supreme-court-300x199[1]In a decision all but certain to engender future litigation, the Supreme Court recently held in the case of Czyzewski v. Jevic Holding Corp. that structured dismissals providing for distributions that do not follow the normal priority rules and that do not have the consent of affected creditors are impermissible. Reversing the Third Circuit Court of Appeals, which had affirmed the decisions of the courts below, the Supreme Court crafted a narrow ruling that raised but left unanswered questions about the permissible contours of structured dismissals.

There are three possible outcomes to a Chapter 11 bankruptcy case. First, the debtor and creditors may negotiate for a confirmed plan that provides for distributions to allowed claims from the proceeds of the debtor’s ongoing business or the sale and liquidation of its assets. Second, the case may be converted to Chapter 7 for the liquidation of the business and distribution to creditors. The third possible outcome is the dismissal of the bankruptcy case with the objective of restoring the pre-petition status quo. Acknowledging that intervening events may have occurred during the bankruptcy that make the restoration of the status quo difficult or even impossible, the Bankruptcy Code permits the Bankruptcy Court to alter, for cause, the ordinary restorative consequences of a Chapter 11 dismissal. A dismissal that does this or attaches other special conditions — such as approving distributions to certain creditors, granting third-party releases, enjoining proscribed conduct by creditors or preserving orders and transactions undertaken in the case — is commonly referred to as a structured dismissal. In recent years, structured dismissals have become a more prevalent exit strategy, especially in cases where the debtor sells its assets in a § 363 sale but is unable to confirm a plan due to the inability to pay administrative claims in full.

The Bankruptcy Code establishes a priority system of distribution that ordinarily determines the order and extent of distribution of assets of the estate. First are secured creditors which must receive the equivalent proceeds of the collateral securing their debts. Next come the range of classes of priority claims which include administrative expenses of operating the estate, certain wage claims, and unpaid taxes. Rounding out the bottom of the distribution order are general unsecured claims followed by holders of equity in the debtor. Under the absolute priority rule, lower priority creditors may not receive anything until higher priority creditors have been paid in full.

The Bankruptcy Code is clear that distribution to creditors in a Chapter 7 liquidation case must follow this prescribed order. More leeway is afforded in Chapter 11, but a court may not confirm a plan that contains priority-violating distributions over the objection of an impaired creditor class. The Bankruptcy Code does not explicitly state what priority rules, if any, apply in a dismissal that includes a distribution. The question before the Supreme Court involved the interplay between the Bankruptcy Code’s priority rules and Chapter 11 dismissal.

A basic understanding of the underlying facts of Jevic is critical for an appreciation of the ruling of the Supreme Court as well as the questions left unanswered by the decision. Jevic filed for bankruptcy after being purchased in a leveraged buyout. This filing prompted two lawsuits. A group of former Jevic truck drivers obtained a judgment against the debtor for Jevic’s failure to provide sufficient advance notice of the business closure required under the WARN Act. Part of this judgment constituted a priority wage claim, entitling payment ahead of general unsecured claims. In the second suit, the creditors committee brought a fraudulent conveyance suit against Jevic’s secured lenders arising from the leveraged buyout. The parties to the second suit negotiated a settlement that provided for a structured dismissal of the bankruptcy case conditioned on the following: dismissal of the fraudulent conveyance adversary; the payment of $2 million by the lender to be earmarked for the committee’s legal fees and administrative expenses; and the assignment of the bank’s lien on the remaining cash held by the debtor to a trust that would pay taxes and administrative expenses and with the remainder to be paid pro rata to general unsecured claims but excluding the WARN act claimants from distribution.

The WARN act claimants objected to the settlement, asserting that the distribution plan violated the Bankruptcy Code’s priority scheme because it skipped over their claims while paying lower-priority creditors. The Bankruptcy Court held that the failure of the settlement to adhere to the ordinary distribution rules did not bar approval because the payout would be made in connection with a structured dismissal rather than a Chapter 11 plan. Additionally, the Bankruptcy Court reasoned that due to the blanket liens, there was no realistic prospect outside of the settlement of a meaningful distribution to anyone other than the secured creditors. The District Court and Third Circuit each affirmed, concluding that the absolute priority rule applied only to plan confirmation and that courts may in “rare instances” approve a structured dismissal that deviated from the priority scheme.

