Most corporate bankruptcy filings result in either a plan of reorganization under Chapter 11 of the Bankruptcy Code (the Code) or a liquidation under Chapter 7 of the Code. Sometimes, however, neither option is viable and the debtor may need to seek a “structured dismissal” in accordance with Section 349 of the Code. Structured dismissals provide administratively insolvent debtors with a framework to distribute the estate’s remaining assets (without the additional cost of a Chapter 7 liquidation), wind down the estate, and obtain final dismissal of the case.
Structured dismissal jurisprudence is limited with the seminal case being Czyzewski et al., v. Jevic Holding Corp., et al., 137 S. Ct. 973 (2017). In Jevic, the Court narrowly ruled that structured dismissals must comply with the Code’s priority scheme. Recently, the Bankruptcy Court in the Southern District of New York, was presented with an opportunity to consider the terms of a structured dismissal offering guidance to debtors that may need an alternative resolution of their Chapter 11 cases.
After five years in Chapter 11, the Great Atlantic & Pacific Tea Co. debtors (Great Atlantic) proposed a structured dismissal to exit bankruptcy. Great Atlantic had “liquidated substantially all of their assets” but lacked sufficient funds to confirm a plan (or fund a Chapter 7 liquidation). The dismissal proposed the creation of a wind down company to disburse Great Atlantic’s remaining assets consistent with a global settlement agreement between its senior secured lender, Mount Kellett Master Fund II LP (Mount Kellett) and administrative claimants. Administrative claims with priority under Section 503 of the Code would receive a 20% recovery (pro rata from a pool of $10.35 million) and junior unsecured creditors would receive no distribution. The residual assets would then be transferred to Great Atlantic’s sole secured creditor, Mount Kellett. The debtors also proposed (a) the creation of a disputed claims reserve sufficient to pay all disputed administrative claims on a pro rata basis; (b) $500,000 to fund any adjustments to allowed union claims; and (c) releases and exculpation provisions to protect participants in the Chapter 11 process from liability.
The US Trustee asserted that the structured dismissal violated the Jevic ruling because it included provisions in the dismissal order that would permit the debtor to achieve “plan-like” benefits without the procedural and substantive protections of a plan confirmation process. The US Trustee argued that there existed no statutory basis for the dismissal order to provide for “(a) an end of-case distribution scheme of the estates’ assets; (b) the establishment of reserves to protect certain creditors; (c) an exculpation that is essentially the equivalent of nonconsensual third-party releases and injunctions; (d) abandonment, destruction, or disposal of the Debtors’ books and records; and (e) dissolution of the Debtors.”
The facts of Great Atlantic do not fit neatly into the narrow holding of Jevic. In Jevic the Court simply confirmed that the Bankruptcy Code does not permit a debtor to use a structured dismissal to circumvent the Code’s priority rules. Jevic Holding Corp, the product of failed leveraged buyout, filed bankruptcy owing $53 million to its secured creditors and over $20 million to tax and general unsecured creditors. During the Chapter 11 case, Jevic’s former employees prevailed on WARN Act violation claims and were awarded $8.3 million for wage claims. Separately, Jevic negotiated a settlement of a fraudulent conveyance action, which proposed a structured dismissal that would provide distributions to Jevic’s secured creditors and general unsecured creditors, but provided no distributions to the $8.3 million WARN wage claims that had priority over unsecured claims under the Code in any Chapter 11 plan.
The Bankruptcy Court recognized that the Jevic settlement and dismissal would violate the Code’s ordinary priority rules, but nevertheless held that, without the settlement and dismissal, there would be no meaningful distribution for any creditor; accordingly approval of the structured dismissal was appropriate. The district court and the US Court of Appeals for the Third Circuit affirmed.
The Supreme Court reversed. The Court’s decision closely adhered to the Code’s text and legislative history and made clear that the Bankruptcy Court could not order a structured dismissal that distributed estate assets in a manner contrary to the Code’s priority rules without the impacted creditors’ consent. The holding did not prohibit structured dismissals generally, it only prohibits nonconsensual structured dismissals that violate the Code’s priority principles.
STRUCTURED DISMISSALS POST-JEVIC
The nature and scope of any other constraint on structured dismissals remains fertile ground for dispute. In Great Atlantic, the US Trustee took the opening and opined that Jevic “left unresolved whether structured dismissals that do not violate priority are permissible” and suggested that the inclusion of features in the dismissal proposal that are similar to features of a Chapter 11 plan, violated the Code. The Great Atlantic court disagreed, characterizing the objection as “not well taken.”
The Court, in an oral ruling, walked through the similarities between the proposed structured dismissal and a Chapter 11 plan and explained why those similarities were entirely consistent with the Code and provided no basis to prevent the proposed dismissal.
First, with respect to the provision for the payment of administrative claims and appointment of a responsible officer to liquidate the claims - the Court observed that Chapter 11 debtors have the right to pay administrative expenses at any point during a case and must be pay them to confirm a plan. Accordingly, there is nothing inherently contrary to the Code in permitting Great Atlantic to provide for the payment of administrative claims (or an officer to oversee such payments) as part of the dismissal procedures.
Second, the Court found nothing improper about the appointment of a responsible party to oversee the wind-down of Great Atlantic and the distribution of its remaining assets. There is nothing unique to a Chapter 11 plan about assigning duties to employees or reducing its management team. The Court stated that it was “simply irresponsible” of the US Trustee to suggest “that the state of affairs [i.e., winding up operations with a skeleton crew of staff] is somehow contrary to the Bankruptcy Code.”
Finally, the Court held that there is no limitation on exculpation clauses and third-party releases outside of a Chapter 11 plan. The proposed exculpation clause, as approved by the Court, is “based on the commonsense notion . . . that once a court approves a transaction on notice and a hearing in a bankruptcy case, and that approval is final, people should not be allowed to sue parties either because they sought approval of such a transaction or because they were carrying out the transaction as it was approved.” The Court, however, narrowed the exculpation clause to matters approved by the Court during the Chapter 11 cases, not broadly to all matters relating to the administration of the case.
The Court concluded that the relief requested by Great Atlantic was “entirely consistent with the Bankruptcy Code” and overruled the US Trustee’s objections. Although the facts and circumstances of Great Atlantic are unique, the US Trustee’s broad objection to the use of a structured dismissal generally can be seen as a warning to similarly situated debtors that the structured dismissals will draw scrutiny. However, the Court’s clear support for the tool in Great Atlantic offers guidance to debtors navigating the boundaries of how to exit bankruptcy where the traditional Chapter 11 or 7 avenues are unavailable or infeasible.