historical background of the East-group analysis Substantive consolidation traces its roots to the Bankruptcy Act of 1898. The Act then contained no express statutory authorization for consolidation, either generally or in the case of spouses. Instead, the authority to order substantive consolidation was implied from the bankruptcy court’s general equitable powers. See Pepper v. Litton, 308 U.S. 295, 304, 60 S.Ct. 238, 244, 84 L.Ed. 281 (1939) (“courts of bankruptcy are essentially courts of equity, and their proceedings inherently proceedings in equity”).

In 1940, the Supreme Court gave its tacit approval to this equitable power to substantively consolidate two estates. Sampsell v. Imperial Paper & Color Corp., 313 U.S. 215, 61 S.Ct. 904, 85 L.Ed. 1293 (1940).

Early decisions in the corporate context applied essentially an alter ego or pierce the corporate veil test in assessing the propriety of substantive consolidation. See, e.g., Fish v. East, 114 F. 2d 177 (10th Cir.1940); Stone v. Eacho (In re Tip Top Tailors, Inc.), 127 F. 2d 284 (4th Cir.), cert. denied, 317 U.S. 635, 63 S.Ct. 54, 87 L.Ed. 512 (1942); Maule Industries, Inc. v. Gerstel, 232 F. 2d 294 (5th Cir.1956).

Subsequently, a series of .decisions from the Second Circuit articulated the contours of substantive consolidation which continue to guide current ease law in this area. See In re Continental Vending Machine Corp., 517 F. 2d 997 (2d Cir.1975); In re Flora Mir Candy Corp., 432 F. 2d 1060 (2d Cir.1970); Chemical Bank New York Trust Co. v. Kheel, 369 F. 2d 845 (2d Cir.1966); Soviero v. Franklin National Bank of Long Island, 328 F. 2d 446 (2d Cir.1964).

Because of then-continued importance, we examine each of these decisions in turn.

In Soviero v. Franklin National Bank of Long Island, 328 F. 2d 446 (2d Cir.1964), the evidence established that one bankrupt corporation had commingled funds with its affiliates and flagrantly disregarded corporate forms. 328 F. 2d at 447. The court concluded that the claims of the individual corporate entities for property also claimed by the corporation’s debtors were without merit because the affiliates were mere instrumentalities of the bankrupt, lacking an independent existence. Id. at 448. Instead of relying upon the traditional alter ego theory, the court emphasized the injustice to creditors which would result were the separate corporate entities recognized. Id.

Thus, it was not simply the commingling of assets and flagrant disregard of corporate forms which led to consolidation, but the injustice to creditors which would result if consolidation were not permitted. The court’s reference to Stone v. Eacho, 127 F. 2d 284 (4th Cir.), cert. denied, 317 U.S. 635, 63 S.Ct. 54, 87 L.Ed. 512 (1942) suggests that the injustice to creditors inquiry is central: where consolidation may be otherwise warranted, creditors who knew of the close association between bankrupt and affiliate may be estopped to assert any prejudice caused by consolidation. See 127 F. 2d at 288. In the subsequent decision of Chemical Bank New York Trust Co. v. Kheel, 369 F. 2d 845 (2d Cir.1966), the Second Circuit upheld consolidation of seven corporate debtors involved in the shipping industry where all the corporations were owned or controlled by one man, and all were operated as a single unit with common directors and stockholders. 369 F. 2d at 846. In addition to ignoring corporate formalities, the debtors had commingled funds and conducted intercorporate loan transactions which they had failed to record sufficiently on the separate books of the various debtors. Id.

Thus, the court held that “where the interrelationships of the group are hopelessly obscured and expense necessary even to attempt to unscramble them so substantial as to threaten the realization of any net assets for all the creditors,” consolidation was mandated. Id. at 847. The court emphasized the existence of a critical factor not present in Soviero, “the expense and difficulty amounting to a practical impossibility of reconstructing the financial records of the debtors to determine inter-corporate claims, liabilities and ownership of assets.” Id.

The court rejected the argument that Soviero’s holding required a showing in every case that a creditor knowingly dealt with the debtors as a unit and relied on the collective assets for payment. Id. Rather, implicit in the court’s decision was the idea that a creditor may oppose consolidation on the basis of its reliance upon the separate credit and assets of one of the debtors. 369 F. 2d at 848 (Friendly, J. concurring). Distilling Soviero and Kheel, two central themes emerge.

First, disregard of corporate formalities and commingling of assets may indicate substantive consolidation is appropriate. This follows from the recognition that there is a substantial identity between the debtors, with one entity exercising ultimate control over the assets and the other entities operating as mere instrumentalities.

Second, consideration of possible harm or injustice to the creditors is determinative of the propriety of ordering substantive consolidation. Harm or injustice to the creditors may result where unscrambling the affairs of the debtors would threaten the realization of assets. On the other hand, a creditor may demonstrate that injustice would result in the form of a diminished share of the assets were consolidation ordered, due to the creditor’s reliance upon the separate credit and assets of one of the entities. The Second Circuit directly addressed this latter proposition in In re Flora Mir Candy Corp., 432 F. 2d 1060 (2d Cir.1970).

