On March 22, 2017, the United States Supreme Court (the Supreme Court) in In re Jevic Holdings Corp. held that a final disposition of estate funds cannot violate the Bankruptcy Code’s priority system by distributing value to junior creditors ahead of dissenting senior creditors, even in the context of so-called “structured dismissals” effected outside of a formal plan of reorganization.[1] The Supreme Court’s decision potentially narrows the use of structured dismissals which have become a more common solution to resolve some complex chapter 11 cases. In the wake of Jevic, structured dismissals will have to be tailored to comply with the established priorities for distribution under the United States Bankruptcy Code.[2]

Methods of Resolving Chapter 11 Cases

The Bankruptcy Code provides debtors with three principal options for exiting a chapter 11 case: (i) confirmation of a plan of reorganization;[3] (ii) conversion to a liquidation under chapter 7;[4] and (iii) dismissal “for cause.”[5] The first option is typically viewed as the ideal outcome for the debtor and its stakeholders as it often provides a global settlement of the debtor’s liabilities that allows the debtor to emerge as a reorganized entity.[6] By contrast, conversion results in liquidation and the end of the debtor as a going concern[7] and dismissal effectively restores parties to their pre-bankruptcy positions. [8]

In recent cases, some courts have approved a “fourth” option commonly known as the “structured dismissal.”[9] Structured dismissals are best recognized as a “hybrid dismissal and confirmation order” and generally are the product of a traditional dismissal combined with the effects of a court-authorized settlement.[10] Such settlements may provide distributions to creditors, grant third party releases, and enjoin conduct by creditors—relief similar to that found in plans of reorganization.[11] Accordingly, structured dismissals have increasingly been viewed as a cost-effective and efficient way to exit bankruptcy.[12]

The Pitfall of Structured Dismissals

Despite the attractive hybrid nature of structured dismissals, the method of exit has an inherent flaw: the Bankruptcy Code does not define the contours of a structured dismissal. Unlike plan confirmation (section 1129), conversion to liquidation (sections 1112(a), (b)), and traditional dismissal (sections 1112(b) & 349), there is no Bankruptcy Code section that expressly establishes requirements for structured dismissals.[13] Accordingly, bankruptcy courts have been left to evaluate whether a proposed structured dismissal is warranted in a given case, and recent cases show such determinations are not without controversy and challenge by interested parties.

Challenge to Structured Dismissal in Jevic

In Jevic, Sun Capital Partners (Sun), a private equity firm, acquired Jevic Transportation Corporation (Jevic), a trucking company, using proceeds of a loan from CIT Group (CIT) in a leveraged buyout (the LBO).[14] The business did not develop as planned and Jevic filed for chapter 11 relief two years after the LBO.[15] At the time of the filing, Jevic owed $53 million to senior secured creditors, Sun and CIT, and over $20 million in tax obligations and general unsecured claims.[16]

The circumstances surrounding Jevic’s bankruptcy led to two lawsuits.[17] First, a group of former Jevic truck drivers sued Jevic and Sun for violating certain statutes that provide workers be given advance notice before their termination (the WARN Action).[18] Second, the official committee of unsecured creditors (the Committee) sued Sun and CIT on theories that the LBO constituted a fraudulent transfer and preferential payment under relevant sections of the Bankruptcy Code (the LBO Action).[19]

With respect to the WARN Action, the Bankruptcy Court granted summary judgment to the truck drivers as against Jevic and awarded them $12.4 million, of which $8.3 million constituted a priority wage claim under the Bankruptcy Code.[20] Additionally, the United States Bankruptcy Court for the District of Delaware (the Bankruptcy Court) held the Committee had adequately pleaded claims of fraudulent transfer and preferential transfer in the LBO Action.[21]

Sun, CIT, Jevic, the truck drivers, and the Committee attempted to negotiate a settlement of the LBO Action. By that time, however, the costs of litigating the LBO Action and WARN Action had taken their toll on the Jevic estate. Substantially all of Jevic’s tangible assets had been liquidated to repay the lender group led by CIT and the only assets left in Jevic’s estate was $1.7 million in cash, which was subject to a lien held by Sun, and the value of the LBO Action, the success of which was recognized as “uncertain at best” by the Bankruptcy Court.[22] The result of the negotiations was a proposal for a structured dismissal agreed to by all parties—except the truck drivers—whereby, in exchange for dismissal of the LBO Action, CIT and Sun would provide a combined $3.7 million, which ultimately would inure to the benefit of the Committee’s professionals, Jevic’s general unsecured creditors, and priority administrative expense and tax creditors. Under the proposal, however, the truck drivers holding priority claims would receive nothing.[23] The apparent rationale for their exclusion was that Sun did not want to enter a deal that would fund the truck drivers’ WARN Action against it.[24]

