Can a bankruptcy court order the “structured dismissal” of a Chapter 11 case if such dismissal would alter the ordinary priority rules for creditor distributions under the Bankruptcy Code? In Czyzewski v. Jevic Holding Corp., 580 U.S. (March 22, 2017) (Jevic), the Supreme Court recently determined that such an order cannot issue without consent from all affected creditors even in “rare cases in which courts could find sufficient reasons to disregard priority.”
In general, Chapter 11 cases are resolved one of three ways: (1) confirmation of a Chapter 11 plan; (2) conversion to Chapter 7 liquidation, or (3) dismissal of the case. A “structured dismissal” occurs when the bankruptcy court, “for cause,” alters the ordinary consequences of dismissal or attaches special conditions to the dismissal.
In Jevic, petitioners filed suit against the debtor alleging Worker Adjustment and Retraining Notification (WARN) Act and other violations. Petitioners prevailed against Jevic on summary judgment, leaving petitioners with a judgment that, in part, counted as a priority wage claim. Also, a committee of Jevic’s unsecured creditors filed a fraudulent-conveyance claim against the private equity firm that acquired the debtor and that firm’s lender. The parties to the second lawsuit, which did not include petitioners, reached a settlement agreement that provided for payment to lower-priority general unsecured creditors, did not distribute anything to petitioners on their wage claim, and required dismissal of Jevic’s Chapter 11 bankruptcy.
The bankruptcy court held that failure to follow the ordinary priority rules did not bar approval of the structured dismissal, because “without the settlement and dismissal, there was ‘no real prospect’ of a meaningful distribution for anyone other than the secured creditors.” The district court and the Third Circuit both affirmed.
In a 6-2 decision, the Supreme Court reversed, holding that a bankruptcy court cannot approve a structured dismissal that provides for distributions that do not follow ordinary priority rules without the affected creditors’ consent. The Court reasoned that Chapter 7 liquidations provide for absolute priority—creditors with higher priority must be paid in full before any payment to creditors with lower priority—and a Chapter 11 plan violating priority rules cannot be confirmed over the objection of an impaired class of creditors. Although the Bankruptcy Code is silent as to approval of structured dismissals containing priority-violating distributions, the Court was clear that it “would expect to see some affirmative indication of intent” if Congress wanted to allow for approval of structured dismissals without consent from all affected creditors.
Justice Thomas dissented, noting that the original question presented was “whether a bankruptcy court may authorize the distribution of settlement proceeds in a manner that violates the statutory priority scheme.” While similar to the ultimate question decided, the Jevic holding appears to be more narrow and, according to Justice Thomas, not the subject of a circuit split. As a result, it appears the broader question, which is not limited to payments under structured dismissals, has yet to be clarified.
Some bankruptcy courts have already started citing Jevic as instructive on various issues involving priority of claims, including in so-called “critical vendor” motions that seek to pay certain prepetition vendor claims up front. These courts have noted that orders altering priority rules should serve a “significant offsetting bankruptcy-related justification.”