The Third Circuit recently affirmed a bankruptcy court's approval of a joint settlement and structured dismissal of a chapter 11 case that did not comply with the priority scheme under the Bankruptcy Code by providing payment to a lower class of settling trade creditors, over the objection of a higher class of priority creditors—former employees of the debtor. The court ruled that the structured dismissal did not need to comply with the priorities established in the Bankruptcy Code if the proponents of the structured dismissal "have specific and credible grounds to justify the deviation."

This decision is significant for practitioners. The Third Circuit's approval of structured dismissals resolved a split in its lower courts and provides an alternative resolution to a chapter 11 proceeding where a plan, conversion to chapter 7, or straight dismissal are not feasible resolutions to the case. With this new avenue, the court laid guidelines for future cases. Proponents of a structured dismissal cannot use that resolution as a way to explicitly avoid the plan process or conversion to a chapter 7. And proponents attempting to distribute assets without conforming to the priority requirements of the Bankruptcy Code need to justify their deviation with specific and credible facts. In this case, the Third Circuit viewed the structured dismissal, which did not comply with priority requirements, as fair and equitable because all of the assets of the debtor were secured and there was very little hope of any recovery for any unsecured creditors through expensive and time consuming litigation with the secured creditor.

Practitioners and clients involved in the chapter 11 process should keep in mind the use of structured dismissals as a way to resolve significant chapter 11 disputes. The Third Circuit's endorsement of structured dismissals, including those that deviate from the Bankruptcy Code's priority scheme, seems to be the prevailing view. Polsinelli has a team of bankruptcy practitioners who have experience in large, complex chapter 11 cases and have experience with structured dismissals and other alternative means to confirmation. This case is also a reminder for creditors to keep close tabs on bankruptcy cases, as their class may be skipped over for payment under a structured dismissal.