At oral argument in the Supreme Court today, five justices seemed inclined to reverse the Third Circuit in Czyzewski v. Jevic Holding Corp. and hold that settlements cannot distribute proceeds departing from the priority scheme in the Bankruptcy Code when the claim being settled belongs to the estate.
The Supreme Court will resolve a split of circuits in which the Third and Second Circuits held in 2015 and 2007, respectively, that bankruptcy courts may approve so-called structured dismissals where the distribution of proceeds from settlements does not comply with the priorities contained in Section 507. The Fifth Circuit barred structured dismissals in 1984 when it decided AWECO and held that the “fair and equitable” test must apply to settlements.
The outcome of the Jevic case will likely also determine whether bankruptcy courts can confirm so-called gift plans, where a secured creditor or buyer makes a payment, supposedly from its own property, that enables a distribution in a chapter 11 plan that is not in accord with priorities.
The Facts in Jevic
In the unsuccessful reorganization of Jevic Holding Corp., the official unsecured creditors’ committee had sued the secured lender and negotiated a settlement calling for the lender to set aside some money for distribution to general unsecured creditors following dismissal. The distribution scheme did not follow the priorities set forth in Section 507 because wage priority claimants were to receive nothing from the lender through a trust set aside exclusively for lower-ranked general unsecured creditors.
Despite the wage claimants’ objection, the bankruptcy court approved the settlement and was upheld in district court. On a second appeal, the Third Circuit, in a 2-1 opinion, upheld the structured settlement, cutting out any recovery by priority wage claimants. Although the dissenter in the Third Circuit agreed that structured dismissals sometimes can be approved, he did not believe Jevic was a proper case. Until the Supreme Court granted certiorari in June, the appeals court’s opinion was important because the Third Circuit makes law for Delaware, where many of the country’s largest chapter 11s are filed.
Before granting certiorari, the Supreme Court sought comment from the Solicitor General, who subsequently urged granting the petition to reverse the court of appeals, stating that “bankruptcy is not a free-for-all in which parties or bankruptcy courts may dispose of claims and distribute assets as they see fit.” The government said that “nothing in the Code authorizes a court to approve a disposition that is essentially a substitute for a plan but does not comply with the priority scheme set forth in Section 507.”
Five Justices Seem Primed to Reverse
Justices Sonia Sotomayor, Elena Kagan and Stephen G. Breyer seemed firmly in the reversal camp. Justice Ruth Bader Ginsburg also seemed to favor the workers’ arguments, as did Chief Justice John G. Roberts, Jr., although his questions were fewer and more difficult to interpret.
Justice Breyer often appears to be the justice best versed in bankruptcy law and practice. Initially, he seemed undecided when he observed that nothing in the Bankruptcy Code either permits or prohibits dismissal with distributions departing from Section 507 priorities. Later, he asked how any group of parties can reverse the order of priorities by agreement among themselves and cut out creditors who do not consent to the settlement.
Later still, Justice Breyer said it was a “dangerous principle” to allow departure from the statutory priorities of distribution.
Justice Breyer focused on the primary weakness in the respondents’ argument when he got the lawyer to admit that the settlement was in compromise of a claim belonging to the estate. Therefore, he said, the allocation of settlement proceeds was “quite contrary” to Congress’ scheme of distribution.
Although Justice Kagan said that permitting a structured dismissal might be “sensible,” she said it does not appear in the Bankruptcy Code.
Justice Sotomayor, like Justice Anthony M. Kennedy, did not think the Jevic case and the company’s inability to confirm a chapter 11 plan was particularly rare. Since the situation was not extraordinary, Justice Sotomayor asked how a court should protect disfavored creditors from being “preyed upon.”
Similarly, Justice Kagan asked where the Bankruptcy Code permits distributions departing from Section 507 even if the situation is extraordinary. She also said the settlement was seemingly done “in collusion.”
Early in the morning’s one-hour argument, Justices Kagan and Sotomayor were concerned with narrowing their ruling so as to not upset bedrock bankruptcy principles like the so-called doctrine of necessity, which is utilized to approve critical vendor motions and pay workers pre-petition wages before plan confirmation.
The government, although arguing for the justices to reverse the Third Circuit, urged the Court to narrow the ruling to ensure that first-day motions like critical vendor and wage motions are not proscribed.
On the issue of narrowness, the Chief Justice possibly kept the door open to approval of structured settlements in some cases. If priorities inform the exercise of discretion in approving a settlement, then, he said, there must be extraordinary reasons to depart from the statutory distribution scheme.
The Chief Justice’s comments were similar in some regards to the view of the Third Circuit’s dissenter, who agreed that structured settlements were theoretically permissible. The dissenter, however, did not believe that Jevic presented a proper case.
If the Chief Justice is not prepared to outlaw settlements with distributions contrary to Section 507, there is the possibility of a 4/4 split on the Supreme Court, meaning that the Third Circuit would be upheld. In that case, there would be no Supreme Court precedent, leaving the issue open until the Court is at full strength.
If the court is evenly divided, the justices might not rule on whether structured dismissals are always prohibited. In that event, they could say, like the Third Circuit dissenter, that Jevic was not a proper case for departing from statutory priorities.
One other outcome is possible. Justice Samuel A. Alito, Jr. queried the workers’ lawyer as to whether she had briefed the same issue the court agreed to decide in granting certiorari. Earlier this term, the Court dismissed a petition as improvidently granted because the appellant’s brief was based on arguments not encompassed by the certiorari petition.
In the Supreme Court, the workers’ lawyer was Danielle Spinelli, supported by Sarah E. Harrington, Assistant Solicitor General. Urging affirmance was Christopher Landau.
The case in the Supreme Court is Czyzewski v. Jevic Holding Corp., 15-649 (Sup. Ct.). The opinion in the Third Circuit is Official Committee of Unsecured Creditors v. CIT Group/Business Credit Inc. (In re Jevic Holding Corp.), 787 F.3d 173 (3d Cir. May 21, 2015).