United States: Supreme Court To Resolve Circuit Split Over Structured Dismissals

The Supreme Court again will be addressing the powers of bankruptcy courts. At the end of the term, the Court granted certiorari in Czyzewski v. Jevic Holding Corp. to decide whether a bankruptcy court may authorize the distribution of settlement proceeds in a way that violates the statutory priority scheme in the Bankruptcy Code. No. 15-649, 2016 WL 3496769 (S. Ct. June 28, 2016). The Supreme Court is expected to address this fundamental bankruptcy issue sometime early next year.

Background

Jevic Transportation was a New Jersey-based trucking company. In 2006, Sun Capital Partners, a private equity firm, acquired the company in a leveraged buyout. Sun Capital financed the transaction by borrowing against Jevic's assets. Shortly thereafter, Jevic refinanced the debt it had incurred pursuant to the buyout with a consortium of lenders led by CIT Group. By late 2007, Jevic had defaulted on this loan. Jevic then filed for chapter 11 bankruptcy protection on May 20, 2008.

A class of nearly 1800 truck drivers, whom Jevic laid off without warning near the time of the bankruptcy, brought suit against both Jevic and Sun Capital. The official committee of Jevic's general unsecured creditors also brought suit on behalf of Jevic's estate against Sun Capital and CIT Group, arguing that the leveraged buyout was a preference and fraudulent transfer. As Jevic was administratively insolvent—i.e., the administrative and priority claims against the estate exceeded the value of the estate's unencumbered assets—it pursued a settlement of the estate's claims and a structured dismissal that would distribute the proceeds among creditors.

In June 2012, Jevic, Sun Capital, CIT and the unsecured creditors committee filed a joint motion seeking court approval of a proposed settlement and structured dismissal. Under the settlement: (i) CIT agreed to pay $2 million on account of various administrative priority claims; (ii) Sun Capital agreed to assign its lien on Jevic's remaining $1.7 million in cash to a trust to pay other administrative and tax claims, and then to pay the general unsecured claims on a pro rata basis; (iii) the parties agreed to dismiss the fraudulent transfer action and the bankruptcy case; and (iv) the settling parties agreed to release all claims against each other.

The class of laid off drivers and the U.S. Trustee (an officer of the Department of Justice) each objected to the settlement and structured dismissal. The drivers had priority claims against the estate under sections 507(a)(4) and (5) as a result of Jevic's violations of the New Jersey equivalent of the Worker Adjustment and Retraining Notification Act (better known as the WARN Act). The drivers argued that the settlement violated the priority scheme under 11 U.S.C. § 507 and improperly channeled a recovery to general unsecured creditors before paying their priority claims in full. The drivers further contended that the unsecured creditors committee had breached its fiduciary duty to the estate by "agreeing to a settlement that, effectively, freezes out the [drivers]." Additionally, the U.S. Trustee objected on the ground that the Bankruptcy Code does not permit structured dismissals.

Jevic, Sun Capital and CIT responded by arguing that section 507 does not apply to settlements, including structured dismissals like the one at issue here. "Section 507 of the Code simply describes the priority of particular 'expenses and claims.' ... It does not specify the circumstances under which bankruptcy courts are required to apply those priorities." Section 1129 in turn applies this scheme but only in the context of a plan. Accordingly, the parties argued that section 507 has no bearing on a settlement.

Analysis

Section 507 of the Bankruptcy Code details the priority order of the payment of certain claims when assets of the bankruptcy estate are distributed. In particular, section 507(a)(4) requires payment of $12,475 per employee in wages and compensation. Under section 507(a)(5), the debtor must pay claims contributions to an employee benefit plan arising from services rendered within 180 days of the petition date (in amount totaling $12,475 per employee covered under the benefit plan).

Prior to Jevic, two Courts of Appeals grappled with whether or not distributions of settlement proceeds must comply with section 507. In In re AWECO, Inc., the Fifth Circuit rejected a settlement of a lawsuit against a chapter 11 debtor that would have transferred $5.3 million worth of estate assets to an unsecured creditor before satisfying outstanding senior claims. 725 F.2d 293 (5th Cir. 1984). The Fifth Circuit held that settlements must be "fair and equitable," and that "fair and equitable" means compliant with the priority scheme.

The Second Circuit adopted a more flexible approach when confronted with the same question several years later. In In re Iridium Operating LLC, 478 F.3d 452 (2d Cir. 2007), the unsecured creditors committee proposed a settlement that would split the estate's cash between the lenders and a litigation trust set up to fund a different debtor action against one of the priority administrative creditors. The priority administrative creditor objected to the settlement because the proposed distribution allocated funds to lower-priority creditors and skipped over the administrative claim. Finding the Fifth Circuit's approach in AWECO, Inc. "too rigid," the Second Circuit concluded that the absolute priority rule is not necessarily implicated when a court is asked to approve a settlement outside the context of a reorganization plan. Although complying with the Code's priority scheme must be "the most important factor for the bankruptcy court to consider when determining whether a settlement is 'fair and equitable' under Rule 9019," the Second Circuit held that courts may nonetheless approve settlements with distributions deviating from the priority structure when "the remaining factors weigh heavily in favor of approving a settlement[.]"

