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Legal Update

US Supreme Court Reverses a Chapter 11 Structured Dismissal

22 March 2017
Mayer Brown Legal Update

Czyzewski v. Jevic Holding Corp., No. 15-649 (2017)

On March 22, 2017, in an opinion by Justice Breyer, the US Supreme Court held in Czyzewski v. Jevic Holding Corp.1 that a dismissal of a Chapter 11 bankruptcy case may not be “structured” to depart from ordinary priority of distribution rules under the Bankruptcy Code absent the affected creditors’ consent, even in rare cases where no better alternative outcome is possible.2 The Jevic decision likely spells the end of structured dismissals in commercial bankruptcy practice, at least where there is no bona fide dispute in the Chapter 11 case as to the priority of the claims and/or the liens at issue.

The debtor in Jevic was a trucking company based in New Jersey. In 2006, a private equity firm (the “PE Firm”) acquired Jevic Transportation Corporation (“Jevic”) in a leveraged buyout. The financing for the buyout was led by an agent (the “LBO Lender”) for a group of lenders. The LBO Lender entered into a revolving credit facility with Jevic, but in the ensuing two years, the company struggled and eventually reached a forbearance agreement with the LBO Lender, which was guaranteed by the PE Firm. In 2008, with the expiration of the forbearance agreement at hand, Jevic ceased substantially all of its operations and notified employees of their impending terminations on May 19, 2008. The next day, the company filed a Chapter 11 bankruptcy case in Delaware.

At the time Jevic filed bankruptcy, it owed more than $50 million to the senior secured creditors (the LBO Lender and the PE Firm) and over $20 million to taxing authorities and its general unsecured creditors. A creditors’ committee was appointed to represent the unsecured creditors.

The circumstances giving rise to the bankruptcy led to two lawsuits. First, a group of the company’s former truck drivers filed a class action adversary proceeding alleging that the company violated federal and state laws requiring the company to provide 60 days’ written notice before laying them off. Notably, the drivers asserted that $8.3 million of their $12.4 million claim consisted of priority wage claims under Section 507(a)(4) of the Bankruptcy Code (thus entitling the drivers to payment ahead of Jevic’s general unsecured creditors as a matter of statutory priority).

Second, the creditors’ committee brought an action on behalf of Jevic’s estate against the LBO Lender and the PE Firm that alleged preference and fraudulent conveyance claims under Sections 547 and 548 of the Bankruptcy Code relating to the leveraged buyout of Jevic. The creditors’ committee ultimately settled its case, at which time the debtor’s only remaining assets were $1.7 million in cash (subject to the PE Firm’s lien) and the lawsuit brought by the committee. The PE Firm, LBO Lender, Jevic and committee then negotiated a settlement of the committee’s lawsuit. The settlement had four parts: (1) the bankruptcy court would dismiss the committee’s lawsuit with prejudice; (2) the LBO Lender would deposit $2 million into an account earmarked to pay the committee’s legal fees and administrative expenses; (3) the PE Firm would assign its lien on the $1.7 million in cash to a trust, which would be used to pay taxes and administrative expenses, with the remainder to be distributed pro rata to general unsecured creditors; and (4) Jevic’s case would be dismissed. No assets were to be distributed to the truck drivers in connection with the settlement, even though they had asserted that $8.3 million of their claim was entitled to priority. In short, the settlement would result in a “structured dismissal” of Jevic’s case that, instead of returning the parties to the pre-bankruptcy status quo (as a traditional dismissal would be expected to do), would provide for a distribution of the debtor’s assets that differed from the priority rules applicable to a Chapter 7 liquidation or a Chapter 11 plan.

The truck drivers and U.S. Trustee objected to the settlement. They argued that it violated the Bankruptcy Code’s priority rules because it paid nothing to the drivers on account of their priority claims while distributing assets to an inferior class of creditors, i.e., the general unsecured creditors. The bankruptcy court agreed that the distributions under the proposed structured dismissal failed to follow ordinary priority rules. However, the bankruptcy court concluded that without settlement and dismissal that there was “no realistic prospect” of a meaningful distribution for anyone other than the secured creditors; that a confirmable Chapter 11 plan was not possible; that there would be no funds to operate, investigate or litigate if the case were converted to Chapter 7; and that, thus, the truck drivers would not have stood to receive any distributions in any event. In these “dire circumstances,” the bankruptcy court concluded that the settlement and structured dismissal could be approved.

