SCOTUS: Payments Made under Structured Dismissals Can’t Violate Absolute Priority Rule

March 2017

The Supreme Court ruled on March 22, 2017 in Czyzewski v. Jevic Holding Corp. that payments made to creditors pursuant to structured dismissals of bankruptcy cases cannot violate the Bankruptcy Code’s absolute priority rule without the consent of the affected creditors.[1] The decision is important for its primary holding, but also because it also represents a de facto approval of structured dismissals as a way to conclude unsuccessful bankruptcy cases.

Jevic Holding Corp. (“Jevic”) was a trucking company acquired in 2006 by Sun Capital Partners, a private equity firm (“Sun Capital”), with CIT Corp. (“CIT”) providing debt financing. The transaction was a failure and approximately two years later, Jevic filed a chapter 11 petition in the bankruptcy court for the District of Delaware (the “Bankruptcy Court”). Immediately prior to filing its chapter 11 case, Jevic terminated a number of truck drivers who became the plaintiffs in this action, and who contended that Jevic’s layoffs violated the federal and New Jersey Worker Adjustment and Retraining Notification Acts (“WARN”).[2] The Bankruptcy Court granted the terminated truck drivers a $12.4 million summary judgment, of which $8.3 million ranked as priority wage claims under the Bankruptcy Code.[3] The former employees also sued Sun Capital, contending that it was an employer for purposes of their WARN claims.

The creditors committee in the chapter 11 case brought claims against Sun Capital Partners and CIT, contending that Sun’s acquisition of Jevic was a fraudulent conveyance. Jevic’s chapter 11 reorganization failed, with the result that, prior to the settlement of the fraudulent conveyance action, the bankruptcy estate had just $1.7 million in cash, subject to a lien in favor of Sun Capital.

Jevic, the creditors committee, Sun Capital and CIT reached a settlement under which: (1) Jevic’s chapter 11 case would be dismissed; (2) CIT would pay the estate $2 million, earmarked for payment of the committee’s legal fees and expenses and other administrative expenses, and (3) Sun would assign its lien on the estate’s $1.7 million in cash to a liquidating trust that would pursue avoidance actions and make a distribution to unsecured creditors. But the structured dismissal would provide no payment to the former employees who held priority wage claims. According to the Supreme Court decision, Sun Capital insisted that no funds be paid to the former employees, who were still pursuing their claims against Sun Capital. Sun Capital’s rationale was that it was unwilling to see settlement proceeds fund a litigation against itself.[4]

Sun Capital, CIT, Jevic and the creditors committee asked the Bankruptcy Court to approve the settlement; the truck drivers and the U.S. Trustee objected, arguing that the payout scheme violated the Bankruptcy Code’s priority scheme. The Bankruptcy Court acknowledged that the payout did not follow the Bankruptcy Code’s priority scheme, but held that because the payments were being made in connection with a structured dismissal, and not a plan of reorganization, the settlement could be approved. The Bankruptcy Court also noted that in the “dire circumstances” of the case, there was “no realistic prospect” of a meaningful distribution to any parties other than the secured creditors, and that this result was thus better for at least some unsecured creditors.

The District Court affirmed, finding that although the settlement violated the Bankruptcy Code’s priority scheme, those rules were not a bar because the structured settlement was not a reorganization plan. The Third Circuit approved in a 2-1, holding that Congress had codified the “absolute priority rule…in the specific context of plan confirmation.”[5] As a result, the Third Circuit concluded, the Bankruptcy Court did not abuse its discretion in approving the settlement, even though it did not follow the absolute priority rule, because that court had the discretion to ratify such resolutions in “rare cases.”

The Supreme Court began its analysis by observing that there are three ways a chapter 11 case can end – with a plan of reorganization, with a conversion to a chapter 7 proceeding, or through dismissal. The Supreme Court noted that the purpose of dismissals is to restore the parties to the positions they occupied immediately prior to the commencement of the chapter 11 case. But the Supreme Court acknowledged that due to events in the chapter 11 case, it may not be possible to effect a full restoration, and that, consequently, a bankruptcy court has the authority under section 349(b) of the Bankruptcy Code to attach conditions to such a dismissal. The Supreme Court noted that such dismissal orders, which it characterized as a hybrid between a strict dismissal and confirmation of a plan of reorganization, were commonly referred to as “structured dismissals.” The Supreme Court quoted a report from the American Bankruptcy Institute to the effect that such structured dismissal orders have provided for distributions, granted third-party releases, and contained injunction provisions, and noted that the American Bankruptcy Institute said that they “appear to be increasingly common.”[6]

The Supreme Court noted that distributions in a chapter 7 case must follow the priority provisions of sections 725 and 726 of the Bankruptcy Code. It acknowledged that while a chapter 11 plan may depart from the absolute priority rule of § 1129(b)(2)(B)(ii) of the Bankruptcy Code, it may do so only with the consent of the affected creditor class. In Jevic, the structured dismissal order provided for distributions for creditors that followed neither the chapter 7 liquidation priorities nor the absolute priority rule, and excluded the truck drivers, who held priority claims, from any distributions. Against that background, the Supreme Court asked whether a court could approve a structured dismissal order that followed neither set of rules, and determined that it could not, noting that there was no express authority in the Bankruptcy Code for such an order.