One parent corporation and twelve affiliates or subsidiaries filed for individual Chapter XI relief. 432 F. 2d at 1061. Despite a multitude of intercorporate transactions, the affairs of one affiliate could be readily disentangled because it ceased operating before the transactions occurred. Noting that consolidation “is no mere instrument of procedural convenience ... but a measure vitally affecting substantive rights,” the court held that substantive consolidation would be inequitable, even though most creditors had treated the debtors as a single entity. 432 F. 2d at 1062-63. In so holding, the court stated: ‘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 knowledge of its interrelationship with others.’ 432 F. 2d at 1062-63 (quoting Kheel, supra, 369 F. 2d at 847).

Thus, harm to one set of creditors sufficiently outweighed the possible benefits of consolidation for other creditors. The importance of the inquiry into the relative harm to creditors was underscored in the final decision in this line of cases, In re Continental Vending Machine Corp., 517 F. 2d 997 (2d Cir.1975).

Upon a weighing of the relative harm to each group of creditors, the court upheld a plan of reorganization which permitted consolidation of the unsecured creditors’ claims but denied consolidation of the secured creditors’ claims. Reasoning that the inter-entity transfers that had prejudiced the claims of many unsecured creditors had not implicated or diminished the value of lien property, the court concluded that consolidation of secured claims was unnecessary because the class had not been harmed. 517 F. 2d at 1001. In emphasizing the showing of harm required for consolidation, the court noted that “the inequities it [consolidation] involves must be heavily outweighed by practical considerations such as the accounting difficulties (and expense) which may occur....” Id.

Thus, creditors must make a strong showing that harm will occur absent consolidation. In sum, this line of decisions suggested a two-fold inquiry for ordering substantive consolidation.

First, substantial identity of the entities must be demonstrated by the absence of corporate formalities or by commingling of assets.

Second, there must be a demonstration that harm to the creditors will result without consolidation. This heavy showing may be made by demonstrating that the affairs of the entities are hopelessly scrambled, making disentanglement prohibitively expensive. Alternatively, there may be a showing that some creditors will inequitably receive a lesser share of the assets if consolidation is permitted. The inequity arises from these creditors’ reliance upon the separate credit and assets of one entity. Absent such reliance, these creditors would be estopped from asserting prejudice from the proposed consolidation.

2. The Eastgroup analysis From these precepts, two similar but not identical tests have evolved for assessing the propriety of substantive consolidation in the corporate context. See In re Augie/Restivo Baking Co., Ltd., 860 F. 2d 515 (2d Cir.1988); Drabkin v. Midland-Ross Corp. (In re Auto-Train Corp.), 810 F. 2d 270 (D.C.Cir.1987). This Circuit adopted the D.C. Circuit’s approach in Eastgroup Properties v. Southern Motel Assoc., Ltd., 935 F. 2d 245 (11th Cir.1991). In Eastgroup Properties, this Circuit set forth the following analysis for governing substantive consolidation of corporate entities.

Pursuant to the general equitable power conferred by section 105 of the Bankruptcy Code, a court may order substantive consolidation of corporate entities upon an evaluation of “whether ‘the economic prejudice of continued debtor separateness’ outweighs ‘the economic prejudice of consolidation.’ ” 935 F. 2d at 249 (quoting In re Snider Bros., Inc., 18 B.R. 230, 234 (Bankr.D.Mass.1982)).

A court accordingly must analyze whether “ ‘consolidation yields benefits offsetting the harm it inflicts on objecting parties.’ ” Id. (quoting Drabkin v. Midland-Ross Corp. (In re Auto-train Corp.), 810 F. 2d 270, 276 (D.C.Cir.1987)).

Under this analysis, the proponent of a motion for substantive consolidation must demonstrate: (1) there is substantial identity between the entities to be consolidated; and (2) consolidation is necessary to avoid some harm or to realize some benefit. 935 F. 2d at 249. Upon this demonstration, a presumption arises “ ‘that creditors have not relied solely on the credit of one of the entities involved.’ ” Id. (quoting Matter of Lewellyn, 26 B.R. 246, 251-52 (Bankr.S.D.Iowa 1982)).

Once the prima facie showing of substantial identity and harm or benefit is made, the burden shifts to an objecting creditor to show: (1) it has relied on the separate credit of one of the entities to be consolidated; and (2) it will be prejudiced by substantive consolidation. 935 F. 2d at 249. The Second Circuit has adopted an alternative test in In re Augie/Restivo Co., Ltd., 860 F. 2d 515 (2d Cir.1988).

The inquiry focuses on two factors: (1) whether creditors dealt with the entities as a single economic unit and did not rely on their separate identity in extending credit; or (2) whether the affairs of the debtors are so entangled that consolidation will benefit all creditors. 860 F. 2d at 518. The presence of either factor justifies substantive consolidation. The Second Circuit recently reaffirmed this test in the 1992 case of FDIC v. Colonial Realty Co., 966 F. 2d 57, 61 (2d Cir.1992).