The truck drivers objected to the structured dismissal on the basis that it violated the Bankruptcy Code’s priority scheme by paying junior creditors ahead of higher ranking middle-priority creditors.[25] Typically, a junior class of claims or interests is not permitted to a final distribution ahead of a dissenting senior class.[26] The Bankruptcy Court did not agree, finding that in “dire circumstances” where there is “no realistic prospect” of a meaningful distribution for anyone other than the secured creditors, a structured dismissal that provides for a meaningful recovery is warranted, even if it violates the Bankruptcy Code’s priority scheme.[27] The Bankruptcy Court also applied the multifactor test of In re Martin for evaluating settlements under Federal Rule of Bankruptcy Procedure 9019 (Rule 9019)[28] and found that the settlement and structured dismissal were warranted.[29]

On appeal, the United States District Court for the District of Delaware (the District Court) reasoned that because a structured dismissal was not a plan of reorganization, it did not need to follow the Bankruptcy Code’s priority rules.[30] The United States Court of Appeals for the Third Circuit affirmed the District Court’s decision holding that “in rare instances” bankruptcy courts may approve structured dismissals that do not strictly adhere to the Bankruptcy Code’s priority scheme.[31] The truck drivers appealed to the Supreme Court, which granted certiorari.

The Supreme Court Decision

In a 6-2 decision, the Supreme Court reversed the lower courts’ rulings and held that a structured dismissal cannot provide final distributions to creditors in violation of the Bankruptcy Code’s priority rules without creditor consent.[32] The Supreme Court reasoned that the priority system is fundamental to the Bankruptcy Code’s operation and those ordinary case-ending distributions of the debtor’s estate—either through a chapter 11 plan or a chapter 7 liquidation—must respect the priority system established by the Bankruptcy Code.[33]

In its opinion, the Supreme Court reconciled the Bankruptcy Code’s priority system with section 349(b), which governs dismissals.[34] It noted that the authority for structured dismissals stems from the language of section 349(b) which provides that dismissals will effect a return to the status quo “[u]nless the court, for cause, orders otherwise.”[35] That language, the Supreme Court reasoned, was too weak an indication from Congress that it intended to allow structured dismissals to provide final distributions that violated the Bankruptcy Code’s priority system.[36]

The Supreme Court also did not agree with the Third Circuit that “sufficient reasons”—such as the impossibility of an alternative settlement or beneficial distribution—may permit a bankruptcy court to override the Bankruptcy Code’s priority rules through a structured dismissal.[37] The Supreme Court expressed concern that such a “rare case” exception might turn into a general rule, lead to uncertainty, and encourage future litigation.[38]

Additionally, in dicta, the Supreme Court condoned the practice of providing interim distributions that may violate the Bankruptcy Code’s priority system, so long as those distributions “enable a successful reorganization and make even the disfavored creditors better off.”[39] Accordingly, common relief such as “first-day” wage orders that allow payment of prepetition employee wages, “critical vendor” orders that allow payment of essential supplier invoices, and “roll-ups” that allow lenders that provide debtor-in-possession financing to be paid first on their prepetition claims will likely continue to be recognized as viable options by bankruptcy courts.[40]

The Supreme Court’s decision is a narrow one that rejected a non-consensual structured dismissal that violated the priorities established under the Bankruptcy Code. Jevic, however, does not preclude the continued use of structured dismissals that comply with such priorities or which are consensual.[41] Moreover, absent from the Supreme Court’s decision is any further discussion of the scope for approving structured dismissals as settlements under Rule 9019,[42] or by analogous arguments used to support confirmation of a so-called “gifting plan” where a senior creditor agrees, pursuant to a plan, to “gift” a distribution to a junior class that would otherwise be paid to the senior creditor.[43] Finally, Jevic confirms that certain interim distributions made in furtherance of the overall restructuring and bankruptcy, such as critical vendor payments, will continue to be permitted even though such distributions may otherwise violate the Bankruptcy Code’s priority rules.