News
March 27, 2017

Supreme Court Bans Use of 'Structured Dismissals' to Circumvent Bankruptcy Code's Priority Scheme

Advisory

On March 22, 2017, the United States Supreme Court issued its widely-anticipated decision in Czyzewski v. Jevic Holding Corp., 580 U.S. ___ (2017). Writing for a 6-2 majority,1 Justice Breyer rejected the use of "structured dismissals" to make distributions to creditors that violate the priority scheme applicable to Chapter 11 plans and Chapter 7 liquidations without the consent of affected creditors—even in those "rare cases" where there may be no better alternatives.

In the last few years, the use of structured dismissals has become increasingly common in cases where the debtor sold its assets under section 363 of the Bankruptcy Code but could not confirm a plan because the sale proceeds were not sufficient to pay administrative expenses in full. Historically, the alternatives were to dismiss the case or convert to a Chapter 7 liquidation. Structured dismissal recently became a third option, with potential to reduce costs and increase creditor recoveries.

The Jevic case was watched closely by industry experts, many of whom were concerned the decision could alter a delicate balance in complex restructurings. On the one hand, parties and the courts need flexibility in tough cases to fashion creative solutions for the "greater good," even where the solution may not comply with the strict priority rules. On the other, courts need to protect workers, taxing authorities and other priority creditors and ensure, as the Solicitor General argued, that they are not squeezed out by deals between senior and junior creditors.

Prior to the decision, there was also debate as to whether the Court might deviate from its general practice of interpreting bankruptcy issues narrowly, in order to provide guidance on other key restructuring issues potentially implicated by the issue presented in Jevic. There also was concern that a broad holding might, perhaps unintentionally, impact other key elements of restructuring cases. One key related issue is whether courts may approve "gifting" plans or settlements, where a senior creditor gifts a portion of its recovery to a junior class and "skips" an intervening class that ranks ahead of the junior class. Another is whether the Court's rationale might curtail payment of "critical vendor" claims, wages, taxes and the like early in a case, usually as part of "first day" motions. Those payments do not comply with the priority rules but are approved routinely in most cases.

Ultimately, the Court decided only the precise issue of whether parties can "structure" dismissal of a Chapter 11 case to circumvent the strict priority rules applicable to Chapter 11 plans and Chapter 7 liquidations. The Court's answer to that question was a resounding "no."

Background

In 2008, Jevic Transportation, a New Jersey trucking company, and its parent filed Chapter 11 in Delaware. The case followed a leveraged buyout two years earlier in which the sponsor left the company saddled with substantial acquisition debt. When it filed, Jevic owed $53 million to the sponsor and its lenders, which debt was secured by liens on substantially all of the estate's assets, and over $20 million in priority taxes and general unsecured claims.

Jevic never sought to reorganize. Prior to filing bankruptcy, Jevic ceased operations and terminated thousands of drivers with little or no notice. That prompted the drivers to file a class action in the bankruptcy case against the debtor and the sponsor, alleging that the mass layoffs violated state and federal WARN (Worker Adjustment and Retraining Notification) Acts. Those laws generally require an employer to give workers a minimum of 60 days' notice prior to termination. The drivers obtained summary judgment against the debtor, and a portion of their damages constituted priority wage claims that rank senior to general unsecured claims. The drivers continued the WARN Act litigation against the sponsor for several years, until the courts ultimately determined that the sponsor was not an "employer" at the time in question.

Separately, Jevic's official committee of unsecured creditors obtained authority in the bankruptcy case to sue the sponsor and lenders on grounds that the buyout "hastened Jevic's bankruptcy by saddling it with debts that it couldn't service." The committee's complaint attacked the buyout as a fraudulent transfer and sought to subordinate the sponsor's and lenders' secured debt to general unsecured claims. The defendants sought to dismiss the case unsuccessfully. By that time, the debtors' assets had been sold off and the proceeds were applied as partial repayment of the senior loans. All that remained of Jevic's estate was $1.7 million of cash, subject to the sponsor's secured lien, and the committee's litigation claims.

With insufficient cash to pay its administrative expenses, the debtor had no ability to confirm a plan and faced the choice of dismissing the Chapter 11 case or converting to a Chapter 7 liquidation. Negotiations ensued and a deal was struck to settle the lawsuit and pursue a structured dismissal of the Chapter 11 case. The drivers were not parties to the settlement.

The settlement provided that, in exchange for dismissal of the lawsuit, the lenders would pay $2 million to fund committee legal fees and expenses, and the sponsor would assign its lien on the $1.7 million of cash to a trust to pay taxes and administrative expenses, with the balance used to make a small distribution to general unsecured creditors. The settlement was predicated on "skipping" any payment on the drivers' priority wage claims, which statutorily would rank senior to general unsecured claims in a Chapter 11 plan or Chapter 7 liquidation. The sponsor acknowledged that it structured the settlement in this manner to avoid funding the drivers' continued litigation, which at the time was still pending against the sponsor. The drivers and the US Trustee objected to the structured dismissal and lost. The drivers appealed to the District Court and, subsequently, the Third Circuit, both of which affirmed the structured dismissal.

Implications

Ultimately, the Court's decision in Jevic was a narrow one—structured dismissals may not be used to circumvent the Bankruptcy Code's priority rules, absent consent of the affected creditors.

The Court did not say definitively whether it approved of "gifting" plans or settlements. The practice has fallen out of favor with courts in the plan context but has some viability in pre-plan settlements. There is language in the decision, however, that left open the door for cases in which gifting might be appropriate upon a finding of "significant Code-related objectives." Specifically, the Court discussed Iridium, a case where the Second Circuit approved a distribution of settlement proceeds to fund a litigation trust to pursue claims on the estate's behalf. Jevic distinguished Iridium on the basis that the payments were made earlier in the bankruptcy case, when the nature and extent of the estate and claims against it were not fully resolved, as opposed to at the final stages as part of dismissal of the case.

The Court also was careful to distinguish non-consensual distributions made pursuant to a structured dismissal from payments of certain pre-petition claims earlier in a case, including as part of "first day" motions. The Court cited as examples critical vendor payments, pre-petition wages, and "roll ups" that allow lenders who continue financing the debtor to be paid first on their prepetition claims. Courts exercise their equitable powers to approve such payments despite the absence of express support in the Bankruptcy Code. The Supreme Court distinguished such payments, again, on the basis that they are approved earlier in a Chapter 11 case, at a time when less is known about the nature and extent of the debtors' assets and liabilities. The Court also noted that such payments may increase the likelihood of a successful reorganization and, from that view, would make even disfavored creditors better off.

It is clear in the wake of Jevic that parties may no longer use structured dismissals to end around the Bankruptcy Code's priority rules. The decision may have broader implications, however. Bankruptcy courts are courts of equity, and often require flexibility to approve unique solutions to difficult problems. The Court has taken away some of that flexibility, and it will be interesting to see if the lower courts extend that reasoning in other restructuring contexts.

  1. It is noteworthy that the two dissenters, Justice Thomas and Justice Alito, did not disagree with the majority's conclusions. Rather, they would have declined to decide the issues on procedural grounds because the petitioning drivers argued a different issue than what they presented when they asked the Court to take the case.

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