Priority Rules Cannot Be Undermined in a Structured Dismissal
10/1/2017First published in the Oregon State Bar Debtor-Creditor Newsletter Vol. XXXVI, No. 2
Czyzewski et al. v. Jevic Holding Corp. et al.
137 S. Ct. 973 (2017)
Jevic Transportation Corporation (“Jevic”) was a trucking company. In 2006, Sun Capital Partners (“Sun”), a private equity firm, acquired Jevic with funds borrowed from CIT Group (“CIT”) in a leveraged buyout. Two years later, Jevic filed for bankruptcy relief under Chapter 11. At that time, Jevic owed approximately $53 million to its senior secured creditors (Sun and CIT) and approximately $20 million to general unsecured creditors.
During the bankruptcy proceeding, two lawsuits were filed. A group of former truck drivers brought claims against Jevic and Sun for failure to provide proper termination notices in violation of state and federal Worker Adjustment and Retraining Notification (“WARN”) Acts. A judgment was subsequently entered in favor of the truck drivers against Jevic. A substantial portion was entitled to priority treatment as wage claims under §507(a)(4).
Additionally, an Official Committee of Unsecured Creditors brought fraudulent transfer claims against Sun and CIT in connection with the leveraged buyout. Those parties negotiated a $3.7 million settlement which called for the structured dismissal of Jevic’s chapter 11 bankruptcy case. Under the proposed structured dismissal, the truck drivers would receive nothing on account of their priority wage claims. Interestingly, the truck drivers’ suit against Sun was still pending. By cutting the truck drivers out of the settlement, Sun was essentially refusing to fund that continued litigation.
Under the settlement, lower-priority general unsecured creditors would receive payment. The truck drivers objected. The Bankruptcy Court nevertheless approved the settlement agreement. The Bankruptcy Court’s ruling was motivated, in great part, by the overwhelming administrative expenses and lack of funds to continue litigation. The settlement proponents argued that without the proposed structured dismissal, only secured creditors would see any recovery. The Bankruptcy Court reasoned that because the proposed payouts would occur pursuant to a structured dismissal rather than an approved chapter 11 plan, the failure to follow priority rules did not bar approval.
The Supreme Court disagreed. It held that bankruptcy courts may not approve structured dismissals which provide for distributions that do not follow ordinary priority rules without the consent of the affected creditors. The Court explained that it is important to keep in mind that a chapter 11 bankruptcy has three possible outcomes – a confirmed chapter 11 plan, a conversion to chapter 7, or a structured dismissal. A dismissal typically aims to return the debtor to the prepetition “financial status quo” under §349(b)(3). As the Court explained, “conditions may have changed in ways that make a perfect restoration of the status quo difficult or impossible, [so] the Code permits the bankruptcy court, ‘for cause,’ to alter a chapter 11 dismissal’s ordinary restorative consequences.” This is often referred to as a “structural dismissal.” See 11 USC §349(b). A structured dismissal is essentially a hybrid dismissal and confirmation order which may involve the court approving certain distributions to creditors, third party releases, and injunctions restraining creditor conduct. While the Bankruptcy Code does not expressly discuss structural dismissals they have become increasingly common.
The Court went on to explain that both a chapter 11 plan and a liquidation require a debtor to follow prescribed priorities. Although there is somewhat more flexibility in a chapter 11 plan than in a chapter 7 liquidation, a bankruptcy court cannot confirm a plan that contains priority-violating distributions over the objection of an impaired creditor class. See
11 USC §§1129(a)(7), 1129(b)(2), and compare with 11 USC §§725, 726. In contrast, §349(b) provides a bankruptcy court with discretion to structure a dismissal order. It provides that “unless a court, for cause, orders otherwise” the dismissal order will essentially reinstate the status quo (e.g.
, liens and transfers that were avoided are revived, certain orders, judgments, and transfers are unwound, etc.). The Supreme Court held that this authority is not without bounds and is still subject to the Bankruptcy Code’s ordinary priority scheme. The Court explained, “[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.”
Since the holding in Jevic
, it appears that bankruptcy courts are more closely scrutinizing settlements that deviate from basic priority rules, even when structured dismissals are not involved.
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