The Third Circuit’s recent holding in In re Jevic Holding Corp., raised a number of intriguing topics for us bankruptcy nerds so we could not resist taking a closer look at one of the issues presented in the case – structured dismissals.  If you are not familiar with the concept, you are probably not alone, as the use of a structured dismissal as a means to exit bankruptcy is relatively uncommon.  Although the main issue inJevic Holding Corp. involved whether a settlement, which required a structured dismissal of the case, should be approved notwithstanding that its terms violated the absolute priority rule, we did not want todismiss (pun intended!) the issue of permissibility of structured dismissals in a bankruptcy case.  So we take this opportunity to provide an overview of structured dismissals and how they work in a bankruptcy case.  Stay tuned for Part II of our In re Jevic Holding Corp. case study where we’ll examine the Third Circuit’s ruling with respect to deviations from the Bankruptcy Code’s priority scheme.  For now, though, we’ll turn to structured dismissals. 

Structured Dismissals Generally

The Bankruptcy Code provides for three means of exiting a chapter 11 case:  confirmation of a plan of reorganization, conversion to another chapter (usually chapter 7 liquidation), or dismissal of the case.  The ordinary effect of dismissal is reversion to the status quo ante.  The concept of a structured dismissal is controversial, however, because it is not a plain vanilla dismissal.  That is, because structured dismissals are understood to be dismissals that are preceded (and governed) by other orders of the bankruptcy court (e.g., orders approving settlements, granting releases, establishing claims reconciliation and distribution procedures), they do not necessarily reinstate the prepetition state of affairs.  Nevertheless, the use of structured dismissals, particularly after asset sales, seems to be increasingly appealing to debtors confronted with the delay and expense of promulgating a chapter 11 liquidating plan and the uncertainty and additional cost of a chapter 7 conversion.

Because the Bankruptcy Code does not expressly authorize structured dismissals, parties generally rely on section 1112(b), section 305(a)(1), and/or section 105(a) of the Bankruptcy Code as authority to grant the requested relief.  Under section 1112(b), a party in interest may request that the court dismiss a case “for cause.”  Section 1112(b)(4) contains a non-exhaustive list justifying “cause.”  Where the estate lacks funds needed to confirm a plan or liquidate under chapter 11, some courts have permitted a structured dismissal of the chapter 11 case pursuant to section 1112(b).  Under section 305(a), a court may dismiss a case if the interests of the creditors and the debtor would be better served by such dismissal.  Finally, section 105(a) grants a court equitable powers to enter orders that are necessary or appropriate to carry out the provisions of the Bankruptcy Code.

Opposing Views on the Use of Structured Dismissals

While some view structured dismissals as a useful tool to resolve a chapter 11 case, others view it as an end-run around the protections granted to creditors in, and the express requirements of, the Bankruptcy Code.  For example, in an article authored by staff of the Executive Office for the United States Trustees in Washington, D.C., Office of the United States Trustee in Wilmington, Delaware and Office of the United States Trustee in Dallas, the U.S. Trustees’ offices criticize structured dismissals, stating that they are “a new permutation of the sub rosa plan[]”and that structured dismissals ignore important chapter 11 safeguards including voting, acceptance, disclosure, and the “fair and equitable” standards, including the absolute priority rule.  The authors conclude that “the supposed expediency of a structured dismissal should not trump the statutory protections it alters or ignores.  Cases should be administered according to the structure set forth in the Code and not concluded in a summary manner that is ‘structured,’ but flawed.”  In their Report to Study the Reform of Chapter 11, the American Bankruptcy Institute commissioners expressed a similar view, regarding structured dismissals as “short-circuiting” the creditor protections under the disclosure and soliciting provisions of the Bankruptcy Code.  For more of our analysis of the ABI commissioners’ views on structured dismissals, click here.  While at least one court has agreed with the view of the opponents of structured dismissals, there are few published opinions on the issue and up until the Third Circuit’s recent decision in Jevic Holding Corp., there existed little guidance on whether structured dismissals are permissible under the Bankruptcy Code.

