On May 21, 2015, the United States Court of Appeals for the Third Circuit approved the settlement and dismissal of chapter 11 bankruptcy cases through a structured dismissal in rare instances.  See Official Committee of Unsecured Creditors v. CIT Group/Business Credit Inc., Case No. 14-1465, -- F.3d --, 2015 WL 2403443 (May 21, 2015).  In the case before it, the Court approved the structured dismissal of the Chapter 11 bankruptcy case even where the dismissal called for a distribution that did not specifically adhere to the priority scheme set forth in Bankruptcy Code section 507.

Background:

In 2006, Sun, a private equity firm purchased all of the equity of Jevic, a trucking company, through a leveraged buy-out financed by CIT Group.   May 19, 2008, Jevic terminated its employees and wound down its operations.  The next day, Jevic filed Chapter 11 bankruptcy in the United States Bankruptcy Court for the District of Delaware.  During the bankruptcy, two lawsuits relevant to this decision were filed:  1) a class action adversary proceeding by a group of terminated truck drivers against Jevic and Sun alleging violations of state and federal Workers Adjustment and Retraining Notification (WARN) laws and 2) an adversary proceeding by the Official Committee of Unsecured Creditors brought against CIT and Sun, alleging fraudulent conveyances and preferential transfers resulting from the leveraged buy-out.

By March 2012, Jevic’s assets had been depleted, with only $1.7 million in cash, which was subject to Sun’s priority lien.  The Committee, Jevic, Sun and CIT settled the Committee’s lawsuit whereby CIT would paid $2 million toward Jevic’s and the Committee’s legal fees and the remaining $1.7 million in cash subject to Sun’s priority lien would be turned over to a trust to pay administrative claimants and then general unsecured creditors, pro rata.  The chapter 11 cases would be dismissed.  The terminated truck drivers were not included as part of the settlement and their claims alleging that they were entitled to at least $8.3 million in priority wage claims were not included in the settlement.

The terminated drivers and the United States Trustee objected to the settlement agreement arguing that the settlement agreement violated the priority scheme (i.e., that the employee wages were to be paid before tax and general unsecured creditors under section 507).  The United States Trustee also argued that structured settlements were not permitted by the Bankruptcy Code. 

The Bankruptcy Court overruled the objections and approved the settlement.  It acknowledged that that the Bankruptcy Code does not expressly exercise structured dismissals but justified the relief sought because of the “dire circumstances” of the case.  There was “no prospect of a confirmable Chapter 11 plan” and (ii) conversion to chapter 7 would be impracticable because the remaining funds would be subject to a Sun’s lien.  The Bankruptcy Court determined that a chapter 7 trustee would likely lack the funds to further litigate the claims, and would likely simply turn over the cash and close the case.  The Bankruptcy Court further explained that the Bankruptcy Code’s priority scheme does not apply to settlements.  The U.S. District Court for the District of Delaware affirmed and the case was appealed to the Third Circuit.  Casimir Czyzweski v. Jevic Holding Corp. (In re Jevic Holding Corp.), No. 13-104-SLR, 2014 WL 268613 (D.Del. 2014).

Third Circuit’s Decision:

The Third Circuit viewed the case as presenting two issues:  (1) whether structured dismissals are permissible as a matter of law and (2) whether a settlement may skip a class of creditors in favor of more junior creditors.

The objecting WARN creditors (the terminated truck drivers) argued that a structured dismissal is not permissible by the Bankruptcy Code.  They argued that the Code only permits three types of exits from Chapter 11 (i.e., plan confirmation, Chapter 7 conversion, or a straight dismissal).    The Court, rejecting this argument, held that a bankruptcy court has discretion to order a structured dismissal “absent a showing that a structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation processes” (2015 WL 2403443, at *6).

 Next, while noting that it was a “close call,” the Court of Appeals permitted the unsecured creditors to receive payment through a settlement that deviates from the Bankruptcy Code’s priority scheme.  The Court held that “bankruptcy courts may approve settlements that deviate from the priority scheme” of Bankruptcy Code section 507 if “specific and credible grounds … justify [the] deviation.”  Id. at *9.    Looking to the bankruptcy court’s findings of fact, the Court concluded that the settlement and structured dismissal presented “the least bad alternative since there was no prospect of a plan being confirmed and conversion to Chapter 7 would have resulted in the secured creditors taking all that remained of the stated in short order.”  Id.

The Jevic decision confirms that within the Third Circuit, a structured dismissal of a bankruptcy may be a viable alternative to Chapter 7 conversion or dismissal.  While the Court was clear to note that approval of such dismissals may be rare, the facts of the case offer a proposed road map whereby a structured dismissal may be appropriate. 

The extent to which parties invoke structures dismissals and settlements remains to be seen.  The Jevic decision makes the Third Circuit the first court of appeals to approve a structured dismissal, and may provide additional flexibility to parties and judges in resolving future bankruptcy cases.  Note, however, that structured dismissals continue to be a hot topic of debate in the restructuring community.  Indeed, the 2014 report of the American Bankruptcy Institute Commission to Study the Report of Chapter 11 recommended eliminating structured dismissals.  Report at 272-73 (recommending “strict compliance with the Bankruptcy Code in terms of orders ending the chapter 11 case” and explaining that dismissal orders should “satisfy the applicable provisions of, and [] not permit the parties to work around, the Bankruptcy Code”).