3. Applicability of Eastgroup to the spousal context Few decisions have addressed or even discussed substantive consolidation in the context of debtor spouses. See In re Chan, 113 B.R. 427 (D.N.D.Ill.1990); In re Knobel, 167 B.R. 436 (Bankr.W.D.Tex.1994); In re Steury, 94 B.R. 553 (Bankr.N.D.Ind.1988); In re Birch, 72 B.R. 103 (Bankr.D.N.H.1987); In re Scholz, 57 B.R. 259 (Bankr.N.D.Ohio 1986); In re Barnes, 14 B.R. 788 (Bankr.N.D.Tex.1981).

Three cases have formulated the following rule: “[cjases should be consolidated where the affairs of the husband and wife are so intermingled that their respective assets and liabilities cannot be separated.” Chan, supra, at 428; Birch, supra, at 106; Barnes, supra, at 790. This inquiry represents one of the factors articulated by the Second Circuit in In re Augie/Restivo and is encompassed within the second prong of the inquiry adopted by this court in Eastgroup. This inquiry is entirely consonant with the concerns set forth in Eastgroup but should not be the sole test. As recognized by the court in Steury, the ultimate answer to the question of substantive consolidation “requires the court to weigh ‘the economic prejudice of continued debtor separateness versus the economic prejudice of consolidation.’ ” Steury, 94 B.R. at 554 (quoting In re Snider Bros., Inc., 18 B.R. 230, 234 (Bankr.D.Mass.1982)).

Accord Eastgroup, 935 F. 2d at 249.

Thus, questions concerning substantive consolidation “are to a great degree sui generis ... [Precedents are of limited value. Instead, the Court must determine what equity requires.” In re Augie/Restivo Banking Co., Ltd., 84 B.R. 315, 321 (Bankr.E.D.N.Y.1988).

With this caveat, we adopt the analysis of substantive consolidation set forth in Eastgroup as modified by the following considerations for the spousal context. In assessing the propriety of substantive consolidation, a court must determine: (1) whether there is a substantial identity between the assets, liabilities, and handling of financial affairs between the debtor spouses; and (2) whether harm will result from permitting or denying consolidation. In assessing the extent of substantial identity, relevant factors will include the extent of jointly held property and the amount of joint-owed debts. H.R. No. 95-595, 95th Cong., 1st Sess. 321 (1977); S.Rep. No. 95-989, 95th Cong., 2d Sess. 32 (1978) U.S.Code Cong. & Admin.News 1978, pp. 5787, 5818, 5963, 6277. Upon a determination of substantial identity, the court must then analyze the harm attendant to a failure to consolidate. Where administrative difficulties in disentangling the spouses’ estates makes it prohibitively expensive or where disentanglement is otherwise impracticable, consolidation should ordinarily be permitted. A creditor may also demonstrate that it will be unfairly prejudiced by a failure to consolidate and may interpose the fraud or bad faith of the debtors as a defense. To prevent consolidation, a creditor may demonstrate that it has relied on the separate credit and assets of one of the spouses and would be harmed by a consolidation of assets. The burden is upon the proponent of a motion for consolidation and is exacting. See Knobel, supra, 167 B.R. at 441 n.

10. Ultimately, the court must be persuaded that “ ‘the creditors will suffer greater prejudice in the absence of consolidation than the debtors (and any objecting creditors) will suffer from its imposition.’” Steury, supra, 94 B.R. at 554-55 (quoting Holywell Corp. v. Bank of New York, 59 B.R. 340, 347 (D.S.D.Fla.1986)). Substantive consolidation should be invoked “sparingly” where any creditor or debtor objects to its use. See Chemical Bank New York Trust Co. v. Kheel, 369 F. 2d 845, 847 (2d Cir.1966). Great care must be taken to avoid confusion between the attributes of joint administration and indicia supporting substantive consolidation. The filing of a joint petition by a husband and wife does not result in the automatic substantive consolidation of the two debtors’ estates.

In re Ageton, 14 B.R. 833, 835 (9th Cir. BAP 1981); In re Chandler, 148 B.R. 13, 15 (Bankr.E.D.N.C.1992); In re Masterson, 55 B.R. 648, 649 (Bankr.W.D.Pa.1985). Joint administration is designed for the ease of administration and to permit the payment of only one filing fee.

In re Crowell, 53 B.R. 555, 557 (Bankr.M.D.Tenn.1985); In re Stuart, 31 B.R. 18 (Bankr.D.Conn.1983). Joint administration is thus a procedural tool permitting use of a single docket for administrative matters, including the listing of filed claims, the combining of notices to creditors of the different estates, and the joint handling of other ministerial matters that may aid in expediting the cases.

Rule 1015, Advisory Committee Note (1983). Used as a matter of convenience and cost saving, it does not create substantive rights. Unsecured Creditors Committee v. Leavitt Structural Tubing Co., 55 B.R. 710, 712 (D.N.D.Ill.E.D.1985). By contrast, substantive consolidation “is no mere instrument of procedural convenience ... but a measure vitally affecting substantial rights.” In re Flora Mir Candy Corp., 432 F. 2d 1060, 1062 (2d Cir.1970).

Thus, conduct by the debtor spouses in jointly administering their estates should be accorded relatively little weight in assessing the propriety of substantive consolidation.