Client Alerts
March 24, 2017

Without Consent of Skipped Creditor

Stites & Harbison Legal Update, March 24, 2017

In elementary school, there was always the kid from the back of the line muscling in ahead of others who were patiently waiting their turn for the slide. Known as “the cutter”, this kid’s goal was to evade taking an orderly turn. The 6-2 Supreme Court Opinion in Czyzewski v. Jevic Holding Corp. does nothing to improve recess for kids near the back of the line. However, to the delight of skipped creditors in Chapter 11 structured dismissals, the bankruptcy playground just got a little more fair.

Not to make light of the injustices at the slide, the swings or the water fountain, but, Jevic is a really big deal. More and more structured dismissals are occurring in Chapter 11 bankruptcies and bankruptcy courts have struggled to determine whether the Code allows for low priority unsecured creditors to receive a distribution over the objection of higher priority creditors. Petitioners in Jevic were the perfect example. Petitioners were terminated Jevic employees litigating priority wage claims with Jevic, the Debtor. In a separate simultaneous suit, an authorized committee representing unsecured creditors had sued two senior secured creditors. The committee and secured creditors reached an agreement through which the bankruptcy estate would receive significant funds. However, the secured creditors wanted to cut out the distribution to the terminated employees whose priority wage claims would entitle them to funds which could be used to litigate against Jevic on those wage claims.

The secured creditors, Jevic and the committee sought bankruptcy court approval of the settlement through a structured dismissal and distributions that did not follow ordinary priority rules. The settlement provided for payment for distribution to unsecured creditors, but skipped payment to the terminated employees holding prior claims. The Bankruptcy Court found that while the settlement deviated from the Code’s priority of distribution, this did not bar approval because the distribution occurred pursuant to a dismissal and not a plan. The District Court affirmed on the same conclusions. The Third Circuit also affirmed, determining that structured dismissals need not always respect the Code priorities.

The Code does not explicitly state what priority rules – if any – apply to a distribution upon case dismissal. However, the Supreme Court noted that the Code’s priority system is the underpinning of bankruptcy law. In Chapter 7 liquidations, priority is an absolute command. Although Chapter 11 plans provide somewhat more flexibility, a priority-violating plan still cannot be confirmed over the objection of an impaired class of creditors. The Supreme Court expected that the Code would give some affirmative indication if Congress intended to make structured settlements a backdoor means to achieve the exact kind of nonconsensual priority –violating final distributions that the Code prohibits in Chapter 7 liquidations and Chapter 11 plans. Finding none, the Supreme Court concluded that a distribution scheme in connection with the dismissal of a Chapter 11 case cannot, without the consent of affected parties, deviate from the basic priority rules.

The Jevic decision highlighted the purpose of dismissal, which is to undo the bankruptcy as far as practical, and restore property rights to the status quo in place at the beginning of the case. Skipping a creditor objecting to such treatment upon dismissal does not achieve this purpose.

For the cutter looking for an exception where sufficient cause will exist to avoid the priority rule, the Supreme Court has already blocked your move. Dismissal of a case is unlike the “first day” wage orders and “critical vendor” orders which the Supreme Court describes as serving Code-related objectives that violate priority. A structured dismissal does nothing to preserve the debtor as a going concern or promote the possibility of a confirmable plan – and no “rare case” exception has been authorized by Congress.

Does Jevic ward against collusion in bankruptcy by eliminating the ability to skip priority creditors? Does Jevic impede settlement by eliminating the ability to recast bargaining power among creditors? The answer depends upon where you stand in the line of priority.

Related Capabilities
Health Care - Bankruptcy & Restructuring