On November 28, 2016, the Supreme Court is scheduled to hear oral arguments in the appeal of Official Committee of Unsecured Creditors v. CIT Group/Business Credit Inc. (In re Jevic Holding Corp.), 787 F.3d 173 (3d Cir. 2015), as amended (Aug. 18, 2015), cert. granted sub nom. Czyzewski v. Jevic Holding Corp., 136 S. Ct. 2541 (2016). The question before the Court is whether a bankruptcy court may authorize the distribution of settlement proceeds in derogation of the absolute priority rule; the issue is the subject of a circuit split. Notably, the parties to the case did not ask the Court to consider whether structured dismissals are an appropriate exit vehicle from bankruptcy in spite of the fact that that issue was also discussed by the Third Circuit.

In Jevic, the Third Circuit affirmed a bankruptcy court’s approval of a settlement agreement that skirted the Bankruptcy Code’s priority scheme and brought about the structured dismissal of the debtors’ cases.¹ Although the Third Circuit made apparent its reluctance to affirm Jevic’s class-skipping settlement agreement, it found that, unlike plans, settlement agreements are not required to comply with the absolute priority rule. Nevertheless, it opined that “[i]f the ‘fair and equitable’ standard is to have any teeth, it must mean that bankruptcy courts cannot approve settlements and structured dismissals devised by certain creditors in order to increase their shares of the estate at the expense of other creditors.” Accordingly, it held that the absolute priority rule may be circumvented in the context of a settlement agreement if a court has “specific and credible grounds to justify [the] deviation.” In Jevic, the Third Circuit found that the structured dismissal at issue did, in fact, justify a deviation from the absolute priority rule in light of the fact that the debtor was facing administrative insolvency and had no viable means to exit bankruptcy absent the structured dismissal route and, most importantly, the structured dismissal was not “contrived to evade the procedural protections and safeguards of the plan confirmation or conversion processes.”

While at odds with the Fifth Circuit’s decision in U.S. v. AWECO, Inc. (In re AWECO, Inc.), 725 F.2d 293 (5th Cir. 1984), the Third Circuit noted that its approach aligns with that of the Second Circuit, which has found that although compliance with the absolute priority rule is the most important factor in determining if a settlement is “fair and equitable,” a settlement that does not adhere to the priority scheme may be approved if other factors weigh heavily in its favor. Motorola, Inc. v. Official Committee of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452 (2d Cir. 2007) (expressing approval for one deviation from the priority scheme but remanding for more information to justify a different deviation). But cf. AWECO, 725 F.2d 293 (a settlement is “fair and equitable” only if it complies with the Bankruptcy Code’s priority scheme).

The case has garnered significant interest from third parties. For example, numerous scholars have submitted amicus briefs in support of the Third Circuit’s decision, arguing that imposing the absolute priority rule’s requirements on settlement agreements would expand existing law and limit debtors’ chapter 11 exit strategies. See generally, Brief for Amici Curiae Law Professors David Gray Carlson et al. Supporting Respondents, Czyzewski v. Jevic Holding Corp. (No. 15-649); Brief for Amici Curiae Law Professors Jagdeep S. Bhandari et al. Supporting Respondents, Czyzewski v. Jevic Holding Corp. (No. 15-649). These scholars emphasize the importance of flexibility in the bankruptcy process and the longstanding tradition of allowing parties-in-interest to craft unique, if imperfect, solutions for the benefit of the greater good. They caution that rigid application of the absolute priority rule would hamper the efforts of bankruptcy courts and all of their constituencies in fashioning constructive solutions to complicated problems.

On the other hand, Acting Solicitor General Ian Heath Gershengorn filed an amicus brief advocating for Jevic’s reversal, arguing that the absolute priority rule does indeed apply to settlements. Brief for the United States as Amicus Curiae Supporting Petitioners, Czyzewski v. Jevic Holding Corp. (No. 15-649). The United States was motivated by a desire to prevent non-consenting creditors (such as the United States itself) from being denied the benefit of their priority claim status. A group of 19 states also submitted an amicus brief advocating for the reversal of the Third Circuit opinion, noting the effect that a disruption of the priority scheme could have on tax claims, domestic support obligations, certain pre-petition wage claims, and consumer deposits. Brief for Illinois et al. as Amici Curiae Supporting Petitioners, Czyzewski v. Jevic Holding Corp. (No. 15-649). The states argued that in the absence of a reversal such class-skipping settlements will “become the norm” as non-priority creditors, secured lenders, potential buyers, and debtors will increasingly enlist the bankruptcy system to augment their coffers at the expense of the interests of priority creditors.

Regardless of the outcome, the Court’s decision on this matter will significantly affect the trajectory of American bankruptcies for years to come. Stay tuned for more information on this momentous case!