Czyzewski v. Jevic Holding Corp.: Structured Dismissal Must Follow Priority Rules Even in “Rare Cases”

In Czyzewski v. Jevic Holding Corp.,[1] the Supreme Court, overturning the Third Circuit, held that bankruptcy courts are not authorized to disregard the priority system set forth in the Bankruptcy Code via structured dismissal orders — even when “sufficient reasons” exist in “rare case[s].” Although careful to distinguish situations such as prepetition wage orders or critical vendor payments where the Court noted “significant offsetting bankruptcy-related justification[s],” the Court found that the “priority system constitutes a basic underpinning of business bankruptcy law,” and the Court “would expect to see some affirmative indication of intent if Congress actually meant to make structured dismissals a backdoor means to achieve the exact kind of nonconsensual priority-violating final distributions that the Code prohibits in chapter 7 liquidations and chapter 11 plans.” Given the narrowly crafted reasoning of the opinion, the Jevic opinion should not, however, be read as providing authority for an absolute prohibition against deviations from the timing and priority schemes set forth in the Code.

The Facts

The Jevic Transportation chapter 11 bankruptcy resulted from a failed leveraged buyout. The bankruptcy prompted two sets of litigation key to the dispute before the Supreme Court. First, a group of former Jevic truck-drivers brought claims against Jevic and its purchaser, Sun Capital Partners, for Jevic’s failure to provide proper notice of termination in violation of state and federal Worker Adjustment and Retraining Notification (WARN) Acts. These employees obtained summary judgment against Jevic in an award that the former employees alleged to be worth $12.4 million, of which approximately $8.3 million was entitled to priority status pursuant to §507(a)(4).

In the second suit, the Official Committee of Unsecured Creditors sued Sun Capital and CIT Group, Jevic’s secured lender, for fraudulent conveyance in connection with the leveraged buyout of Jevic. The Committee ultimately negotiated a settlement agreement that called for a structured dismissal of Jevic’s chapter 11 bankruptcy. Under the proposed structured dismissal, petitioners would receive nothing on their WARN claims, but lower-priority general unsecured creditors would be paid. The former employees appealed arguing that the payments to general unsecured creditors violated the Code’s priority rules. The Bankruptcy Court approved the settlement agreement and dismissed the case, reasoning that because the proposed payouts would occur pursuant to a structured dismissal rather than an approved plan, the failure to follow ordinary priority rules did not bar approval.[2] The District Court and the Third Circuit affirmed, concluding that structured dismissal was permissible in “rare” circumstances.[3]

Justice Breyer’s Opinion

Before turning to the issue of priority in structured dismissals, the Supreme Court first addressed respondents’ argument that the former Jevic employees had not “suffered an injury in fact,” or at least one “likely to be redressed by a favorable judicial decision,” Spokeo, Inc. v. Robins, 578 U. S. ___, ___, because petitioners would not have received a recovery even if the Bankruptcy Court had not approved the structured dismissal and would still get nothing if the structured dismissal was overturned. That argument, the Court noted, relied upon two assumptions that (1) without a violation of ordinary priority rules, there would be no settlement, and (2) without a settlement, the fraudulent-conveyance lawsuit would have no value. Justice Breyer disagreed, reasoning that “a settlement that respects ordinary priorities remains a reasonable possibility.” Further, the fraudulent transfer claim “could have litigation value” because the defendants were willing to pay $3.7 million in settlement. Consequently, “the structured settlement cost petitioners something. They lost a chance to obtain a settlement that respected their priorities. Or, if not that, they lost the power to bring their own lawsuit.”

Turning to the merits, the Court began by examining what Justice Breyer noted were the three possible conclusions to a chapter 11 bankruptcy: (i) debtor and creditors may negotiate a plan to govern the distribution of the estate’s value; (ii) the bankruptcy court may convert the case to chapter 7 for liquidation; or (iii) the bankruptcy court may dismiss the case. Under the first two scenarios, the Bankruptcy Code establishes basic priority rules for determining the order in which a debtor’s assets are distributed. The Code does not, however, explicitly state what priority rules — if any — apply to the distribution of assets in a structured dismissal. A court ordering a dismissal ordinarily attempts to restore the prepetition financial status quo. Yet if perfect restoration proves difficult or impossible, the court may, “for cause,” alter the dismissal’s normal restorative consequences, §349(b) — i.e., it may order a “structured dismissal.”

