Bankruptcy Judge Shelley D. Rucker of Chattanooga, Tenn., wrote the first opinion pondering what Czyzewski v. Jevic Holding Corp. means when the court is called on to approve a settlement in mid-case that departs from the rules of priority.
Judge Rucker’s April 25 opinion rejecting the settlement erects a high barrier for approval of priority-defying settlements and may provide guidance when other courts are confronted with so-called gift plans.
The facts in Judge Rucker’s case were complex, but the basic pattern was simple. The individual chapter 11 debtor sought approval of a settlement with his secured bank lender. The deal would sell property to a business associate and bring $500,000 into the estate. In return for releasing the debtor, the bank would get about $350,000 applied to a debt of about $530,000. The bank would subordinate its remaining claims to the claims of unsecured creditors.
The bank, however, was undersecured in view of prior liens on the property being sold. Significantly, the bank would be receiving about $200,000 more on its deficiency claim than it would receive were the lender to foreclose.
Several unsecured creditors objected to the sale because the bank would receive a distribution on its unsecured deficiency claim ahead of creditors with the same priority.
The debtor argued that the settlement would avoid foreclosure and result in tax-recapture that would generate new claims, possibly obviating confirmation of a plan. With the settlement, the debtor said he could propose a plan paying 53% to all unsecured creditors. Were there foreclosure instead of settlement, unsecured creditors might be wiped out.
Judge Rucker noted that the Sixth Circuit has held that Congress did not abrogate the absolute priority rule in individual chapter 11 cases. Because the plan would not pay creditors in full, she said that creditor opposition could kill the plan.
Skeptical about how the case would end, Judge Rucker said the “settlement is more of a preamble to a conversion or structured dismissal than it is to the situation” in the Second Circuit’s Iridium decision that approved a settlement deviating from the rules of priority.
Judge Rucker conceded that Jevic, 2017 BL 89680, 85 U.S.L.W. 4115 (Sup. Ct. March 22, 2017), was not precisely on point because her case did not entail a structured dismissal. She alluded to dicta in Jevic suggesting that priority-defying actions early in a chapter 11 case can be approved if they serve “significant Code-related objectives” like first-day wage or critical vendor orders.
Still, Judge Rucker said that “settlement standards may have changed based on Jevic.” To approve a settlement not in accord with the rules of priority, she held that a debtor must satisfy not only traditional approval standards but must also serve a “significant Code-related objective,” like enabling a debtor to reorganize and showing how “disfavored creditors are better off.”
Judge Rucker said it would be an abuse of discretion to approve a settlement “which is a sub rosa plan or a precursor for a conversion or dismissal in which the Code’s priority scheme is ignored.”
It is unclear whether Judge Rucker would have disapproved were the debtor a corporation where the absolute priority rule did not apply.