Restructuring

Good news: structured dismissals have survived Supreme Court scrutiny. Bad news: dismissals may be harder to structure, given yesterday’s 6-2 decision overruling the Third Circuit in Jevic narrowing the context in which they can be approved. We now have guidance on whether or not structured dismissals must follow the Bankruptcy Code’s priority scheme. The short answer is that they must. In issuing a decision that requires absolute adherence to the absolute priority rule outside the context of a chapter 11 plan, the Supreme Court shifted leverage back to hold-out creditors, whose position in the priority scheme must be respected in any structured dismissal approved by a Bankruptcy Court.

There are three possible outcomes in a chapter 11 bankruptcy: first, the court can confirm a plan of reorganization or a plan of liquidation to govern the distribution of the estate’s value; second, the case may be converted to a chapter 7 liquidation; and third, a bankruptcy court may dismiss the case as a straight or a “structured” dismissal. A bankruptcy court-ordered dismissal ordinarily attempts to restore the prepetition financial status quo. Yet if perfect restoration proves difficult or impossible (which it almost always will be) or if certain parties wish to achieve other outcomes, the bankruptcy court may, “for cause,” alter the dismissal’s normal restorative consequences and order a dismissal with some additional technology built in (most commonly releases, retention of jurisdiction, claims reconciliation mechanisms, and potentially additional value to junior stakeholders who otherwise might not be entitled to it).
The Bankruptcy Code makes clear that distributions in chapter 7 liquidation must follow the priority distribution scheme. While chapter 11 has more flexibility than chapter 7 of the Bankruptcy Code when it comes to the priority of distributions, a bankruptcy court cannot confirm a chapter 11 plan that contains priority-violating distribu­tions over the objection of an impaired creditor class. However, the Bankruptcy Code does not explicitly provide for what priority rules—if any—apply to the distribution of assets if a case is dismissed. Jevic addressed that gap.
Jevic Transportation skidded into bankruptcy after being purchased in a leveraged buyout. The company’s bankruptcy precipitated the filing of two lawsuits against it. In the first lawsuit, a group of the company’s truck drivers won a judgment against the company for its failure to provide proper notice of termination required under the WARN Act. This victory led to a priority wage claim that would entitle the drivers to payment ahead of Jevic’s general unsecured claimants. In the second case, a committee of unsecured creditors sued the sponsor that led the company’s LBO for fraudulent conveyance in connection with the transaction. That case was settled with an agreement that involved a structured dismissal of Jevic’s chapter 11 cases that proposed to distribute the estate’s assets to general unsecured creditors while skipping wage claims with a higher priority in the Bankruptcy Code’s distribution scheme.
The Bankruptcy Court for the District of Delaware approved the settlement agreement and dismissed the case, reasoning that because the possibility of recovery for the drivers was “remote at best,” the failure to follow ordinary priority rules did not bar approval. The District Court and the Court of Appeals for the Third Circuit subsequently affirmed. The Supreme Court reversed these decisions, and remanded the case for further consideration in light of its decision.
In ruling that the distribution scheme violated the Bankruptcy Code’s priority rules and was therefore improper, the Supreme Court first held that the drivers had Article III standing because a settlement that respected ordinary priorities was a reasonable possibility. As a result of the dismissal of Jevic’s bankruptcy cases, the truck drivers lost a chance to obtain a settlement that would respect their priorities, which could be redressed in a decision in their favor.
Then, given the “importance of the priority system,” the Supreme Court stated that it could not identify an “affirmative indication of intent” from the Bankruptcy Code necessary to conclude that Con­gress meant to make a major departure for the priority rules in the structured dismissal of a bankruptcy case. Instead, the Supreme Court found that the Bankruptcy Code was designed to protect reliance interests acquired in the bankruptcy, and not to make “general end-of-case distributions” that would be “flatly impermissible” in a chapter 11 plan or chapter 7 liq­uidation, as happened in Jevic.
The Supreme Court also distinguished Jevic from In re Iridium Operat­ing LLC, 478 F. 3d 452 (2d Cir. 2007), where the Court of Appeals for the Second Circuit approved a distribution under a settlement agreement that violated ordinary priority rules. In that case, a structured dismissal was not involved, the distribution was only interim in nature, and it would be “difficult to employ the rule of priorities” because “the nature and extent of the estate and the claims against it [were] not yet fully resolved.” The Supreme Court also noted that there were cases like Iridium where courts had approved such interim distributions. However, in those cases, “significant Code-related objectives” were served, such as pre­serving the debtor as a going concern, making the disfavored creditors better off, promoting the possibility of a confirmable plan, and pro­tecting reliance interests. The Supreme Court found none of these factors to be present in the current case.
Finally, the Supreme Court rejected the Third Circuit’s use of a “rare case” exception that would per­mit bankruptcy courts to disregard priority in structured dismissals for “suffi­cient reasons.” Reasoning that it would be difficult to give precise content to the concept of “sufficient reasons,” the Supreme Court noted a “rare case” carve-out would run the risk of turning the exception into a more general rule, introducing uncertainty with “potentially serious” consequences—for example, departure from the protec­tions granted particular classes of creditors, changes in the bargain­ing power of different classes of creditors even in bankruptcies that do not end in structured dismissals, risks of collusion between senior secured creditors and general unse­cured creditors to squeeze out priority unse­cured creditors, and increased difficulty in achieving settlements.
The Jevic decision determined that the Bankruptcy Code’s priority rules, as applied in chapter 11 and chapter 7 cases, also apply to the distribution of assets in a structured dismissal. Bankruptcy courts cannot approve structured dismissals that offend the priority scheme in the Bankruptcy Code without the consent of affected creditors. As a result, debtors and creditors alike will be limited in their ability to explore creative options that could maximize estate value and pragmatically resolve issues in particular circumstances—for example, some cases best positioned for structured dismissals will nevertheless end up in liquidation. Players in restructurings will just need to, as they always have, live with the changing rules.
Another issue is how parties in bankruptcy proceedings will use Jevic outside the context of structured dismissal to argue for a literal reading of the requirements under the Bankruptcy Code, which could limit a bankruptcy court’s discretion in a wide range of issues unrelated to how a chapter 11 case will wind up. That is certainly something to look out for in the future. For now, while the Supreme Court made it clear it expressed no view about the legality of structured dismissals in general, structured dismissals that do not violate the absolute priority rule have survived the highest court’s scrutiny. This should put to rest industry fears that the “rapidly developing field” of structured dismissals, as described by Justice Thomas in his Jevic dissent, would itself be dismissed.