Delaware Bankruptcy Court and District Court Opinions in Jevic

In an oral opinion, the Bankruptcy Court for the District of Delaware approved the proposed Jevic settlement and entered the structured dismissal. The court held that the Bankruptcy Code does not expressly authorize structured dismissals, but it found them permissible because they are "simply dismissals that are preceded by other orders of the bankruptcy court ... that remain in effect after dismissal." It also found section 507 inapplicable because the case did not involve a chapter 11 plan. The bankruptcy court stated that it had the power approve the structured dismissal under section 105(a) of the Bankruptcy Code—which gives it the power "to issue any order ... that is necessary or appropriate to carry out the provisions" of the Bankruptcy Code—because it was more appropriate than the alternative of converting the case to chapter 7.

The bankruptcy court applied the multifactor test of In re Martin, 91 F.3d 389 (3d Cir. 1996) used for evaluating settlements under Federal Rule of Bankruptcy Procedure 9019. Under this test, a bankruptcy judge must consider the following in deciding whether to approve a proposed compromise: (1) probability of success in litigation; (2) likely difficulties in collection; (3) complexity of litigation involved, and expense, inconvenience and delay necessarily attending it; and (4) paramount interest of creditors. The Jevic court balanced these factors and found that the balance tipped in favor of approving the settlement, and nothing in the Bankruptcy Code dictated otherwise.

The district court affirmed. The court found that the bankruptcy court had not abused its discretion in concluding that structured dismissals are permissible, and that the settlement did not need to follow the absolute priority rule because it was not a reorganization plan. In re Jevic Holding Corp., No. 08-11006, 2014 WL 268613 (D. Del. Jan. 24, 2014).

Third Circuit Opinion in Jevic

A divided panel of the Third Circuit affirmed. In re Jevic Holding Corp., 787 F.3d 173 (3d Cir. 2015). Like the lower courts, the Third Circuit's decision ultimately turned on the fact that the absolute priority rule as codified under section 1129(b)(2) applies by its terms only to plans, and that there is no specific Code provision prohibiting distributions that bypass the priority scheme outside the plan context. In so holding, the Third Circuit expressly rejected the Fifth's Circuit holding in AWECO, Inc. and, instead, adopted the Second Circuit's holding in Iridium Operating.

The Third Circuit began its analysis by noting that settlements are favored in bankruptcy. It also expressly agreed with the Second Circuit's statement that "compliance with the Code priorities will usually be dispositive of whether a proposed settlement is fair and equitable." The Third Circuit therefore held 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 deviation." Noting that Jevic presented a "close call," the Court ultimately found "specific and credible grounds" for approving the settlement because it presented "the least bad alternative" where there was "no prospect" of a plan being confirmed and conversion to chapter 7 would have resulted in the secured creditors taking all that remained of the estate in "short order."

Judge Scirica dissented. He stated that approving the settlement "undermined the Code's essential priority scheme... by skip[ping] over an entire class of creditors" in making distributions. While he did not advocate for a per se rule similar to the one made in AWECO, Inc., he did not find the circumstances in Jevic extraordinary enough to warrant an exception. Instead, he deemed the settlement "an impermissible end-run around the carefully designed routes by which a debtor may emerge from Chapter 11 proceedings."

Supreme Court Considerations

There is a strong textual argument for affirming the Third Circuit's opinion given the lack of provisions in the Bankruptcy Code dictating that priorities apply to settlements, as opposed to plans. While the absolute priority rule is critical to the bankruptcy scheme, under the plain text of the Bankruptcy Code, only plans need comply with it.

The Solicitor General, together with the Executive Office for the U.S. Trustee, weighed in on this matter with an amicus brief. The Solicitor General recommended granting review and argued that the Third Circuit should be reversed. The Solicitor General's brief rejected reading the statutory priorities as limited to plans, contending that "bankruptcy is not a free-for-all in which parties or bankruptcy courts may dispose of claims and distribute assets as they see fit." Much like Judge Scirica, the Solicitor General saw a settlement as essentially a substitute for a plan, which needs to comply with the priority scheme under section 507.

Impact

The Supreme Court's decision will, hopefully, resolve one of the most important circuit splits in business bankruptcy law. Currently, the Third Circuit's decision enables parties to reach settlements that do not comply with the priority scheme under section 507. Given the strong policy favoring consensual agreements and the balance of factors weighing in favor of settlement approval under Martin, affirming the Third Circuit's decision may be consistent with Congress' intent. A ruling in favor of structured dismissals would serve to channel cases away from chapter 11 plans and toward consensual settlements. This could reduce administrative costs and facilitate quicker bankruptcy resolutions. However, this could also lead to settlements that run counter to the expected results under the absolute priority rule. This represents a close and complex question for the Court.

Additionally, the Supreme Court's decision may affect the permissibility of "gift plans," i.e. payments from secured creditors or buyers—supposedly from their own property—that enable distribution in a chapter 11 plan not in accordance with priorities. If the Supreme Court signs off on orders where creditors agree to recoveries outside the scope of the absolute priority rule, it might tacitly endorse gift plans whereby secured creditors agree that their recoveries may be distributed in part to junior creditor classes to ensure completion of the bankruptcy. Historically, gifting has occurred in the plan context, but structured dismissals could also provide a platform for this activity.

The oral argument date for Jevic has not been set yet. We expect that it will be held in early December of this year.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.