Timing is Everything: Priority-Skipping Settlements Post-Jevic

Editor's Note: For a new decision upholding a gift plan despite Jevic, see In re Nuverra Environmental Solutions Inc., 17-1024 (D. Del. Aug. 3, 2017), analyzed in Rochelle's Daily Wire on August 9, 2017.

On May 16, 2017, the U.S. Bankruptcy Court for the District of Delaware denied a settlement motion in In re Constellation Enterprises LLC.[1] Due to the presence of certain class-skipping distributions in the proposed settlement, the court heavily focused on the Supreme Court’s recent ruling in Czyzewski v. Jevic Holding Corp.,[2] and the decision of the Third Circuit Court of Appeals in In re ICL Holding Company.[3]

In Jevic, the Supreme Court reversed the lower courts’ approval of a structured dismissal involving a settlement of certain estate causes of action on the grounds that the arrangement provided for distributions to general unsecured creditors, while other higher priority creditors would receive nothing. The Court held, “A distribution scheme ordered in connection with the dismissal of a Chapter 11 case cannot, without the consent of the affected parties, deviate from the basic priority rules....”[4]

Prior to Jevic, the Third Circuit heard a similar appeal in In re ICL Holding. In ICL, the settlement at issue also involved class-skipping distributions. However, certain facts in ICL were importantly different from Jevic. In ICL, the class-skipping distributions were cash payments transmitted from the secured lender group directly to a trust, and then from the trust directly to the general unsecured creditors. The ICL court held that the settlement funds did not constitute estate property, as they never entered the debtor’s estate. Because the distributions were not of estate property, the court reasoned, they did not implicate the absolute priority rule. Accordingly, the court held that the settlement was permissible.[5] ICL therefore stands for the proposition that settlements may involve class-skipping distributions, so long as the consideration being distributed is not estate property.

In In re Constellation Enterprises LLC, the U.S. Bankruptcy Court for the District of Delaware was also asked to approve a settlement that involved class-skipping distributions.[6] In Constellation, the debtors reached a settlement with the creditors’ committee resolving a number of objections previously raised by the committee, including its objection to the debtors’ proposed sale of substantially all of their assets. While the proponents did not frame the settlement as a structured dismissal, the debtors had by then sold substantially all of their assets, leaving nothing left to be done in the bankruptcy cases, and had subsequently filed a separate motion to dismiss the cases following consummation of the settlement.[7]

The settlement would create a General Unsecured Creditors (GUC) Trust that would include $1.25 million in cash to be contributed by the purchaser of the debtors’ assets, which would be distributed solely to certain general unsecured creditors, despite the existence of unpaid higher and equal-priority creditors. The purchaser would also contribute certain “Specified Causes of Action,” which had previously been property of the debtors, and which the purchaser had acquired in the sale. As with the $1.25 million in cash, the proceeds from the Specified Causes of Action would be distributed solely to certain general unsecured creditors, while other higher and equal priority creditors would be left unpaid. Finally, the parties, including the debtors, would exchange mutual releases. Perhaps in an effort to invoke ICL, the parties specified in the settlement term sheet that the assets contributed to the GUC Trust “will not be part of the Purchase Price (as defined in the APA), but rather shall be a separate cash obligation of the members of the Ad Hoc Noteholder Group who are capitalizing the Purchaser.”[8]

When the settlement was first proposed in September 2016, the U.S. Trustee, certain pre-petition second-lien lenders whose deficiency claims would be unpaid under the settlement’s distribution scheme, the IRS, and the WARN Act claimants objected, arguing that the settlement was an attempt at an end-run around § 1129 and the absolute priority rule. When the Supreme Court issued the Jevic ruling in March 2017, the bankruptcy court permitted a round of supplemental briefing before it considered the settlement motion. The proponents of the settlement likened it to an ICL situation, arguing that the Specified Causes of Action and the funds to be distributed were not property of the estates. The opponents disagreed and argued that the settlement was similar to Jevic because property belonging to the estates was being distributed, and the distribution was being made in connection with the dismissal of the case. The opponents reasoned that the Specified Causes of Action were effectively estate property, and that the debtors had tried to “launder” these assets through the sale to the purchaser for their later use in the GUC Trust.

In its oral ruling, the court rejected the settlement proponents’ argument that the Specified Causes of Action were not estate property and therefore outside the scope of Jevic:

They are no longer property of the estate, but they were at some point property of the estate. And I don't think you can claim them for purposes of the ICL ruling by transferring them for some time to the purchaser with them just to be transferred back.

The court further stated that it believes that ICL is a narrow exception to the Jevic holding, and while it may not have been explicitly overturned by Jevic, future cases with ICL-like fact patterns would place the court in a “tough spot.” The court also emphasized the fact that in ICL the transferred assets had never belonged to the bankruptcy estate at any time.

Although it may be a threshold question in evaluating a proposed class-skipping distribution, the court went on to explain that the question of “estate property” vs. “non-estate property” is not determinative of whether Jevic applies to a given settlement.

Instead, the court focused on the question of timing. The Supreme Court’s opinion referred in several places to the prohibition of class-skipping distributions applying “in connection with the dismissal,”[9] or “attached to a dismissal of the case.”[10] On the other hand, the Court’s opinion endorsed the continued permissibility of class-skipping interim distributions, such as critical vendor or wage orders, provided that such distributions met the applicable standard of facilitating an objective of the Bankruptcy Code.

Accordingly, the bankruptcy court in Constellation essentially asked whether the proposed distributions were akin to “interim” distributions — which are untouched by the Jevic decision — or whether they were akin to distributions in connection with the end of the case, which, in the context of a dismissal, are subject to Jevic’s class-skipping prohibition.

Looking at where the Constellation cases stood, the court stated that “we’re not at the beginning, we’re not in the middle, we’re at the end of this case’s Chapter 11 life.”[11] The court noted that nothing but dismissal remained to be done in the case. The hallmark of a permissible interim distribution is the promotion of Bankruptcy Code objectives. However, when a case is at the end of its life, as in Constellation, no Code-related tasks remain to be performed. Under these circumstances, the court ruled that the proposed distributions were not “interim” distributions. On the contrary, they were distributions proposed to be made in connection with the dismissal of the case. Consequently, the court held that the distributions were within the scope of Jevic, and subject to Jevic’s prohibition of class-skipping. The court, therefore, denied approval of the settlement.

At bottom, Constellation leaves us with the idea that in applying Jevic the court’s inquiry should focus on the timing of the class-skipping distribution in question relative to the end of the case. If the distribution is properly characterized as an “interim” distribution, then Jevic would not apply. On the other hand, a class-skipping distribution that comes either at the chronological or substantive end of the case would be considered made “in connection with” a dismissal of the case, and would be impermissible under Jevic.