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Third Circuit Approves of Structured Dismissals That Deviate From the Bankruptcy Code’s Priority Scheme – But Only in Rare Cases

Official Comm. of Unsecured Creditors v. CIT Group/Business Credit, Inc. (In re Jevic Holding Corp.), No. 14-1465, 2015 WL 2403443 (3d Cir. May 21, 2015)

The Third Circuit Court of Appeals (the “Third Circuit”) answered a novel question of bankruptcy law in the affirmative—whether a chapter 11 case can ever be resolved in 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) that deviates from the priority scheme of the Bankruptcy Code.  In rare cases, the Bankruptcy Code “permits a structured dismissal, even one that deviates from the [section] 507 priorities, when a bankruptcy judge makes sound findings of fact that the traditional routes out of Chapter 11 are unavailable and that a settlement is the best feasible way of serving the interests of the estate and its creditors.”  The Third Circuit found that this was one of those rare cases.

Jevic Transportation, Inc. (“Jevic”) filed for chapter 11 following a leveraged buyout by a subsidiary of the private equity firm Sun Capital Partners (“Sun”), which was financed by a group of lenders led by CIT Group (“CIT”).  At the time of the bankruptcy filing, Jevic owed approximately $53 million to its first-priority senior secured creditors (CIT and Sun) and over $20 million to its tax and general unsecured creditors.  Prior to the petition date, Jevic ceased substantially all of their operations and gave notice to employees of their impending terminations.  During the bankruptcy case, a group of terminated truck drivers (“Drivers”) filed a class action against Jevic and Sun alleging violations of the federal and state Worker Adjustment and Retraining Notification (WARN) Acts.  The Drivers estimated their WARN claim to be in excess of $12 million, of which $8.3 million was a priority wage claim under section 507(a)(4) of the Bankruptcy Code.  Meanwhile, the official committee of unsecured creditors brought a fraudulent conveyance action against CIT and Sun on the estate’s behalf related to the pre-petition LBO.

Three years later, Jevic, the creditors’ committee, CIT, and Sun reached a settlement, at which time Jevic’s only remaining assets were $1.7 million in cash (which was subject to Sun’s lien) and the LBO action against CIT and Sun.  The proposed settlement provided that (i) the parties would exchange mutual releases and the LBO action would be dismissed with prejudice; (ii) CIT would pay $2 million to satisfy certain unpaid administrative expenses, including professional fees; (iii) 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 general unsecured creditors on a pro rata basis; and (iv) Jevic’s chapter 11 case would be dismissed.  Under the proposed settlement, the Drivers received nothing.

The Bankruptcy Court approved the settlement under the multifactor test of In re Martin, 91 F.3d 389 (3d Cir 1996), over the objection of the Drivers and the Office of the United States Trustee given the “dire circumstances” that there was “no realistic prospect” of a meaningful distribution to anyone except the secured creditors.  The Drivers appealed to the Delaware District Court, which affirmed the Bankruptcy Court’s approval of the settlement and dismissal of the bankruptcy case.  An analysis of that ruling may be found here.

On further appeal, the Third Circuit affirmed.  Despite acknowledging that structured dismissals are not expressly authorized by the Bankruptcy Code, the Court held that “absent a showing that a structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation or conversion processes, a bankruptcy court has discretion to order such a disposition.”  The Third Circuit relied heavily on the Bankruptcy Court’s uncontested finding that there was no real prospect of a confirmable plan and conversion to chapter 7 would have been unavailing.  Importantly, the Court did not opine on whether a structured dismissal would be permissible “when a confirmable plan is in the offing or conversion to Chapter 7 might be worthwhile.”

The Third Circuit further held that settlements in the context of structured dismissals may skip a class of objecting creditors in favor of more junior creditors. The Court was skeptical whether section 103(a) of the Bankruptcy Code requires settlements in chapter 11 cases to comply with the priorities set forth in section 507 of the Bankruptcy Code.  Although neither the Bankruptcy Code nor the Bankruptcy Rules extend the absolute priority rule to settlements, the policy underlying that rule applies in the settlement context.  The Third Circuit rejected the per se rule articulated by the Fifth Circuit in the Matter of AWECO, Inc., 725 F.2d 293, 295–96 (1984), and instead agreed with the flexible approach taken by the Second Circuit in In re Iridium Operating LLC, 478 F.3d 452 (2007)—whether a settlement’s distribution complies with the priority scheme of the Bankruptcy Code must be the most important factor for the bankruptcy court to consider when determining whether a settlement is “fair and equitable” under Bankruptcy Rule 9019, but a noncompliant settlement could be approved when the remaining factors weigh heavily in favor of approving a settlement.  While compliance with the priority scheme will usually be dispositive of whether a proposed settlement is fair and equitable, bankruptcy courts may approve settlements that deviate from section 507 only if they have “specific and credible grounds to justify [the] deviation.”  In this case, it was a close call, but the settlement and structured dismissal was the “least bad alternative” since there was no prospect of a confirmable plan and conversion to chapter 7 would have resulted in the secured creditors taking all that remained in the estate.  Absent the settlement, there was “no realistic prospect” of a meaningful distribution to Jevic’s unsecured creditors.  The Third Circuit was troubled by the fact that the exclusion of the Drivers lent an element of unfairness, but the alternative option would not have served the interests of creditors or the estate.