Looking to the Bankruptcy Code statutes relating to dismissals, the Supreme Court found no indication of legislative intent to make structured dismissals a backdoor means to achieve the exact type of non-consensual priority-violating distributions expressly prohibited in Chapter 7 liquidations and Chapter 11 plans. The Court further found that the statutory language permitting the bankruptcy judge to “for cause, order otherwise” was limited to giving the court the flexibility to restore the pre-filing status quo and to protect rights acquired in reliance of the bankruptcy case. Nothing in the Bankruptcy Code authorized a court ordering a dismissal to make end-of-case distributions to creditors of a kind that would be prohibited in a Chapter 7 liquidation or Chapter 11 plan, let alone final distributions that neither restore the status quo nor protect reliance interests.

The Supreme Court distinguished instances of permissible interim distributions that nevertheless violate priority rules on the grounds that they advance significant Code-related objectives, enable a successful reorganization and make the disfavored creditor better off. Examples include first-day wage orders that allow payment of pre-petition wages to employees, critical vendor orders that permit the payment of pre-petition invoices of essential suppliers, “roll-ups” allowing lenders to continue financing to the debtor to be paid first on their pre-petition claims. In contrast, the Supreme Court found that the structured dismissal in Jevic did not present any these offsetting bankruptcy-related justifications. The Supreme Court rejected the Third Circuit rationale that priority-violating structured dismissals should be permissible in “rare cases” when courts find “sufficient reasons” to disregard priority. Recognizing the difficulty of ascertaining “sufficient reasons,” the Supreme Court feared that the “rare case” exception would become a more general rule. This would present potentially serious consequences, including the disregard for the legislative protections granted to different classes of creditors, changes in the bargaining power of different classes of creditors, risks of collusion between secured creditors teaming with unsecured creditors to squeeze out priority creditors, and making settlements more difficult to achieve.

While the immediate implications of Jevic in putting to an end non-consensual structured dismissals that violate the priority scheme are clear, the ramifications of the decision are not. In crafting a narrow ruling, the Supreme Court purposefully avoided further disruption to Chapter 11 practice and refrained from any definitive comment on the other ways the priority rules are violated in a Chapter 11 case. In reversing the Third Circuit, the Supreme court stated that it “express[es] no view about the legality of structured dismissals in general,” which raises the question about the viability of a structured dismissal that does not violate the priority scheme of the Bankruptcy Code or one that does violate the order of priority but is nevertheless consented to by affected creditors. Also left unanswered is the propriety of so-called “gifting plans” where non-estate assets from secured lenders are skipped over certain classes of creditors in distribution to more junior creditors. The Court distinguished other interim distribution priority violations that might serve to benefit disfavored creditors from final distributions that cement creditor’s rights, like those in play in Jevic. However, the demarcation between interim and final distributions is not always so clear.

Bankruptcy Courts are courts of equity which often utilize flexibility and creativity to forge solutions to often difficult and complex problems to serve the greater good. In rejecting this approach, the Supreme Court adhered to Congressional intent and a rules-driven application. While the scope of the Jevic decision was narrow, the potential implications are broad. The contours of both structured dismissals and non-conforming interim distributions will surely be tested in the courts below and may await further examination by the Supreme Court.


Alex BarnesMr. Barnes represents businesses and individuals facing preference and avoidance litigation, Chapter 11 debtors-in- possession, Chapter 7 and 11 Trustees, Liquidating Trustees, Creditor Committees, secured and unsecured creditors, asset purchasers, and equipment lessors in all facets of commercial bankruptcy. Additionally, Mr. Barnes represents individuals and business clients in commercial litigation and transactional matters.  He can be reached at alexander.barnes@obermayer.com or at 215.665.3184.