In a widely anticipated ruling, the Supreme Court in Czyzewski v. Jevic Holding Corp. ruled that bankruptcy courts “may not approve structured dismissals that provide for distributions that do not follow ordinary priority rules without the consent of affected creditors.” In doing so, the Court rejected the Third Circuit’s ruling that the circumstances were an unusual “rare case,” justifying deviation from the ordinary priority rules. As the “rare case” rationale is a common basis for many noteworthy bankruptcy practices, the rejection of that approach, at least in this instance, may raise questions about whether other “rare case” exceptions remain viable post Jevic. Jevic eliminates non-consensual structured dismissals to close out bankruptcy cases without complying with the Bankruptcy Code’s priority scheme. However, it carefully excludes from its prohibition common payments to creditors during a bankruptcy case such as for key vendor and prepetition payroll claimants, as well as “roll-ups” of prepetition debt into debtor-in-possession financing. Exactly what other payments may fit under this exception may also lead to further development by the lower courts.

Structured Dismissals

Structured dismissals were a growing trend in bankruptcy cases, where a bankruptcy case is dismissed pursuant to an order for distributions to specified creditor groups. These arrangements typically directed payments to certain classes of creditors who struck a deal with the senior creditors while bypassing other, non-consenting creditor classes. This arrangement could not be done under a plan of reorganization without consent of the bypassed class because it would violate the “absolute priority rule.” That rule generally requires that senior classes be provided for before junior ones, unless the senior class consents to lesser treatment. Because a structured dismissal permitted a senior creditor to channel consideration to the unsecured class, it was often an effective way to resolve cases where reorganization is impossible and the funds were inadequate to otherwise obtain support from unsecured creditors if priorities are observed. As in Jevic, it is typically asserted that the only alternative is liquidation under Chapter 7.

Jevic’s Bankruptcy Case

Jevic Transportation filed for chapter 11 in the United States Bankruptcy Court for the District of Delaware after a failed leveraged buy-out in which Jevic was acquired by Sun Capital Partners with funds borrowed from CIT Group. Jevic’s bankruptcy led to two lawsuits: (i) a lawsuit filed by a certified class of former Jevic truck drivers asserting claims under state and federal Worker Adjustment and Retraining Notification (WARN) acts and alleging that Jevic and Sun failed to provide proper termination notices under such WARN acts; and (ii) a fraudulent conveyance action filed by the Jevic creditors’ committee against Sun Capital and CIT Group relating to the LBO. The truck drivers were awarded a judgment against Jevic, a portion of which counted as a priority wage claim under the Bankruptcy Code. (After the structured dismissal of the bankruptcy case was approved, Sun Capital ultimately prevailed in the WARN action brought against it.) As for the fraudulent conveyance action, the Debtors and the Committee negotiated a $3.7 million settlement that provided for a structured dismissal of Jevic’s chapter 11 cases. Under the dismissal order, certain administrative expenses and tax claims would be paid, and general unsecured creditors would receive a distribution, while the class of truck drivers would receive nothing on account of their priority claims.

In opposing the settlement, the truck drivers argued that paying unsecured creditors ahead of their priority wage claims, the distribution scheme under the proposed structured dismissal violated the Bankruptcy Code’s absolute priority rule. The Bankruptcy Court overruled the objection and approved the settlement agreement, reasoning that the Bankruptcy Code’s priority rules did not bar payments outside of a plan of reorganization. The bankruptcy court found that the priorities of the absolute priority rule did not technically apply and that this was a “rare case” where deviation was appropriate because no other solution was apparent. The district and circuit courts affirmed this analysis.

The Supreme Court’s Opinion – No Structured Dismissal, No Rare-Case Exceptions

Justice Breyer, writing for a 6-2 majority, stated the dispute before the Court simply: “Can a bankruptcy court approve a structured dismissal that provides for distributions that do not follow ordinary priority rules without the affected creditors’ consent?” The court concluded, “Our simple answer to this complicated question is ‘no.’”

The decision labels the absolute priority rule “fundamental to the Bankruptcy Code’s operation.” Thus, the Court demanded “more than simple statutory silence if, and when, Congress were to intend a major departure.” In the absence of such an affirmative grant, the Court declined to create one. Furthermore, the Court noted that the Bankruptcy Code’s other provisions relating to chapter 11 dismissals make no mention of the power to condition dismissal of a chapter 11 case on making distributions to creditors in violation of the Bankruptcy Code’s priorities. The Court found a provision permitting dismissal orders to impose restrictions on dismissal “for cause” “too weak a reed upon which to rest so weighty a power” as a structured dismissal. Rather, the Court ruled the provision was designed to protect those who properly relied on orders during the case from prejudice to their prepetition position.

Perhaps most importantly, the Supreme Court rejected the Third Circuit’s ruling that non-consensual priority-violating structured dismissals could be permissible in “rare case[s]” in which courts could find “sufficient reasons” to disregard priority. Although the Court noted that the showing of “rare” facts in the case was questionable, it ultimately slammed the door on such inquiry. Quoting from a prior opinion “noting the importance of clarity and predictability in light of the fact that the ‘Bankruptcy Code standardizes an expansive (and sometimes unruly) area of law,’ . . . we conclude that Congress did not authorize a ‘rare case’ exception. We cannot alter the balance struck by the statute . . . not even in ‘rare cases.’” In short, even a better showing of “rare facts” and the alternative specter of Chapter 7 liquidation would not justify deviation.

The Court Preserves “Interim Distributions” That Serve Restructuring-Related Objectives

Nevertheless, the Court itself appears to permit one significant deviation. In oral argument, it explored whether strict adherence to absolute priority rules would bar common payments outside that rule, such as payments of unpaid payroll or to key vendors, as is common in “first-day” orders. Those payments have become almost routine in operating cases, and are often viewed as essential to continued operations. Here, the Court stated that while there was no statutory authority for these payments, they were different because they served a “Code-related objective” of facilitating reorganization. The Court noted that such a Code-related objective might also apply to a “roll-up” of prepetition debt into debtor-in-possession financing. Though not expressly authorizing these practices, the Court certainly recognizes that they are different from the issue before it in Jevic.

Implications for Future Cases

Jevic has closed the door to distribution of entire estates in violation of the absolute priority rule. In doing so, the Court continues to show suspicion of any “rare case” exception from the Bankruptcy Code’s express text. Nevertheless, by permitting payments that serve “Code-related objectives” to arguably deviate from this priority, the Court both showed a practical understanding of the needs of bankruptcy cases and likely engendered efforts by parties to bring other kinds of distributions within that exception.