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Supreme Court Closes ‘Backdoor’ Circumvention of Bankruptcy Priority Scheme

Chapter 11 bankruptcy cases generally conclude in one of three ways: a plan, conversion to a liquidation under Chapter 7, or dismissal. Classically, dismissal restores the debtor to its financial condition as of the date it filed bankruptcy, but “for cause” Bankruptcy Courts can order a “structured dismissal” effecting the distribution of some or all of the debtor’s assets and affording other related relief.

Structured dismissal orders are often comprehensive, complex documents with provisions mirroring those typically found in Chapter 11 plans. Because structured dismissals offer an efficient alternative to Chapter 11 plans, their use as an end-of-case option has grown substantially in recent years.

A problem with structured dismissals, however, is that the proposed distribution does not always track the Bankruptcy Code’s priority scheme. In Czyzewski v. Jevic Holding Corp., 580 U.S. ___, 5 (2017), the U.S. Supreme Court considered the issue and held that Bankruptcy Courts are not authorized to enter structured dismissal orders that deviate from the distribution scheme required by the Bankruptcy Code, absent consent of the affected parties.

The Jevic Case

In 2006, Sun Capital Partners executed a leveraged buyout of Jevic Transportation Corporation, a shipping company. CIT Group provided the financing, and Jevic’s assets were pledged for the loan. Id. Jevic filed Chapter 11 bankruptcy less than two years later. Id. Just prior to the petition date, Jevic halted nearly all operations and notified its truck drivers and other employees that they would be fired. Id. at 6. Two adversary proceedings were filed in the bankruptcy, which were at issue on appeal. Id. 

In the first proceeding, the truck drivers brought a class action suit against Sun Capital and Jevic for violations of state and federal Worker Adjustment and Retraining Notification (WARN) Acts. Id. The Bankruptcy Court granted summary judgment in favor of the drivers, leaving them with an estimated $12.4 million claim—$8.3 million of which held priority wage claim status under 11 U.S.C. Section 507(a)(4). Id. 

In the second proceeding, the official committee of unsecured creditors brought a derivative suit on behalf of the bankruptcy estate against Sun Capital and CIT for preferential and/or fraudulent transfers in violation of 11 U.S.C. Sections 547–48. Id. at 6–7. The derivative suit ended in a settlement agreement between Sun Capital, CIT, Jevic, and the committee for $3.7 million, and required entry of a structured dismissal that would provide no distributions from the settlement to the drivers— ignoring the petitioners’ priority status in favor of certain payments to general unsecured creditors. Id. at 7. 

Over the objections of the U.S. Trustee and the petitioners, the Bankruptcy Court approved the settlement agreement and dismissed the case, holding that, in “dire circumstances,” a structured dismissal providing distribution outside of the ordinary priority scheme did not bar approval. Id. at 8. On appeal, the District Court affirmed. Id. at 8–9. The 3rd U.S. Circuit Court of Appeals also affirmed, holding that structured dismissals need not always respect the absolute priority rules because Congress legislated these rules in the context of confirmation of a bankruptcy plan—not structured dismissals. Id. at 9. 

The Supreme Court granted the petitioners’ writ of certiorari from the 3rd Circuit. Jevic, U.S. 580 at 9. Originally, the question posed to the court was “[w]hether the bankruptcy court may authorize the distribution of settlement proceeds in a manner that violates the statutory priority scheme.” Id. at 1 (Thomas, J., dissenting) (citing Pet. for Cert. i). However, the ultimate question addressed was “[w]hether a Chapter 11 case may be terminated by a ‘structured dismissal’ that distributes estate property in violation of the Bankruptcy Code’s priority scheme.” Id. (citing Brief for Petitioners i).

