Option III - Structured Bankruptcy Dismissals are Alive and Well Even After Jevic

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Intro

Justice Breyer of the Supreme Court previously recognized that a chapter 11 bankruptcy case can generally lead to the following results:

    1. reorganization through a confirmed chapter 11 plan, where a deal with creditors can be achieved;
    2. conversion of the the case to chapter 7, where no deal with creditors can be achieved; and
    3. dismissal of the case, where no bankruptcy objective can be achieved.

Czyzewski v. Jevic Holding Corp. (In re Jevic Holding Corp.), 137 S. Ct. 973, 979 (2017).  With respect to the third option, which was the focus in Jevic, section 349 of the Bankruptcy Code, which governs the effect of a dismissal, generally attempts to restore the prepetition status quo of the debtor; but not necessarily in all cases. Id.

In Jevic, the Supreme Court invalidated a certain type of dismissal commonly referred to as a “structured dismissal.”  According to the American Bankruptcy Institute, a structured dismissal is a

hybrid dismissal and confirmation order … that … typically dismisses the case while, among other things, approving certain distributions to creditors, granting certain third-party releases, enjoining certain conduct by creditors, and not necessarily vacating orders or unwinding transactions undertaken during the case.

Id. at 980 (quoting American Bankruptcy Institute Commission To Study the Reform of Chapter 11, 2012–2014 Final Report and Recommendations 270 (2014)) While the Bankruptcy Code does not specifically mention structured dismissals, the Supreme Court recognized that such dismissals “appear to be increasingly common.” Id.

Since the Jevic case was decided, lower courts and parties have often questioned whether structured dismissals are still permissible.  But, courts have increasingly embraced that the holding in Jevic is not as broad as originally thought.

In In re KG Winddown, LLC, Case No. 20-11723(MG) (Bankr. S.D.N.Y. June 9, 2021) (Glenn, J.), the Bankruptcy Court for the Southern District of New York recently joined other courts that have found that Jevic “only imposed limits on structured dismissals,” but did not create a per se ban on such dismissals, which still serve legitimate purposes under the Code.  According to Judge Glenn, Jevic “left the door open where [structured] dismissals do not violate the absolute priority rule and otherwise comply with applicable provisions of the Bankruptcy Code.”

The distinctions drawn out in KG Winddown are worthy of a discussion.

Facts

The debtors in KG Winddown were formerly part of the corporate family of luxury Italian restaurants, commenced by the Il Mulino family in New York in 1981 (the “Debtors“), that filed bankruptcy in July 2020 due to the impact of COVID-19.

Shortly after the bankruptcy filing, the Debtors filed a motion to commence a sales process to sell substantially all of their assets. Five months later, after a market test was completed and a contested sale process was resolved, the bankruptcy court approved the sale to the stalking horse bidder, which sale closed six months later due to restrictions in transferring certain governmental licenses (e.g., liquor licenses).

Regretfully, the lack of operations after the sale and sufficient sale proceeds eventually left the Debtors administratively insolvent.  As such, instead of converting the cases to chapter 7, which would have entailed additional expense, the Debtors filed a motion to dismiss the bankruptcy cases, pursuant to a structured arrangement in which:

    • the dismissal of all the Debtors would occur in stages (to assist in transferring licensing);
    • only administrative priority claimants–but no lower level claimants–would be paid with the remaining cash in the estates;
    • the prior orders of the bankruptcy court would remain effective; and
    • the bankruptcy court would retain jurisdiction over an adversary proceeding involving the debtor’s secured lender and buyer.

The U.S. Trustee objected to the proposed dismissal, arguing that Jevic placed a per se ban on dismissals. The bankruptcy court ultimately disagreed, distinguishing the facts, and clarifying the holding, in Jevic.

Jevic

The debtor in Jevic was a transportation company that filed bankruptcy as a result of a failed leverage buyout by a private equity group (“PEG“).

As with many failed leverage buyouts, Jevic‘s bankruptcy resulted in avoidance litigation against the PEG and the bank that funded the buyout.

In addition to the avoidance litigation, a group of truck drivers initiated litigation on their WARN Act claims, arguing that the debtor never provided requisite notice before terminating its employees.

The unsecured creditors’ committee, which had initiated the avoidance litigation, eventually entered into a global settlement with the debtor, bank and PEG, requiring the PEG and bank to pay a certain sum of money to the debtor’s estate and requiring the debtor to file a structured dismissal of the bankruptcy case.  But, the settlement proceeds were knowingly insufficient to pay all creditors, and at the insistence of the PEG, unsecured creditors would receive a recovery but there would be no recovery for the WARN Act claimants, which held over $8 million in higher-priority claims.

While recognizing that the proposed distribution under the structured dismissal violated the Bankruptcy Code’s priority rules, the bankruptcy court approved the settlement and structured dismissal, because the dire financial condition of the debtor would otherwise result in “no realistic prospect” for distribution to anyone except secured creditors and a chapter 7 conversion would prove futile.