On appeal, the district court affirmed the bankruptcy court’s decision, and the Third Circuit Court of Appeals affirmed the district court. The Third Circuit, in a 2-1 decision, concluded that “absent a showing that a structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation or conversion processes, a bankruptcy court has discretion to order such a disposition.” The Third Circuit noted that the absolute priority rule is not necessarily implicated outside of the plan context and that, instead, bankruptcy courts have more flexibility in approving settlements based on the “fair and equitable” standard under Rule 9019.

The Supreme Court reversed the Third Circuit, holding that “[a] distribution scheme ordered in connection with the dismissal of a Chapter 11 case cannot, without the consent of the affected parties, deviate from the basic priority rules that apply under the primary mechanisms the [Bankruptcy Code] establishes for final distributions of estate value in business bankruptcies.” (See Jevic, slip. op. at 2.) The Court described the priority rules applicable to distributions in both Chapter 7 and Chapter 11 as “fundamental to the Bankruptcy Code’s operation.” (Id. at 12.) Accordingly, the Court reasoned that “[w]e would expect to see some affirmative indication of intent if Congress actually meant to make structured dismissals a backdoor means to achieve the exact kind of nonconsensual priority-violating final distributions” prohibited under Chapter 7 and Chapter 11. (See id.) Notably, the Court appeared to dispense with the possibility of a “rare case” exception to its holding in cases where a court finds “sufficient reasons” to deviate from the Code’s priority scheme by concluding that “Congress did not authorize a ‘rare case’ exception.” (Id. at 18.)

The Court’s decision hinged in significant part on the finality of a distribution pursuant to a structured dismissal. By contrast, the Court noted, in dicta, that interim distributions violating ordinary priority rules often are made in a bankruptcy case in furtherance of “significant Code-related objectives.” (Id. at 15.) For example, and as the Court observed in dicta, “first-day orders” may provide for payment of employees’ prepetition wages, payment of “critical vendors” and for the “roll-up” of lenders’ prepetition claims in exchange for continuing to finance the debtor post-petition. (Id.)

Justice Thomas dissented, joined by Justice Alito. Justice Thomas wrote that he would have dismissed the writ of certiorari as improvidently granted. Specifically, Justice Thomas described the issue the Court decided as not the issue upon which the petition for a writ of certiorari was granted. Justice Thomas noted that, other than the decision below, no appellate court had yet decided the issue, that structured dismissals are a “rapidly developing field” and, therefore, that the Court would have benefited from the views of additional courts of appeals.

The Court’s decision likely spells the end of structured dismissals in commercial bankruptcy practice, at least where there is no bona fide dispute in the Chapter 11 case as to the priority of the claims and/or the liens at issue. What remains to be seen is the impact that the Jevic decision may have on other related but unresolved issues under the Bankruptcy Code, including the viability of “gifting” Chapter 11 plans, where a creditor “gifts” its distribution to junior creditors while skipping an intermediate class of creditors; the use of escrows in Section 363 sales where junior creditors are paid from escrowed funds that purport not to be estate property; and whether settlement agreements not resulting in dismissal of the case itself but that depart from traditional Code priority rules can be approved by a bankruptcy court under the “fair and equitable” standard of Rule 9019. None of these issues were expressly addressed in today’s decision in Jevic, and it remains to be seen whether Jevic might have any implications for the resolution of these issues.

Any questions about the case should be directed to (212-506-2570) in our New York office or (312-701-7275) in our Chicago office.

1 Czyzewski v. Jevic Holding Corp., 580 U.S. ___ (2017).
2 See Mayer Brown’s Supreme Court Decision Alert on the ruling.

Authors

  • Brian Trust
    T +1 212 506 2570
  • Thomas S. Kiriakos
    T +1 312 701 7275
  • Tyler R. Ferguson
    T +1 312 701 7273
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