Structured Dismissal in the Jevic Holding Corp Case

In Jevic Holding Corp, Jevic Transportation, Inc., a trucking company headquartered in New Jersey, and certain of its affiliates commenced chapter 11 cases in the United States Bankruptcy Court for the District of Delaware.  At the time, Jevic owed $53 million to its secured lenders—CIT Group and Sun Capital Partners—and over $20 million to its tax and general unsecured creditors.  During the course of Jevic’s chapter 11 case, the Official Committee of Unsecured Creditors filed a fraudulent conveyance action on the estate’s behalf against CIT and Sun Capital.  The action was ultimately settled by representatives of the committee, CIT, Sun Capital, and Jevic.  By that time, Jevic’s only assets included $1.7 million in cash (which was subject to Sun Capital’s lien) and the fraudulent conveyance litigation (which was to be dismissed with prejudice pursuant to the settlement).  The settlement agreement provided that Jevic’s chapter 11 case would be dismissed pursuant to a structured dismissal, which included mutual releases and the distribution of the $1.7 million subject to Sun Capital’s lien to tax, administrative, and general unsecured creditors.  Notably, the settlement did not provide for payment of the priority wage claims held by Jevic’s terminated truck drivers¾claims which, but for the settlement and structured dismissal, would have been paid in line with the Bankruptcy Code’s priority scheme and ahead of the claims of Jevic’s tax and general unsecured creditors.

Both the drivers and the United States Trustee objected to the settlement and dismissal arguing that the bankruptcy court had no legal authority to approve a structured dismissal, at least to the extent it deviated from the priority system of the Bankruptcy Code.  The bankruptcy court overruled the objections and, in an oral opinion, approved the settlement and dismissal.  The drivers appealed to the United States District Court for the District of Delaware, which affirmed.  The drivers then appealed to the Third Circuit, with the U.S. Trustee supporting them as amicus curiae.

The questions before the Third Circuit were first, whether bankruptcy courts have discretion to approve structured dismissals and second, if structured dismissals are permissible, whether bankruptcy courts have the power to approve settlements, in the context of structured dismissals, which deviate from the priority scheme of the Bankruptcy Code.  While Part II of our In re Jevic Holding Corp. case study will examine the second issue, we examine the first issue below.

The Third Circuit began its analysis by agreeing with the drivers that the Bankruptcy Code does not expressly authorize structured dismissals.  The court, however, disagreed with the drivers’ insistence that a dismissal must be a revision to the status quo ante.  The Third Circuit explained that while section 349 of the Bankruptcy Code contemplates that a dismissal will typically reinstate the prepetition affairs by revesting property in the debtor and vacating orders and judgements of the bankruptcy court, the Bankruptcy Code also authorizes bankruptcy courts to alter the effects of dismissal “for cause.”  In other words, the Third Circuit concluded, the Bankruptcy Code does not strictly require dismissal of a chapter 11 case to be a “hard reset.”  The court was clear in its ruling, however, that it was not presented with¾and thus was not resolving¾the question of whether structured dismissals are permissible when a confirmable plan is possible or conversion to chapter 7 might be worthwhile.  Rather, the court’s ruling that a bankruptcy court has discretion to order a structured dismissal applies only absent a showing that a structured dismissal has been contrived to evade the protections and safeguards of the plan confirmation or conversion processes.

Conclusion

Although the Third Circuit ruled that bankruptcy courts have the power to approve structured dismissals only in limited circumstances, the Jevic Holding Corp. case provides practitioners in the Third Circuit with a tool – the structured dismissal – to use in certain circumstances the viability of which, up until the Third Circuit’s ruling, was questionable.  Indeed, the decision may lead to more creative outcomes that preserve value for creditors.  Only time will tell whether structured dismissals will be more readily used to wind up chapter 11 cases.