On appeal, the district court and Third Circuit affirmed.  However, on further appeal, the Supreme Court found differently.

The basic question posed to the Supreme Court was whether a

bankruptcy court [could] approve a structured dismissal that provides for distributions that do not follow ordinary priority rules without the affected creditors’ consent?

Jevic, 137 S.Ct. at 983.  The Supreme Court answered this question in the negative, emphasizing that “[t]he priority system applicable to [] distributions [in chapter 7 or 11 cases] has long been considered fundamental to the Bankruptcy Code’s operation.” Id. at 984.

Incorporated into the Supreme Court’s analysis was a discussion of (a) section 1112 of the Code, which authorizes a court to dismiss a chapter 11 case for cause, and (b) section 349 of the Code, which governs the effect of a dismissal and generally “seek[s] a restoration of the prepetition financial status quo [of the debtor].”  The Supreme Court found that, while both sections were silent about structured dismissals, section 349, at least, provided a bankruptcy court some flexibility “to make appropriate orders to protect the rights acquired in reliance on the bankruptcy case.” Id. (citing H.R.Rep. No. 95-595, p. 338 (1977)).

In the end, however, the Supreme Court held that the flexibility afforded by section 349 did not authorize

… a court ordering a dismissal to make general end-of-case distributions of estate assets to creditors of the kind that normally take place in a Chapter 7 liquidation or Chapter 11 plan—let alone final distributions that do not help to restore the status quo ante or protect reliance interests acquired in the bankruptcy, and that would be flatly impermissible in a Chapter 7 liquidation or a Chapter 11 plan because they violate priority without the impaired creditors’ consent.

Id. at 984-85.  In doing so, the Court distinguished the cases, like In re Iridium Operating LLC, 478 F. 452 (2nd Cir. 2007), that have allowed interim distributions during a bankruptcy case, on the basis that such cases advanced other “Code-related objectives that priority violating distributions serve.” Id. at 985.  In contrast, according to the Court, “the distributions at issue [in Jevic] more closely resemble[d] proposed transactions[, like sub rosa plans,] that lower courts have refused to allow on grounds that they circumvent the Code’s procedural safeguards.”  Id. at 986.

Judge Glenn’s Analysis

In KG Winddown, Judge Glenn found that the Supreme’s Jevic opinion “declined to express a ‘view about the legality of structured dismissals in general.'” Citing Jevic, 137 S.Ct. at 985.  Rather, according to Judge Glenn, Jevic only “limited the potential scope of structured dismissals, holding that a bankruptcy court cannot ‘approve a structure dismissal that provides for distributions that do not  follow ordinary priority rules without the affected creditors’ consent.'”  Quoting Jevic, 137 S.Ct. at 983; see also 7 Collier on Bankruptcy ¶ 1112.09.

With respect to the proposed retention of jurisdiction, the Court relied on a leading Second Circuit case for the proposition that a court can retain jurisdiction over a related adversary proceeding, even after the dismissal of the underlying bankruptcy case, if it finds that judicial economy, convenience to the parties, fairness and comity are advanced. Citing Porges v. Grunytal & Co. (In re Porges), 44 F.3d. 159 (2d. 1995).  Here, Judge Glenn found that those four factors warranted the retention of jurisdiction.

While the U.S. Trustee argued that the dismissal of the debtors was premature, because it came in stages, the Court found that the staggered process was warranted because only certain debtors were necessary to properly transfer the Debtors’ assets to the buyer.

The U.S. Trustee further argued that, while the proposed distributions did not violate any Code-priority scheme, the distributions did not require court approval.  Judge Glenn held, however, that

While perhaps not required, approval would provide certainty to the Debtors and the creditors, an promote the orderly winding up of the estates, which is precisely the purpose of the contemplated structured dismissal.

Lastly, the Court held that requiring its prior orders to survive were warranted under section 349, because the buyer relied on certain protections in the sale order, including an exculpatory clause, in making the purchase of substantially all the Debtors’ assets.  The Court found that these are precisely the type of rights that section 349 allows a court to protect, even if the Court must adjust the prepetition status quo of a dismissed debtor.

Conclusion

Four years after Jevic was decided, courts are increasingly clarifying that its holding is not as broad as parties originally thought.  In other words, Jevic never placed a per se ban on structured dismissals, pursuant to section 349 of the Code.

Of course, the more and more that debtors become innovative in the types of relief requested in a dismissal order, the more likely their structured dismissals will be challenged.  In KG Winddown, however, Judge Glenn found nothing particular controversial with the staggered dismissals, proposed distributions, retention of jurisdiction and enforcement of prior bankruptcy orders.  Hopefully, other courts will come to the similar conclusions to settle the ongoing debate over structured dismissals.

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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