The Court noted that the priority schemes of the Bankruptcy Code have long been considered “fundamental to the Bankruptcy Code’s operation,” citing with approval a law review article that characterized “a fixed priority scheme is…the cornerstone of reorganization practice and theory.”[7] Because no provision of the Bankruptcy Code authorizes a court to depart from the priority rules in connection with a structured dismissal, the Court observed that: “The importance of the priority system lead us to expect more than simple statutory silence if, and when, Congress were to intend a major departure…[W]e would expect to see some affirmative indication of intent if Congress actually meant to make structured dismissals a backdoor means to achieve the exact kind of nonconsensual priority-violating final distributions that the Code prohibits in Chapter 7 liquidations and Chapter 11 plans.”[8] The heart of the ruling is that a structured dismissal cannot alter the Bankruptcy Code’s priority rules because such an order has no statutory basis.

The Court acknowledged that §349(b) of the Bankruptcy Code gives a bankruptcy court some authority to attach conditions to a dismissal order “for cause,” but held that §349(b)’s general language cannot be used to circumvent the more specific priority rules. The Court also noted that in approving the structured dismissal order in Jevic, the Third Circuit had said that its departure from the priority rules was justified in part because it was a “rare case.” The Court said that the “rare case” exception can easily be undermined into a more general rule.

The Court’s ruling is unexceptional in many ways; since at least 1989, the Court has stressed strict statutory construction in interpreting the Bankruptcy Code.[9] Here the Court found no express authorization for the structured dismissal order, and found that it contravened the priority rules applicable to chapter 7 liquidation and chapter 11 plans, and thus had no difficulty in finding it improper, particularly where it clearly worked to harm the truckers who had priority wage claims. Jevic is also consistent with the Court’s recent decision in Law v. Siegel, where it held that §105(a) of the Bankruptcy Code could not be relied on to create an “equitable surcharge” to a debtor’s exemptions.[10] Although the underlying issues in the cases are different, in both cases the Court was faced with a bankruptcy court decision not based on specific statutory authority in the Bankruptcy Code, and in both cases, the Court reversed.

Another notable aspect of the Jevic decision is the Court’s acknowledgement of the increasing use of structured dismissals as a legitimate means of ending chapter 11 cases. The United States Trustee often opposes structured dismissals, arguing that because they are not expressly authorized by the Bankruptcy Code, they should not be permitted under any circumstances. In examining prior court decisions regarding structured dismissals, the Court referred to them as “reflecting common bankruptcy practice.” And while the Court took an expressly agnostic view: “We express no view about the legality of structured dismissals in general.” But relying on the logic of its opinion, it could have held that structured dismissals are per se improper unless they simply restore the parties to the positions they were in prior to bankruptcy. But it simply took the narrower step of holding that the Jevic structured dismissal was improper because it departed from the Bankruptcy Code’s priority schemes. Thus, structured dismissals, albeit diminished in potential scope, would appear to continue to be available as a means to resolve failed chapter 11 cases.

 

[1] Case 15-649, ___U.S. ___ (2017).

[2] 29 U.S.C. §2102; N.J. Stat. Ann. §341:21-2 (West 2011).

[3] 11 U.S.C. §507(a)(4).

[4] Sun Capital ultimately prevailed in the claims brought by the truckers.

[5] In re Jevic Holding Corp., 787 F.3d 173 at 175.

[6] Slip Op. at 3, quoting American Bankruptcy Institute Commission To Study the Reform of Chapter 11, 2012-2014, Final Report and Recommendations 270 (2014).

[7] Slip Op. at 12, quoting Markell, Owners, Auctions, and Absolute Priority in Bankruptcy Reorganizations, 44 Stan. L. Rev. 69, 123 (1991).

[8] Ibid.

[9] United States v. Ron Pair Enterprises, Inc. 489 U.S. 235 (1989).

[10] 571 U.S. __, 134. S. Ct. 1188 (2014).


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© 2017 Herrick, Feinstein LLP. This alert is provided by Herrick, Feinstein LLP to keep its clients and other interested parties informed of current legal developments that may affect or otherwise be of interest to them. The information is not intended as legal advice or legal opinion and should not be construed as such.