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The Supreme Court’s Answer is Simply “No”—Structured Dismissals Cannot Deviate From the Code’s Priority Rules Without Consent of Affected Creditors

Czyzewski v. Jevic Holding Corp., 580 U.S. ___ (2017)

In Official Comm. of Unsecured Creditors v. CIT Group/Business Credit, Inc. (In re Jevic Holding Corp.), 787 F.3d 173 (3d Cir. May 21, 2015), the Third Circuit Court of Appeals examined structured dismissals and whether the distributions provided for therein can deviate from the Bankruptcy Code’s priority distribution scheme.  It held that they could but only in the “rare case.”  Almost two years later, the Supreme Court has weighed in on the issue, disagreeing with the Third Circuit and holding that a bankruptcy court cannot approve a structured dismissal that provides for distributions deviating from the ordinary priority rules established by the Bankruptcy Code without affected creditors’ consent.  Op. at 11.

The relevant facts underlying the Jevic chapter 11 bankruptcy proceedings as well as in-depth analyses of the lower courts’ decisions on the issue presented to the High Court are thoroughly discussed in our prior blog posts here and here.  In sum, the defendants of a fraudulent transfer action reached a settlement with the debtor and creditors’ committee that provided funding for distributions to the debtor’s administrative creditors, certain priority creditors, and general unsecured creditors.  Notably absent from the list of settlement fund recipients were the petitioners, who possessed priority claims against the debtor but who also were suing one of the settling defendants.  The petitioners’ lower court challenges to the legality of the settlement and the interrelated structured dismissal that resulted in lower priority creditors receiving distributions before them did not prevail.  In ruling, the lower courts noted the priority scheme deviation but focused on the very specific facts and circumstances before them, creating essentially a “rare case” exception.  Namely, without the settlement and the structured dismissal no pathway to a confirmable plan existed, a chapter 7 conversion was unavailing and, ultimately, no funds would be available to any unsecured creditor (priority or otherwise).

Not surprisingly, the Supreme Court focused on the text of the Bankruptcy Code and its fundamental tenets to tackle the “complicated question” before it.  Op. at 11.  While it expressly did not provide a view on the legality of structured dismissals in general, the Court noted that chapter 11 bankruptcies can have three possible outcomes—conversion to chapter 7, a confirmed plan, and dismissal.  In a chapter 7, distributions must abide by the Bankruptcy Code’s distribution scheme.   See 11 U.S.C. §§ 725, 726.  In a chapter 11 plan, distributions must also do so unless affected creditors provide consent.  §§ 1129(a)(7), 1129(b)(2).  In a dismissal, the Bankruptcy Code generally provides for the restoration of the prepetition status quo, but it also allows a bankruptcy court to alter such result (in other words, structure a dismissal) “for cause”.  See § 349(b).  While the Bankruptcy Code does not explicitly state what priority rules apply if a court structures a dismissal, the Supreme Court did not find that silence as permitting priority scheme violations carte blanche.

To the Supreme Court, the priority scheme of the Bankruptcy Code “constitutes a basic underpinning of business bankruptcy law.”  Op. at 11.  To deviate from such a bedrock principle, the Bankruptcy Code must evince an affirmative intent of Congress to do so, and the Supreme Court could find none.  If anything, the relevant dismissal sections indicate a preference for “restoration of the prepetition financial status quo.”  Op. at 13.  While a bankruptcy court is given the ability to structure a dismissal “for cause” under section 349(b), contextually, the Supreme Court found this section permits the entry of an order to protect rights acquired during a case – not to make an end run around ordinary priority rules without any “significant offsetting bankruptcy-related justification.”  Op. at 16.  Moreover, as the Supreme Court instructed, “cause” does not enable a bankruptcy court to violate the spirit of bankruptcy law and policy.  Such a word “is too weak a reed upon which to rest so weighty a power.”  Op. at 14.

While the Supreme Court acknowledged the Third Circuit’s attempt to limit nonconsensual priority-violating structured dismissals to “rare cases” based on facts and circumstances, it did not agree with the approach.  Relying on case specific reasons is imprecise, leads to uncertainty, and could open the flood gates to more general applications of the rule.  Given the fundamental nature of the Bankruptcy Code’s priority scheme, these consequences, the Supreme Court warned, could lead to potentially dire consequences, such as collusion between creditors and the disregard of protections granted by Congress to particular types of creditors.

For all these reasons, the Supreme Court reversed the lower courts’ decisions in Jevic, refusing to allow structured dismissals to deviate from the Bankruptcy Code’s ordinary priority distribution scheme absent consent of affected creditors.  Importantly, as noted above, the Supreme Court did not opine as to the legality of structured dismissals in general, nor did it decide the appropriateness of pre-plan (and thus, interim) distributions of settlement proceeds that violate the priority rules.  See, e.g.In re Iridium Operating LLC, 478 F.3d 452 (2d Cir. 2007).  These questions remain unanswered although with respect to the latter circumstance, the Jevic Court observed favorably that interim distributions violating ordinary priority rules have often been approved by courts if they favorably serve a bankruptcy purpose, e.g., preserving the debtor as a going concern or promoting a pathway to confirmation.  Examples include “first day” wage orders, “critical vendor” orders, and “roll-ups” for lenders.