Chapter III, D. Mere Instrumentality

• Jurisdiction: United States

D. Mere Instrumentality

The term "instrumentality" is at times used interchangeably with "alter ego." Indeed, courts will often refer to the two terms together, finding a party to be both an "alter ego and an instrumentality" of the party for which substantive consolidation is sought.¹²⁶ The Fifth Circuit has explained that where a party was "so involved with [the] debtor that it is in fact actively managing the debtor's affairs, then the quantum of control necessary to support liability under the 'instrumentality' theory may be achieved."¹²⁷ The test for instrumentality in Kentucky requires a showing that an entity is merely the instrumentality of some other party who has exercised control over the entity in a way that harms or defrauds another party, which causes that party some unjust loss.¹²⁸ Other courts have considered factors in applying the instrumentality doctrine such as inadequate capitalization, noncompliance with corporate formalities, complete domination and control, excessive fragmentation, nonpayment of dividends, insolvency of the debtor corporation, siphoning of funds by the dominant shareholder, nonfunctioning of other officers or directors, and absence of corporate records.¹²⁹ However, the Supreme Court of North Carolina emphasized that "these are merely factors to be considered to determine whether sufficient control and domination is present to satisfy the first prong of the three-pronged rule known as the instrumentality rule."¹³⁰

The alter-ego and instrumentality theories can be distinguished along the following lines: An alter ego describes entities that are substitutes for one another (for example, A is B and B is A), whereas an instrumentality describes an entity that does not function of its own but is merely an instrument, or tool, of another entity (in other words A controls B and B cannot function without A). However, in practice this may be a distinction without a difference. Ultimately, the court in making such determinations is concerned with whether the hallmarks of corporate separateness are being observed.

As with piercing-the-corporate-veil and alter-ego theories, bankruptcy courts are making an effort to distinguish the remedy of substantive consolidation from that of mere instrumentality, but there is still an acknowledgement that they are rooted in the same theory. For example, in In re Kretchmar, the court explained that "[w]hile now seen as an independent remedy from such state court remedies, the concept of...