Client Alerts
April 05, 2017

Supreme Court Reins In the Evolving Process of "Structured Dismissals"

Stites & Harbison, PLLC Legal Update, April 5, 2017

by Stites & Harbison, PLLC

The term "absolute priority rule" does not appear in the Bankruptcy Code. Rather, it is a "creature of law antedating the current Bankruptcy Code." Bank of Am. Nat'l Trust & Sav. Ass'n v. 203 N. LaSalle St. P'ship, 526 U.S. 434, 444 (1999). In a decision released on March 22, 2017, the United States Supreme Court held that “structured dismissals” of bankruptcy cases run afoul of the “absolute priority rule” when an inferior class of creditors is favored over a superior claimant. Writing for a 6-2 Court, Justice Breyer framed the question raised in Czyzewski v. Jevic Holding Corp., 580 U.S. ___ (2017) as follows: “Can a bankruptcy court approve a structured dismissal that provides for distributions that do not follow ordinary priority rules without the affected creditor’s consent? Our simple answer to this complicated question is ‘no’.”

Under 11 U.S.C. §349(b) of the Bankruptcy Code, a bankruptcy court may, “for cause,” issue various curative orders in the dismissal of a bankruptcy case where the “status quo” cannot be restored simply through the dismissal of the case. Examples of these curative provisions are comfort orders that do not unwind prior orders of the court such as a sale of estate assets, the authorization of certain distributions to creditors, or the issuance of various continuing injunctions. While not expressly mentioned by the Bankruptcy Code, these structured dismissals are becoming “increasingly common” as a practice tool in cases where confirmation of a Chapter 11 plan would reach the same result, but with attendant costs that make the plan approval process an expensive endeavor with little additional return.

In Jevic, the Debtor had engaged in a leveraged buyout with Sun Capital Partners prior to filing bankruptcy. The deal was financed by CIT which provided the Debtor with an $85 million credit facility. The Debtor’s trucking business declined and the decision to file a Chapter 11 was made. At the time business operations were terminated, all of the employees were laid off without giving the statutory WARN Act notices required by federal law. These same former employees also became the holders of priority claims for unpaid wages in the bankruptcy case by virtue of §507 of the Bankruptcy Code. In addition to pursuing their priority wage claims in bankruptcy, the former employees filed a WARN Act action in federal court against Sun Capital Partners. As might be expected, Sun Capital Partners vigorously defended the federal court action.

Meantime, the Unsecured Creditors Committee filed an avoidance transfer action against Sun Capital Partners and CIT alleging that the leveraged buyout constituted a fraudulent transfer as the Debtor was left with unreasonably low capital as a result of the transaction. Both sets of litigation dragged on and at the end of the day, the Debtor’s estate was completely under water with no potential distribution to creditors beyond CIT’s recovery of its collateral. Rather than continue to litigate, CIT and Sun Capital Partners proposed a deal for a structured dismissal whereby $2 million was set aside to pay administrative costs and the remaining cash in the estate of about $1.7 million would go to the unsecured class of creditors. Not wanting to create a war chest fund for the WARN Act litigation, the former employee truck drivers received no distribution. Each of the courts below approved the structured dismissal “for cause” over the objection of the former employees on the theory that if the case proceeded as either a Chapter 11 or a Chapter 7, the truck drivers were “out of the money” and would never receive a distribution in any scenario.

In reaching its decision, the Court started with the proposition that, “[t]he Code’s priority system constitutes a basic underpinning of business bankruptcy law.” Then the Court observed that there is no provision of the Bankruptcy Code which permits the priority scheme dictated by §507 to be overridden absent consent by the affected class of creditors. Nor did the Court find any congressional intent to upend the priority system which “has long been considered fundamental to the Bankruptcy Code’s operation.” Finally, the Court opined that adherence to the absolute priority rule is a matter of sound public policy in that it promotes certainty and encourages settlement as creditors may more easily predict how they will be treated in a bankruptcy case.

While the Court did not rule that all structured dismissals are invalid, Jevic stands as a cautionary tale to practitioners who seek to confirm a sub rosa plan or to obtain a result not otherwise authorized by the Bankruptcy Code through the rubric of a structured dismissal. This is particularly true in the current trend of bankruptcy practice where it is common to file a Chapter 11, conduct a sale of substantially all of the Debtor’s assets and then dismiss the case after the senior lienholders are paid out of their collateral. The entire notion of a structured dismissal is to preserve the status quo and to protect the parties to a bankruptcy case. Used properly, a structured dismissal is a shield. Here, the device was used as a sword to perform an end run against creditors who would not waive their priority status. Under Jevic, the simple answer is “no.” Parties may not use a structured dismissal to violate the absolute priority rule.