Supreme Court Rules That Structured Dismissals Must Follow Priority Scheme

Stephen W. Sather

Barron & Newburger, P.C.

Austin, TX

ssather@bn-lawyers.com

 

In a blow to creative lawyering, the Supreme Court ruled today that a structured dismissal which allocates value contrary to the priority scheme of the Bankruptcy Code may not be approved.   Czyzewski v. Jevic Holding Corp., No. 15-649 (U.S. 3/22/17).   You can find the opinion here.

What Happened

The case arose out of a leveraged buyout gone wrong.   Sun Capital Partners acquired Jevic Transportation Company with money borrowed from CIT Group.   When Jevic closed its business and filed bankruptcy, two lawsuits ensued.   First, a group of truck drivers brought suit under the WARN Act against both Jevic and Sun.    Second, the Official Committee of Unsecured Creditors sued Sun and CIT to unwind the leveraged buyout as a fraudulent transfer.     

The Bankruptcy Court granted summary judgment against the Debtor (but not Sun) on the WARN Act claim resulting in a priority claim of $8.3 million plus an unsecured claim of $4.1 million.   

Meanwhile, CIT and Sun reached a settlement with the Committee.   CIT agreed to fund $2.0 million to pay the Committee's legal fees and administrative expenses.   Sun agreed to transfer $1.7 million in cash upon which it held a lien to pay taxes and administrative expenses with the balance to be paid to unsecured creditors on a pro rata basis.   However, none of the funds would go to the priority claims of the WARN Act claimants.   Apparently Sun did not want to contribute funds to the WARN Act claimants which they could use to further their case against Sun.   The case would then be dismissed in a structured dismissal.

Subsequently the Third Circuit ruled that Sun was not liable on the WARN Act claims because it was not the drivers' employer.   If this ruling had come earlier, Sun would have had no reason to subvert the priority scheme of the Code and this case would never have made it to the Supreme Court.    

The Court's Ruling

The Court answered two questions.   First, it found that the drivers had standing under Spokeo, even though Sun claimed that they were irreversibly out of the money.   Second, the Court ruled that structured dismissals can not bypass the Code's priority scheme absent consent any more than such result could be reached in a case under Chapter 7 or a Chapter 11 plan.    Justice Thomas, joined by Justice Alito, dissented on the basis that cert was improvidently granted.    

Standing

On the standing issue, Sun argued that the settlement was based on bypassing the WARN Act claimants and that without the settlement there would not be any funds for any of the creditors.  However, the Court sagely noted that since the WARN Act claimants failed in their suit against Sun, there would be no reason to discriminate against them if the case was remanded.  Further, the Court found that if CIT and Sun were willing to pay $3.7 million to settle that the fraudulent transfer action clearly had value.    Even if the case was not settled in chapter 11, the Court found that it could be pursued by a chapter 7 trustee or that the creditors could pursue the action following a dismissal.   

The Court remarked:

Consequently, the Bankruptcy Court’s approval of the structured dismissal cost petitioners something. They lost a chance to obtain a settlement that respected their priority. Or, if not that, they lost the power to bring their own lawsuit on a claim that had a settlement value of $3.7 million. For standing purposes, a loss of even a small amount of money is ordinarily an “injury.”  And the ruling before us could well have cost petitioners considerably more.  A decision in petitioners’ favor is likely to redress that loss. We accordingly conclude that petitioners have standing. (internal citations omitted).

 Opinion, p. 11.   This  ruling is consistent with many decisions coming down which have rejected Spokeo challenges in specific circumstances.

Priority

While the Court's ruling on the priority issue takes up eight pages, it can be succinctly summarized in its first paragraph.

Can a bankruptcy court approve a structured dismissal that provides for distributions that do not follow ordinary priority rules without the affected creditors’ consent? Our simple answer to this complicated question is “no.”

Opinion, p. 14.    The Court went on to explain that the Bankruptcy Code's priority scheme "constitutes a basic underpinning of business bankruptcy law."   Ordinarily a dismissal restores the parties to the status quo.    While 11 U.S.C. Sec. 349(b) states that the Court may order otherwise for cause, this is not carte blance to ignore the Code's system of priorities.   Rather, it exists to "give courts the flexibility to “make the appropriate orders to protect rights acquired in reliance on the bankruptcy case.”

The Court distinguished several precedents raised by the Respondents.   In discussing Judge Harlin Hale's  decision in In re Buffet Partners, LP, 2014 WL 3735804 (Bankr. N.D. Tex. 2014), the Court noted that no party with an economic interest had objected.    I wrote about the Buffet Partners case here.     Thus, a structured dismissal is still possible absent objection.

The Court also noted that there were other instances in which bending the Code's priority scheme would work for the common good and would be permissible.

We recognize that Iridium is not the only case in which a court has approved interim distributions that violate ordinary priority rules. But in such instances one can generally find significant Code-related objectives that the priority-violating distributions serve. Courts, for example,have approved “first-day” wage orders that allow payment of employees’ prepetition wages, “critical vendor” orders that allow payment of essential suppliers’ prepetition invoices, and “roll-ups” that allow lenders who continue financing the debtor to be paid first on their prepetition claims.  In doing so, these courts have usually found that the distributions at issue would “enable a successful reorganization and make even the disfavored creditors better off.”  By way of contrast, in a structured dismissal like the one ordered below, the priority-violating distribution is attached to a final disposition; it does not preserve the debtor as a going concern; it does not make the disfavored creditors better off; it does not promote the possibility of a confirmable plan; it does not help to restore the status quo ante; and it does not protect reliance interests. In short, we cannot find in the violation of ordinary priority rules that occurred here any significant offsetting bankruptcy-related justification. (internal citations omitted).

Opinion, pp. 18-19.    Thus, the court is not shutting the door on common practices in chapter 11 cases.  Indeed, by referencing critical vendor orders, the Court may have implicitly expanded what is permissible.    

Instead, the Court found that the structured dismissal here was more like a sub rosa plan under In re Braniff Airways, Inc., 700 F. 2d 935, 940 (5th Cir. 1983) in that it worked a final resolution of creditors' claims.   

The Dissent

Justice Thomas, joined by Justice Alito cried foul.   They pointed out that the Court had granted cert  to answer the question of "whether a bankruptcy court may authorize the distribution of settlement proceeds in a manner that violates the statutory priority scheme."   However, the issue that the Petitioners actually briefed was  “whether a Chapter 11 case may be terminated by a ‘structured dismissal’ that distributes estate property in violation of the Bankruptcy Code’s priority scheme.” 

While the change in wording may appear slight, Justice Thomas argued that there was a circuit split on the broader question of settlements that violated the priority scheme but not as to structured dismissals.   As a result, he wrote:

Today, the Court answers a novel and important question of bankruptcy law. Unfortunately, it does so without the benefit of any reasoned opinions on the dispositive issue from the courts of appeals (apart from the Court of Appeals’ opinion in this case) and with briefing on that issue from only one of the parties. That is because, having persuaded us to grant certiorari on one question, petitioners chose to argue a different question on the merits. In light of that switch, I would dismiss the writ of certiorari as improvidently granted.

 Dissenting Opinion, p. 1.

What Does It Mean?

The case seems to have three main take-aways:

1. A structured dismissal which allocates property outside of the statutory priority scheme over the objection of a dissenting creditor may not be allowed.
2. The priorities probably can be bypassed if no party objects.
3. Interim actions which bend the priority scheme may be allowed so long as they are not a final resolution and advance a purpose under the Code.