In Czyzewski v. Jevic Holding, 580 U.S. __(2017), decided on March 22, the U.S. Supreme Court held that, without the consent of impaired creditors, a bankruptcy court cannot approve a "structured dismissal" that provides for distributions deviating from the ordinary priority scheme of the Bankruptcy Code. The ruling reverses the decisions of the U.S. Bankruptcy Court for the District of Delaware, the U.S. District Court for the District of Delaware, and the U.S. Court of Appeals for the Third Circuit, and carries with it implications that may affect both pending and future bankruptcy proceedings.

Factual Background

In 2006, Jevic Transportation Inc., a New Jersey trucking company, was acquired by Sun Capital Partners through a leveraged buyout. Sun Capital financed the buyout with funds loaned from a group of lenders led by the CIT Group. By May 2008, Jevic's financial situation had worsened significantly, and Jevic's board ultimately authorized a bankruptcy filing. At that point, the company halted almost all operations and, on May 19, 2008, notified its employees of their imminent termination. The next day, Jevic filed a petition for relief under Chapter 11 of the U.S. Bankruptcy Code. At the time of filing, Jevic owed $53 million to senior secured creditors Sun Capital and CIT, and over $20 million to general unsecured creditors and taxing authorities.

Two lawsuits quickly followed Jevic's filing: first, the petitioners in this case, a group of truck drivers whose employment had been terminated, filed suit against Jevic and Sun Capital, alleging violations of state and federal law and, more specifically, the Worker Adjustment and Retraining Notification (WARN) Act, a federal law that requires workers be given at least 60 days' notice before termination. The Bankruptcy Court for the District of Delaware granted summary judgment in favor of the truck driver-petitioners. This judgment totaled $12.4 million, $8.3 million of which constituted a priority wage claim under Code Section 507(a)(4).

Second, the Official Committee of Unsecured Creditors filed fraudulent conveyance suits against both Sun Capital and CIT, alleging that both parties had facilitated an "ill-advised" buyout that eventually precipitated Jevic's bankruptcy by burdening the company with an overwhelming amount of debt. Rather than move forward with more litigation, the parties attempted to reach settlement of the claim. By this time, however, Jevic's estate had been significantly depleted and the company held only $1.7 million in cash, all of which was subject to the lien of Sun Capital.

Despite the estate's dearth of assets, the parties reached a settlement pursuant to which: the fraudulent conveyance action would be dismissed; CIT would deposit funds to pay the committee's legal fees and administrative expenses; Sun Capital would assign its lien on the $1.7 million to a trust; the trust would use the $1.7 million to pay taxes and administrative expenses, with the remainder to be used to pay a dividend to general unsecured creditors; and Jevic's bankruptcy case would be dismissed. A dismissal with stipulations such as these is popularly referred to as a "structured dismissal," a resolution that, as courts note, is becoming "increasingly common."

Notably, Sun Capital insisted that the distributions out of the trust not include distributions to the truck driver-petitioners, as it contended that such a distribution would only further fund the WARN litigation that was then-pending against it. By so insisting, however, Sun Capital broke from traditional rules of priority in connection with the distribution of estate assets. A correct application of the rules under the code would otherwise have resulted in payment to the truck driver-petitioners (rather than to general unsecured creditors) of a portion of their priority wage claim.

Decisions of the Lower Courts

Jevic, Sun Capital, CIT and the committee petitioned the bankruptcy court to approve the settlement and dismiss the case. The truck driver-petitioners and the U.S. trustee, however, objected on the grounds described above—namely, that the distribution, as proposed, violated the Bankruptcy Code's priority scheme by passing over the truck driver-petitioners, whose claim was of a higher priority than that of Jevic's unsecured creditors.

While acknowledging the proposed settlement's divergence from the code's priority scheme, the bankruptcy court held that such a disconnect did not per se bar approval of the settlement; instead, in light of the "dire circumstances" present in the case, the court deemed the approval necessary. The court opined that, absent settlement, confirmation of a plan was not a realistic prospect, and conversion to Chapter 7 was inadvisable as there was very little cash in Jevic's estate to fund the converted case. Viewing the settlement in this light, the court approved it.

The District Court for the District of Delaware and the Third Circuit both affirmed the bankruptcy court's holding. Specifically, the Third Circuit Court held that structured dismissals need not always respect the priority schemes of the code, and that Congress had only "codified the absolute priority rule ... in the specific context of plan confirmation." Accordingly, the Third Circuit concluded that, in "rare instances" like those before the court in Jevic, a court could in fact approve structured dismissals that deviate from the code's priority scheme.

The Supreme Court Reversal

After addressing and dismissing contentions raised by the respondents challenging the truck driver-petitioners' standing, the Supreme Court turned to the core issue of the case: whether a bankruptcy court may, without the consent of creditors whose claims are impaired, approve a structured dismissal that provides for distributions that deviate from the ordinary priority rules of the Bankruptcy Code. The court answered this "complicated question" with a simple "'no.'"

The Supreme Court grounded its conclusion in a strict adherence to the text of the Bankruptcy Code, and a recognition for the need to maintain the protections that the code confers upon creditors. In recognizing the code's priority scheme as fundamental, the court found nothing within the code that might justify deviation from that scheme, and noted that something more than "simple statutory silence" would be necessary to allow for a major departure from the scheme. Specifically, the court expected "to see some affirmative indication of intent if Congress actually meant to make structured dismissals a backdoor means to achieve the exact kind of nonconsensual priority-violating final distributions that the code prohibits."

The court did, however, acknowledge and address Code Section 349(b), a provision that permits a bankruptcy judge to dismiss a case "for cause," and one heavily relied upon by the respondents in advancing their position in the lower court proceedings. The court concluded that this provision should be read in the context of the entire code, and that the provision did not grant blanket authorization to bankruptcy judges, but instead offered them the "flexibility to 'make the appropriate orders to protect rights acquired in reliance on the bankruptcy case.'" As nothing in the code authorizes a court to make final distributions of estate assets that violate the priority scheme, the court found "the word 'cause' to be too weak a reed upon which to rest so weighty a power."

Moreover, despite the Third Circuit apparent limitation on such a power to only those "rare cases" where "sufficient reasons" require such a finding, the court found difficulty comprehending, much less articulating, the concrete limitations on these "sufficient reasons." This fact, the court asserted, held the potential for bankruptcy courts: to deviate from the protections of the code that congress specifically bestowed upon particular classes of creditors; to allow for unintended shifts in bargaining power between different classes; to increase the risk of collusion among classes; and, ultimately, to make settlements more difficult to achieve.

The court observed that Congress did not authorize any "rare case" exception to the priorities dictated by the code, and it remained unwilling to "alter the balance struck by the statute." To do so, it reasoned, would not only run counter to a strict reading of the code, but could also result in an erosion of the protections to creditors intended by the code's absolute priority rule. Consequently, the court held that a structured dismissal that deviates from the Code's priority scheme cannot be permitted without the consent of the impaired creditor.

Impact

While the long-term implications of this decision will need to play out, the immediate and obvious effect of Jevic will be a steep drop in the practitioner's ability to structure dismissals in any manner that deviates from the priority scheme of the Bankruptcy Code. Clearly, creditors whose claims are impaired now have greater leverage in the structured dismissal scenario: structured dismissal proponents will have to consider the prospect of "sweetening the deal" for impaired creditors in order to gain consent to the structured dismissal.

This article originally appeared in The Legal Intelligencer and is republished here with permission from law.com.