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Supreme Court Reverses Approval of Structured Dismissal That Violates Fundamental Bankruptcy Priority Distribution Scheme

In a May 2015 opinion, the United States Court of Appeals for the Third Circuit approved the “structured dismissal” of the Chapter 11 bankruptcy case of Jevic Holding Corporation.  In Jevic, the secured creditors paid $2 million into an account to be used to pay the attorneys’ fees of Jevic and the Official Committee of Unsecured Creditors and certain administrative expenses and assigned its lien on a $1.7 million deposit account to a trust for the benefit of the remaining administrative expense creditors and the holders of priority tax claims and general unsecured claims in return for a release of claims of Jevic and the Committee that the Committee had asserted in a lawsuit against the secured creditors.  The dismissal left nothing for Jevic’s former drivers who had priority wage claims that would have had to have been paid in full before the holders of general unsecured claims would have been paid anything if the Code priority scheme had been followed.

The drivers objected to the settlement on the grounds that the Bankruptcy Court lacked authority to approve a settlement that violated the Bankruptcy Code’s priority distribution scheme.  The Bankruptcy Court, the District Court, and the Third Circuit all ruled against the drivers.  While recognizing that the Bankruptcy Code’s priority distribution scheme should normally be adhered to, those courts concluded that the fact that: (a) there was no prospect of confirmation of a plan; (b) only the secured creditors would be paid anything in a Chapter 7 liquidation; and (c) the structured settlement resulted in creditors other than the secured creditors receiving some distribution that they would not have received if the case had been converted to a Chapter 7 liquidation presented a “rare case” in which departure from the priority distribution scheme was justified.

On March 22, 2017, the United States Supreme Court reversed the Third Circuit.  Referring to the Bankruptcy Code’s priority distribution scheme as “a basic under­pinning of business bankruptcy law,” “fundamental to the Bankruptcy Code’s operation,” and “the cornerstone of reorganization practice and theory,” the Supreme Court said that departure from the priority distribution scheme could only be justified if there was “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 that the Code prohibits in Chapter 7 liquidations and Chapter 11 plans.”  The Supreme Court said:

We can find nothing in the statute that evinces this intent. The Code gives a bankruptcy court the power to “dismiss” a Chapter 11 case. §1112(b). But the word “dismiss” itself says nothing about the power to make nonconsensual priority-violating distributions of estate value. Neither the word “structured,” nor the word “condi­tions,” nor anything else about distributing estate value to creditors pursuant to a dismissal appears in any relevant part of the Code.

The Supreme Court was not convinced by the lower courts’ conclusion that Jevic was a “rare case” that presented “sufficient reasons” to deviate from the Bankruptcy Code’s priority distribution scheme.  The Court said that “it is difficult to give precise content to the concept “sufficient reasons.” That fact threatens to turn a “rare case” exception into a more general rule.”  The Court concluded 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 Code establishes for final distributions of estate value in business bankruptcies.”

The Supreme Court did not elaborate on what constitutes “consent of the affected parties.”  In the context of confirmation of a Chapter 11 plan, a class of claims is deemed to have accepted a plan if creditors holding at least two-thirds in dollar amount and more than one-half in number of the claims in the class accept the plan.  However, the Bankruptcy Code provides no mechanism for determining whether affected creditors have consented to the terms of a structured dismissal.  Presumably, a single unhappy creditor can stand in the way of a dismissal that provides for distribution of a debtor’s assets that does not strictly conform to the Bankruptcy Code’s priority distribution scheme.

The Supreme Court also did not explain who the “affected parties” are who must consent to the terms of the structured dismissal.  All three lower courts in Jevic had concluded that no creditors other than the secured creditors would be paid anything in a Chapter 7 liquidation of Jevic’s assets.  Clearly, the Supreme Court nevertheless clearly thought that the drivers were “affected” by the structured settlement.  Presumably, since the Bankruptcy Code’s priority distribution scheme may allow, assuming that the debtor’s assets are sufficient, distributions to secured creditors, holders of claims for costs incurred in administering the bankruptcy case, holders of various priority claims for such things as wages and benefits earned shortly before the bankruptcy case and taxes, general unsecured creditors, and holders of equity interests in the debtor, a structured dismissal that that does not strictly conform to the Bankruptcy Code’s priority distribution scheme now requires every creditor and equity holder to consent.

Although it is difficult to quarrel with the Supreme Court’s rejection of an amorphous “sufficient reasons” in “rare cases” standard as justification to disregard the Bankruptcy Code’s priority distribution scheme, the Court’s opinion leaves more questions unanswered than it answers.  Although Bankruptcy Courts will undoubtedly look for creative work arounds to implement settlements over the objections of recalcitrant creditors who clearly would not be entitled to anything under the normal priority scheme, only legislation evidencing “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 that the Code prohibits in Chapter 7 liquidations and Chapter 11 plans”  is likely to provide definitive guidance.