On May 21, 2015, as amended on Aug. 18, 2015, the U.S. Court of Appeals for the Third Circuit issued a decision approving the settlement and dismissal of a chapter 11 bankruptcy case through a structured dismissal.[1] The court approved the use of a structured dismissal of a chapter 11 bankruptcy where the dismissal calls for a distribution that does not specifically adhere to the priority scheme in Bankruptcy Code § 507. The Third Circuit’s decision may be narrowed to rare instances, but it is acceptable when there are “specific and credible grounds to justify [the] deviation” from the priority scheme.[2] The Jevic decision, therefore, may provide a template for practitioners to structure dismissals in future chapter 11 cases, and may require courts to determine what constitutes specific and credible grounds to warrant deviating from the Bankruptcy Code’s priority structure.
Background:
In 2006, Sun Capital Partners, a private-equity firm, purchased the equity of Jevic, a trucking company, through a leveraged buyout financed by CIT Group/Business Credit Inc. On May 19, 2008, Jevic terminated its employees and wound down its operations. The next day, Jevic filed for chapter 11 bankruptcy in the U.S. Bankruptcy Court for the District of Delaware. During the bankruptcy, two lawsuits relevant to the Third Circuit’s structured dismissal decision were filed: (1) a class action adversary proceeding by a group of terminated truck drivers against Jevic and Sun alleging violations of state and federal Workers Adjustment and Retraining Notification (WARN) laws; and (2) an adversary proceeding brought by the unsecured creditors’ committee brought against CIT and Sun, alleging fraudulent conveyances and preferential transfers resulting from the leveraged buy-out.
By March 2012, Jevic’s assets were depleted, leaving only $1.7 million in cash, which was subject to Sun’s priority lien. The committee, Jevic, Sun and CIT subsequently settled the committee’s lawsuit whereby CIT would pay $2 million toward Jevic’s and the committee’s legal fees, and the remaining $1.7 million in cash (subject to Sun’s priority lien) would be turned over to a trust to pay administrative claimants and then general unsecured creditors, pro rata. The chapter 11 cases would thereafter be dismissed. The terminated truck drivers were not included as part of the settlement, and their claims alleging that they were entitled to at least $8.3 million in priority wage claims were also not included in the settlement.
The terminated drivers and the U.S. Trustee objected to the settlement agreement, arguing that the agreement violated the priority scheme (i.e., that the employee wages were to be paid before tax and general unsecured creditors under § 507). The U.S. Trustee also argued that structured settlements were not permitted under the Bankruptcy Code.
The bankruptcy court overruled the objections and approved the settlement. Judge Shannon acknowledged that the Bankruptcy Code does not expressly allow structured dismissals, but granted the relief sought because of the “dire circumstances” of the case. The bankruptcy court found that there was (1) “no prospect of a confirmable Chapter 11 plan” and (2) conversion to chapter 7 would be impracticable because the remaining funds would be subject to Sun’s lien. The bankruptcy court determined that a chapter 7 trustee would likely lack the funds to further litigate the claims, and would likely simply turn over the cash and close the case. The bankruptcy court further explained that the Bankruptcy Code’s priority scheme does not apply to settlements. The U.S. District Court for the District of Delaware affirmed[3] the bankruptcy court’s ruling, and the ruling was appealed to the Third Circuit.
Third Circuit’s Analysis
The Third Circuit viewed the case as presenting two issues: (1) whether structured dismissals are permissible as a matter of law; and (2) whether a settlement may deviate from the “absolute priority” requirement of the Bankruptcy Code and omit making distributions to an entire class of creditors in favor of more junior creditors.
The terminated truck drivers argued that a structured dismissal is not permissible by the Bankruptcy Code, arguing that the Code only permits three types of exits from chapter 11: plan confirmation, chapter 7 conversion or a straight dismissal. The Third Circuit, rejecting their argument, held that a bankruptcy court has discretion to order a structured dismissal “absent a showing that a structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation processes.”[4]
Next, while noting that it was a “close call,” the appeals court permitted the unsecured creditors to receive payment through a settlement that deviated from the Bankruptcy Code’s priority scheme. The court held that “bankruptcy courts may approve settlements that deviate from the priority scheme” in the Bankruptcy Code if “specific and credible grounds … justify [the] deviation.”[5] Looking to the bankruptcy court’s findings of fact, the court concluded that the settlement and structured dismissal presented “the least bad alternative since there was no prospect of a plan being confirmed and conversion to Chapter 7 would have resulted in the secured creditors taking all that remained of the estate in short order.”[6] The unsecured creditors would not have received anything had the settlement not been approved. As such, the truck drivers whose claims were being ignored through the deal were not really losing anything because they likely would not receive anything. The appeals court did not disturb the bankruptcy court’s finding that the settlement was in the best interest of the creditors because the truck drivers were no worse off than they would have been absent the settlement and the unsecured creditors were in a slightly better position because they received a small distribution.
The Jevic decision confirms that within the Third Circuit, a structured dismissal of a chapter 11 case may be a viable alternative to chapter 7 conversion or dismissal. This opinion may also be helpful in other jurisdictions because, as the Jevic majority stated, the absolute priority rule “do[es] not extend to ... settlements in bankruptcy.”[7] This, of course, may be true in the sense that Federal Rule of Bankruptcy Procedure 9019 makes no mention of priority considerations, but rather, the “absolute priority rule” applies under the Bankruptcy Code to plans — not dismissals.[8] While the court was clear to note that approval of such dismissals may be rare, the facts of the case offer a road map where a structured dismissal may be appropriate.
The extent to which parties invoke structured dismissals and settlements remains to be seen. The Jevic decision makes the Third Circuit the first court of appeals to approve a structured dismissal, and may provide additional flexibility to parties and judges in resolving future bankruptcy cases. Note, however, that structured dismissals continue to be a hot topic of debate in the restructuring community. Indeed, the 2014 report of the ABI Commission to Study the Reform of Chapter 11 recommended eliminating structured dismissals.[9]
[1] Official Committee of Unsecured Creditors v. CIT Group/Business Credit Inc., 787 F.3d 173 (3d Cir. 2015).
[2] Id. at 184.
[3] Casimir Czyzweski v. Jevic Holding Corp. (In re Jevic Holding Corp.), No. 13-104-SLR, 2014 WL 268613 (D. Del. 2014).
[4] 787 F.3d 173 at 183.
[5] Id. at 184.
[6] Id. at 185.
[7] Id.
[8] 11 U.S.C. § 1129(b).
[9] ABI Report at pp. 272-73 (recommending “strict compliance with the Bankruptcy Code in terms of orders ending the chapter 11 case” and explaining that dismissal orders should “satisfy the applicable provisions of, and [] not permit the parties to work around, the Bankruptcy Code”).