Legal Alert - U.S. Supreme Court - Bankruptcy Court Not Authorized to Approve Structured Dismissal of Chapter 11 Case Violating Absolute Priority Rule

by Snell & Wilmer

Snell & Wilmer

On March 22, 2017 in Czyzewski v. Jevic Holding Corp. (SCOTUS Case no. 15-649), the Supreme Court of the United States held that a bankruptcy court was not authorized to approve a structured dismissal of a Chapter 11 case that violated the absolute priority rule, over the objection of impaired creditors.

A “structured dismissal” is a hybrid dismissal order that not only dismisses the bankruptcy case but also approves certain stipulated distributions to creditors. Such orders typically also approve forms of relief beyond simply returning the parties to the status quo before the bankruptcy was filed. Although not specifically mentioned in the Bankruptcy Code, structured dismissals have become increasingly common. A structured dismissal does not require a disclosure statement, voting, findings or other statutory procedures that would be required for a bankruptcy court to confirm a plan of reorganization.

Jevic Transportation (the “Debtor”) was a trucking company that had gone through a leveraged buyout transaction (“LBO”). Following the LBO, the Debtor laid off several of its truck drivers. The truck drivers sued the Debtor and Sun Capital (the buyer in the LBO) for violating the WARN Act and, eventually, were awarded a judgment against the Debtor of $12.4MM, part of which ($8.3MM) constituted a priority wage claim under 11 U.S.C. § 507(a)(4).

During the bankruptcy case, the Committee of Unsecured Creditors (the “Committee”) sued the Debtor’s lender (CIT) and the buyer (Sun Capital) for a fraudulent conveyance in connection with the LBO. The parties eventually settled the fraudulent conveyance lawsuit, but the deal required that the case be dismissed pursuant to a structured dismissal. The proposed structure, however, did not provide for any payments to the truck drivers on account of their priority wage claims, even though subordinate general unsecured creditors would receive a distribution. Sun Capital refused to have its settlement funds paid to the truck drivers who, at the time, were still suing Sun Capital in the WARN Act litigation, because they did not want to indirectly fund the litigation.

Reversing both the bankruptcy court and the Third Circuit Court of Appeals, the Supreme Court held that bankruptcy courts may not approve structured dismissals that violate statutory distribution rules without the consent of the affected creditors. The Supreme Court noted that the distribution system is a fundamental aspect of bankruptcy administration and requires that court approved distributions be made in accordance with established priorities, rather than on the basis of inside influence or the economic leverage of particular creditors. The Court found that the dismissal provisions of Chapter 11 seek a restoration of the financial status quo of the Debtor, and that the language in §349 of the Bankruptcy Code, which states “[u]nless the court, for cause otherwise,” only gives courts limited flexibility to protect “reliance interests acquired in bankruptcy.” It does not, however, authorize a bankruptcy court to approve an end run around the Code’s priority scheme of distributions.

The Supreme Court noted that although there are instances where bankruptcy courts can approve priority violating distributions (e.g. critical vendor orders, debtor-in-possession financing order, etc.), those distributions are permissible because they preserve the debtor as a going concern or promote the possibility of a confirmable plan for the benefit of all creditors. In the Jevic case, the proposed structure of the dismissal went beyond restoring the status quo ante or protecting reliance interests. Moreover, the Supreme Court found that Congress did not authorize a “rare case” exception to the absolute priority rule.

The Jevic ruling may cast doubt on the continued viability of other common practices in bankruptcy cases such as secured creditor “gifting” – priority deviations out of a secured creditor’s collateral – or structured distributions of sale proceeds as part of court approved sales under §363 of the Bankruptcy Code. In Jevic the Supreme Court expressed discomfort with certain aspects of §363 and cited two cases where §363 orders were overturned as evasions of statutory Chapter 11 requirements. The Court also cited to an ABI report which proposed substantial reforms to sale practices under §363. In general, the case can be read as a warning to bankruptcy courts that they do not have authority to approve actions that conflict with other statutory requirements of the Bankruptcy Code. Thus, the full impact of the Jevic decision may only be understood in the future cases that struggle to apply its teachings.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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