The Court of Appeal has just decided a “novel question of bankruptcy law: may a case arising under chapter 11 ever be resolved –in a ‘structured dismissal’ that deviates from the Bankruptcy Code’s priority system?” In its May 21, 2015, Opinion, it held in a “rare case, it may.” In re Jevic Holding Corp. (3d Cir. May 21, 2015) (Case No. 14-1465). Because the court determined that there was no prospect of a plan being confirmed, conversion to chapter 7 would have resulted in the secured creditors taking all that remained of the estate, and there was no support in the record for the proposition that a viable alternative to the Settlement (defined below) existed that would have better served the estate and the creditors as a whole, the court affirmed the structured dismissal that skipped a priority afforded class of creditors in favor of junior creditors.
While this holding is limited, it surely will invigorate the imagination of restructuring advisors practicing in the Third Circuit, which includes the Delaware Bankruptcy Court – host to a significant number of large, complex chapter 11 filings.
The facts from the Opinion are as follows: Jevic Transportation, Inc. was a trucking company headquartered in New Jersey. In 2006, after Jevic’s business began to decline, a subsidiary of the private equity firm Sun Capital Partners acquired the company in a leveraged buyout financed by a group of lenders led by Bank. The buyout entailed the extension of an $85 million revolving credit facility by Bank to Jevic. The company continued to struggle in the two years that followed, and by May 2008 – with the company’s performance stagnant and the expiration of the forbearance agreement – Jevic’s board of directors authorized a bankruptcy filing. The company ceased substantially all of its operations, and its employees received notice of their impending terminations May 19, 2008.
Jevic filed a voluntary chapter 11 petition in the United States Bankruptcy Court for the District of Delaware, with about $53 million owed to its first-priority senior secured creditors (Bank and Sun), and more than $20 million to its tax and general unsecured creditors. The Unsecured Creditors Committee sued to recover from Bank and Sun, asserting, inter alia, fraudulent transfers arising from the LBO, and the employee drivers (“Drivers”) filed WARN claims based on the failure of Jevic to follow the proper procedures prior to the termination of the workforce. The Committee, Jevic, Bank, and Sun reached a settlement that included: mutual releases between Jevic, Bank, Sun and the Committee; the LBO litigation would be dismissed with prejudice; Bank would pay $2 million into an account earmarked to pay Jevic’s and the Committee’s legal fees and other administrative expenses; Sun would assign its lien on Jevic’s remaining $1.7 million to a trust, which would pay tax and administrative creditors first and then the general unsecured creditors on a pro rata basis; and Jevic’s chapter 11 case would be dismissed (the “Settlement”).
The Settlement provided for a “structured dismissal, a disposition that winds up the bankruptcy with certain conditions attached instead of simply dismissing the case and restoring the status quo ante.” However, the Settlement did not include the WARN Claims of the Drivers against the Jevic Estate, estimated to have been worth $12.4 million, of which $8.3 million was a priority claim under 11 U.S.C. section 507(a)(4).
The Court of Appeals agreed with the Drivers that the Bankruptcy Code does not expressly authorize structured dismissals: “As we understand them, however, structured dismissals are simply dismissals that are preceded by other orders of the bankruptcy court (e.g., orders approving settlements, granting releases, and so forth) that remain in effect after dismissal. And though § 349 of the Code contemplates that dismissal will typically reinstate the pre-petition state of affairs by revesting property in the debtor and vacating orders and judgments of the bankruptcy court, it also explicitly authorizes the bankruptcy court to alter the effect of dismissal ‘for cause’—in other words, the Code does not strictly require dismissal of a Chapter 11 case to be a hard reset. 11 U.S.C. § 349(b).”
Holding that bankruptcy courts have the power, in appropriate circumstances, to approve structured dismissals, the court then considered whether settlements in that context may ever skip a class of objecting creditors in favor of more junior creditors. The Drivers argued that even if structured dismissals are permissible, they cannot be approved if they distribute estate assets in derogation of the priority scheme of section 507 of the Code: “Whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of the Bankruptcy Code.” (citation omitted)
The court held that when Congress codified the absolute priority rule, “it did so in the specific context of plan confirmation, see §1129(b)(2)(B)(ii), and neither Congress nor the Supreme Court has ever said that the rule applies to settlements in bankruptcy.” Finding that the absolute priority rule was not applicable to settlements in bankruptcy, the Court of Appeals then addressed the “policy underlying that rule—ensuring the evenhanded and predictable treatment of creditors—applies in the settlement context.” “If the ‘fair and equitable’ standard is to have any teeth, it must mean that bankruptcy courts cannot approve settlements and structured dismissals devised by certain creditors in order to increase their shares of the estate at the expense of other creditors. We therefore hold that bankruptcy courts may approve settlements that deviate from the priority scheme of § 507 of the Bankruptcy Code only if they have ‘specific and credible grounds to justify [the] deviation.’” (citations omitted)
Finding there was no prospect of a plan being confirmed, conversion to chapter 7 would have resulted in the secured creditors taking all remaining assets, and the lack of evidence for the proposition that a viable alternative to the Settlement existed that would have better served the estate and the creditors as a whole, the Court of Appeals affirmed the structured dismissal that skipped a priority afforded class of creditors in favor of junior creditors.