In a prior post, we discussed the Third Circuit Court of Appeals’ decision in Jevic Holding Corp., where the court upheld the use of so-called “structured dismissals” in bankruptcy cases, and the Supreme Court’s grant of certiorari. Yesterday, the Supreme Court heard oral argument in Jevic. The Court’s ultimate ruling will likely have a significant impact upon bankruptcy practice.

Under the Jevic structured dismissal, unsecured creditors received a distribution from a settlement reached between the official committee of unsecured creditors and secured lenders. Wage priority claimants received nothing from the settlement, notwithstanding their senior position under the Bankruptcy Code. The bankruptcy court approved the structured dismissal, and by extension the distribution provided for in the settlement, and the district court affirmed on appeal. The Third Circuit also upheld the structured dismissal, holding that the bankruptcy court has discretion to approve structured dismissals except if there is a showing “that the structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation or conversion process.”

Jevic put front and center two competing concerns in bankruptcy. On its face, the Jevic structured dismissal appears to conflict with the priority rules set forth in section 507 of the Bankruptcy Code, since junior creditors were paid while certain senior creditors were not. However, the structured dismissal approved in Jevic also arguably maximized creditor recoveries, albeit in a way that skipped over certain senior creditors. The estate was administratively insolvent and without the structured dismissal, the case would have been converted to Chapter 7 and distributions would have been significantly reduced.

The questions posed yesterday to counsel for Petitioners and counsel for Respondents, as well as to government counsel as amicus curiae, were wide-ranging and pointed. Justice Breyer questioned the statutory basis for the structured dismissal, noting that while no Code provision forbid it, no specific Code provision permitted it either. Justice Kennedy looked for guidance on the “for cause” standard under section 349(b), which permits bankruptcy courts to modify the effect of dismissal orders. Justice Sotomayor expressed concern that there was collusion in Jevic among senior and junior creditors to the detriment of other creditors. Several Justices expressed concern with Respondents’ position that section 363(b) afforded sufficient discretion to the bankruptcy court to approve a distribution that was at odds with the Code’s priority scheme. According to Respondents, Jevic presented the extraordinary circumstances required by section 363(b) to deviate from the absolute priority rule since no plan was possible and conversion to Chapter 7 would lead to little, if any, distribution. Justice Sotomayor questioned Respondents’ position that Jevic was a rare case, and Justice Kennedy took a similar position, noting that it is not rare for there to be no prospect of a confirmable plan, a fact cited by Respondents in support of the Jevic structured dismissal.

Predicting the outcome of cases simply from oral argument is imperfect and notoriously dangerous. Nonetheless, some commentators have opined that a sufficient number of Justices appear to be sufficiently concerned with the Jevic structured dismissal that the Third Circuit’s opinion is in peril. If the Court reverses the Third Circuit, the question becomes how sweeping the Court’s opinion will be.

A reversal may well imperil so-called “gift plans”, where a secured creditor makes a payment to junior creditor (the “gift”) in order to obtain support for plan confirmation. The gift allows the junior creditor to obtain a recovery at odds with the Bankruptcy Code’s priority scheme. If the Court holds that the priority scheme governs all estate distributions, depending upon the scope of the Supreme Court’s opinion, gift plans may not be permitted.

In addition, if the Court rules that the section 507 priority scheme applies to the entirety of a bankruptcy case, such a holding would conceivably threaten the viability of orders that even Petitioners concede are customary in commercial reorganizations, such as wage payment orders and critical vendor orders. Those represent instances where estate property is distributed in violation of the Code’s priority scheme, but in reliance on the so-called “Doctrine of Necessity,” where payments serve the overall goal of maximizing the debtor’s going concern value to create the possibility of greater distribution to creditors than does liquidation.

In fact, the Court seemed to struggle with how far its ruling should go, asking the parties what was the scope of the holding they wanted the Court to enter. Counsel for Petitioners was careful to limit the scope of the holding so as to carve out common Chapter 11 practices, such as wage payment and critical vendor orders. This was in contrast to counsel for the government who said that it was the government’s view that pre-plan distributions in Chapter 11 that violate the priority scheme “are not permissible under any circumstances unless there is consent of the impaired priority claimholder.” Depending upon the scope of the Court’s opinion, regular and customary Chapter 11 practices, such as critical vendor motions and pre-petition wage motions, may no longer be permitted.

We will update our readers when the Supreme Court issues its opinion.