Since § 349(b) does not define when “cause” exists to depart from the ordinary rules governing the effects of dismissal, the Court noted that the appropriateness of structured dismissals posed a “complicated question.” Read in context, Justice Breyer noted that § 349(b) “appears designed to give courts the flexibility to ‘make the appropriate orders to protect rights acquired in reliance on the bankruptcy case’”[4] and that “nothing else in the [Bankruptcy] Code authorizes a court ordering a dismissal to make general end-of-case distributions of estate assets to creditors of the kind that normally take place in a chapter 7 liquidation or chapter 11 plan — let alone final distributions that does not help to restore the status quo ante or protect reliance interests acquired in the bankruptcy, and that would be flatly impermissible in a chapter 7 liquidation or chapter 11 plan.”

The Bankruptcy Code’s “priority system constitutes a basic underpinning of business bankruptcy law,” noted Justice Breyer, and the Court “would expect to see some affirmative indication of intent if Congress actually meant to make structured dismissals a backdoor means to achieve the exact kind of nonconsensual priority-violating final distributions that the [Bankruptcy] Code prohibits in chapter 7 liquidations and chapter 11 plans.” The word “cause” in § 349(b), Justice Breyer opined “is too weak a reed upon which to rest so weighty a power.” Finding no express intent from Congress, in § 349(b) or otherwise, the Court held that, as with any other final disposition of a chapter 11 case, a bankruptcy court was not authorized to approve a structured dismissal that ignored the priority schemes set forth in the Bankruptcy Code.

Early Impact

Justice Breyer was careful to craft an opinion that should not be read broadly to prohibit common practices in chapter 11 cases that depart from the rules and timing of distributions, such as first day orders allowing payment of prepetition wages and claims of so-called critical vendors. Those practices, the Court noted, are designed to enhance the chance for a successful reorganization. Nevertheless, at least one bankruptcy court has relied upon Jevic, inter alia, in denying a critical vendor motion.[5] The Pioneer court interpreted Jevic as confirming those line of cases requiring “increased scrutiny” for “critical vendor” motions.[6] Ultimately, the Pioneer court denied the debtor’s critical vendor motion on grounds that the debtor failed to meet its evidentiary burden to show that the payments were “critical.”[7]

Similarly, in In re Fryar, the Bankruptcy Court for the Eastern District of Tennessee relied upon the reasoning of Jevic in denying a debtor’s motion to approve a settlement pursuant to Bankruptcy Rule 9019.[8] In reaching its holding, the bankruptcy court stated:

In light of the Supreme Court's recent ruling in Jevic, parties who seek approval of settlements that provide for a distribution in a manner contrary to the Code's priority scheme should be prepared to prove that the settlement is not only "fair and equitable" based on the factors to be considered by the Sixth Circuit, Bauer, 859 F.2d at 441, but also that any deviation from the priority scheme for a portion of the assets is justified because it serves a significant Code-related objective. The proposed settlement should state that objective, such as enabling a successful reorganization or permitting a business debtor to reorganize and restructure its debt in order to revive the business and maximize the value of the estate. The proposed settlement should state how it furthers that objective and should demonstrate that it makes even the disfavored creditors better off.[9]

Opinions such Pioneer and Fryar, illustrate that Jevic will likely have an impact that extends beyond the Court’s disapproval of priority violating structured settlements. Post-Jevic, debtors seeking authority to make distributions that violate the normal priority scheme must show that such priority violating distributions are necessary to (i) preserve the debtor as a going concern, (ii) promote the possibility of a confirmable plan, (iii) preserve or restore the status quo, or (iv) protect prepetition reliance interests.

Finally, although questioning the practice, the Jevic holding does not completely forestall the use of structured dismissals — especially where such is necessary to restore the status quo ante or preserve reliance interests. The permissible scope of such orders and which interests may be protected remain open questions, but Jevic makes clear that any distributions provided in a structured dismissal must adhere to the timing and priority schemes set forth in the Bankruptcy Code.