Structured dismissals have become an attractive option for debtors in recent years. The outcome of a case pending before the Supreme Court, however, may halt that trend.
On December 7, 2016, the United States Supreme Court heard oral arguments in Czyzewski v. Jevic Holding Corp. to decide if a bankruptcy court can approve settlements that contravene the Bankruptcy Code’s priority scheme in section 507, so long as the court finds that no creditor would be better off under any available alternative (even though some creditors would fare better under the otherwise non-compliant settlement).
The bankruptcy code expressly allows only three possible outcomes in a chapter 11 case: confirmation of a reorganization plan, conversion to chapter 7, or dismissal. Furthermore, when a case is dismissed, the court typically returns the parties to the status quo ante, and the orders entered in the bankruptcy case do not survive. Recently, however, a number of debtors have sought approval of so-called “structured dismissals,” which are “disposition[s] that wind[ ] up the bankruptcy with certain conditions attached instead of simply dismissing the case and restoring the status quo ante.”
In Jevic, the debtor, a secured creditor, and the committee of unsecured creditors sought to have a bankruptcy case structurally dismissed and further asked that a settlement survive dismissal of the case. In particular, the debtor, secured creditor, and committee negotiated a settlement whereby a secured creditor received a release from claims that were being litigated against it in return for an agreement to allow the distribution of some estate assets—upon which the secured creditor had a lien—to certain administrative and general unsecured creditors. However, certain other administrative creditors who otherwise would have had priority over some of the parties receiving a distribution were excluded and were to receive no distribution under the settlement. The bankruptcy court approved the settlement, dismissal, and survival of the settlement, even though the settlement contravened the Bankruptcy Code’s priority scheme in section 507.
On appeal to the Third Circuit, the court first found that while the Bankruptcy Code does not expressly provide for structured dismissals, section 349(b) does grant bankruptcy courts the power to control the effect of a dismissal “for cause.” Therefore, the Third Circuit reasoned, “the Code does not strictly require dismissal of a Chapter 11 case to be a hard reset.”
The court next determined that a structured dismissal could also include a settlement that deviated from the Bankruptcy Code’s priority scheme. The Third Circuit distinguished a line of Supreme Court cases requiring plans of confirmation to be “fair and equitable” under section 1129(b)(2)(B)(ii) by stating that those cases address the “fair and equitable” requirement in the context of plans of reorganization and not settlement agreements or structured dismissals. The Third Circuit adopted the Second Circuit’s more flexible approach taken in In re Iridium Operating LLC. This approach allows a bankruptcy court to approve a settlement distribution that contravenes section 507 priorities if the other factors under Bankruptcy Rule 9019 “weigh heavily in favor of approving a settlement.”
Applying this framework to the facts of Jevic, the Third Circuit found that, while it was “a close call” and structured dismissals deviating from section 507 are “likely to be justified only rarely,” the facts of Jevic constituted such a “rare” case. The Third Circuit placed particular emphasis on the fact that the objecting administrative claimants were virtually certain to receive no distribution if the settlement was denied and the case was converted, while the settlement provided for distributions to lower priority creditors that would have received nothing but for the settlement. Accordingly, the court found the structured dismissal to be “the least bad alternative.” The Third and Second Circuit decisions deviate from the Fifth Circuit’s decision in In re AWECO, Inc. In AWECO, the court found that all settlements must comply with the absolute priority rule, which means that settlements must be “compliant with the priority system.”
During oral arguments, certain Supreme Court Justices expressed concern by their questions about permitting settlement agreements in bankruptcy that contravene the statutory priority scheme. The Justices questioned whether there is support in the Bankruptcy Code for a bankruptcy court to approve a non-conforming settlement, even if it means that an unsecured creditor—one that would otherwise receive no distribution under a chapter 11 plan or chapter 7 liquidation—receives a distribution.
There could be profound consequences from the Court’s decision, particularly in cases in which a secured creditor has a lien on substantially all of a debtor’s assets. If the Court upholds Jevic and permits structured dismissals that deviate from the Bankruptcy Code’s priority scheme, debtors and creditors will have more flexibility to craft practical solutions, resulting in an overall net benefit to creditors. The Court could, instead, permit structured dismissals, but require that they comply with the Bankruptcy Code’s priority scheme. However, if the Court reverses Jevic, it could hold that structured dismissals are impermissible under the Bankruptcy Code, or that in addition to structured dismissals being impermissible, there can never be any deviation from the absolute priority rule.
Due to the vacancy on the Supreme Court created after the death of Justice Scalia, the Court will have to vote by at least a 5-3 margin to reverse the Third Circuit’s holding, otherwise the Third Circuit’s opinion will be affirmed. The Court will issue its ruling later this year.
A copy of the Third Circuit’s opinion can be found here: Download In re Jevic Holding Corp.
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 136 S. Ct. 2541 (2016).
 11 U.S.C. § 1129 (2016).
 Id. at § 1112.
 Id. at § 349.
 Official Comm. of Unsecured Creditors v. CIT Grp./Bus. Credit Inc. (In re Jevic Holding Corp.), 787 F.3d, 173, 177 (3d Cir. 2015), cert. granted sub nom., Czyzewski v. Jevic Holding Corp., 136 S. Ct. 2541 (2016).
 See 11 U.S.C. § 349(b).
 In re Jevic Holding Corp., 787 F.3d at 181.
 478 F.3d 452 (2d Cir. 2007).
 In re Jevic Holding Corp., 787 F.3d at 183 (quoting id. at 464).
 Id. at 184, 186.
 Id. at 185.
 725 F.2d 293 (5th Cir. 1984).
 In re Jevic Holding Corp., 787 F.3d at 183 (citing id. at 298).