The Supreme Court held that a structured dismissal could not, without the consent of the affected creditors, provide distributions contrary to the Bankruptcy Code’s priority rules. Id. at 11, 16. The court reasoned that it is fundamental to the Bankruptcy Code’s operation that distributions be made according to the priority system, and that Congress would have expressly stated otherwise if it intended to provide a “backdoor” via the use of structured dismissals. Id. at 12. Rather, the Supreme Court found that structured dismissals are intended to restore the “prepetition financial status quo.” Id. at 13 (citing 11 U.S.C. Section 349(b) and legislative history):

Nothing else [besides Section 349(b)’s “for cause” language] in the Code authorizes a court ordering a dismissal to make general end-of-case distributions of estate assets to creditors of the kind that normally take place in a Chapter 7 liquidation or Chapter 11 plan—let alone final distributions that do not help to restore the status quo ante or protect reliance interests acquired in the bankruptcy, and that…violate priority without the impaired creditors’ consent. 

Id. at 13–14 (emphasis in original).

The court declined to make an exception for “rare cases,” fearing such an exception would turn into the general rule. Id. at 16–17. The court therefore reversed the judgment of the 3rd Circuit and remanded.

Commentary 

Structured dismissals have become more common for concluding Chapter 11 cases when parties cannot agree on a plan. But the court closed any backdoor means to circumvent the Bankruptcy Code’s priority system through structured dismissals that alter normal distribution priorities, reasoning that there is no basis for a “major departure” from the priority scheme that undergirds the Bankruptcy Code.

Certainly some would argue that the court’s decision makes it harder for troubled companies to emerge from bankruptcy, already a difficult task. Indeed, in Jevic it was argued that absent the settlement agreement and proposed deviation from the normal priority scheme, it is likely that none of the claimants would have received anything, regardless of their priority. At least under the settlement, some of the creditors were paid—so which is worse: that senior creditors received nothing because they were skipped over in favor of junior creditors, or that all creditors receive nothing?

In such a “rare case” and under such “dire circumstances,” it could be argued the greater good would be served by allowing at least some creditors to receive something versus all creditors receiving nothing, similar to the “necessity exception.” But the court rejected that argument, recognizing that nearly all cases could be characterized as rare cases operating under dire circumstances. Indeed, creditors might instead refuse last-minute compromises that engender many exits from bankruptcy in order to create the necessary circumstances.

Instead, the court upheld the principles of distribution priorities under the Bankruptcy Code, under which bedrock principles parties can negotiate with greater certainty, yielding settlements that appropriately balance litigation risks and the distribution requirements of the Bankruptcy Code, without the risk that structured dismissal could ignore such requirements.  


Nothing in this article constitutes an opinion or view of Dentons, or any of its clients.

Oscars Pinkas

Oscar Pinkas

Dentons US LLP

Oscar Pinkas is a partner in Dentons’ Restructuring, Insolvency & Bankruptcy practice group. He represents clients in and out of court in stressed, distressed, workout, insolvency, and bankruptcy situations, whether in operational restructurings, transactions, litigation, or otherwise. Clients include distressed investors, asset purchasers, lenders, agents, bondholders, indenture trustees, bankruptcy estate fiduciaries, secured and unsecured creditors, committees, and debtors. Pinkas practices in Dentons’ New York office and can be reached at Oscar.Pinkas@Dentons.com.

Bryan Baes

Bryan Bates

Dentons US LLP

Bryan Bates is a partner in Dentons' Restructuring, Insolvency & Bankruptcy practice group. He focuses his practice on corporate bankruptcy and commercial litigation, representing debtors, creditors, contract parties, and other parties in interest in Chapter 11 reorganization proceedings, insolvency matters, and related litigation. Bates practices in Dentons’ Atlanta office, serving clients’ interests throughout the United States and abroad. Bates can be reached at Bryan.Bates@Dentons.com.

 

Sarah Schrag

Sarah Schrag

Dentons US LLP

Sarah Schrag is an associate in the Atlanta office and a member of Dentons’ Restructuring, Insolvency and Bankruptcy practice. Formerly she served as a legal intern for the U.S. Senate, focusing on Committee on the Judiciary matters. She also served as a legal intern to U.S. Magistrate Judge Lawrence R. Leonard in U.S. District Court for the Eastern District of Virginia. Schrag can be reached at Sarah.Schrag@Dentons.com.

 

Topics: 
Bankruptcy
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