United States: The Structure Of Dismissals – Supreme Court's Jevic Decision Lays Out Ground Rules For Parties Seeking To Resolve Bankruptcies Through The Increasingly Popular Method Of Structured Dismissals

On March 22, 2017, the Supreme Court in Czyzewski v. Jevic Holding Corp., 580 U.S. __ (2017) held that a bankruptcy court does not have the power to approve a structured dismissal of a bankruptcy case that violates the Bankruptcy Code's priority scheme unless the affected parties consent.

The federal Bankruptcy Code is nearly 40 years old, and as one might expect, bankruptcy practice has evolved in a myriad of ways since its enactment. One such Darwinian creation is the development and increasing use of the so-called "structured dismissal" as the means to resolve a chapter 11 bankruptcy case. The Bankruptcy Code contemplates in Sections 305 and 1112 that a chapter 11 bankruptcy case may be resolved by dismissal, but provides in Section 349 that the effect of such a dismissal will be to restore the parties to the status quo ante as if the bankruptcy was never filed – that is, unless the bankruptcy court "for cause, orders otherwise."

A structured dismissal seizes on the "for cause, orders otherwise" language in Section 349, and typically seeks the bankruptcy court to authorize certain distributions of estate funds, to approve a related settlement or sale, and/or to approve certain releases of major parties in the case. A key feature of structured dismissals is also that the bankruptcy court's orders entered during the case will remain in effect despite the dismissal. Since dismissals, including structured dismissals, are sought by motion they are much quicker and cheaper to do than a chapter 11 plan. In addition, they allow the main parties in the case to control the resolution of the case in a way that conversion to a chapter 7 does not, given that conversion to a chapter 7 involves appointment of a new chapter 7 trustee to represent the estate, as well as an associated additional layer of administrative expense. The structured dismissal is also typically faster than the general timeline for resolution of a chapter 7 case.

For all of these reasons, structured dismissals have been increasingly used as vehicles to resolve a case, in particular in situations where the expense of a chapter 11 plan process does not appear warranted – e.g., cases with limited funds that are insufficient to pay administrative or priority creditors, cases where the debtor's assets have been sold and all that remains is to distribute the limited proceeds, or cases where a settlement obviates the debtor's need to obtain a discharge through a plan.

Many structured dismissals simply seek authorization to distribute funds to creditors according to the priorities set forth in the Bankruptcy Code. In other words, they do not seek to violate the so-called "absolute priority rule" of Section 1129(b) of the Code.

However, Jevic presented a different situation. The structured dismissal approved by the bankruptcy court in Jevic involved a settlement between the debtor's secured creditors and the official committee of unsecured creditors, after the committee had alleged certain fraudulent conveyance actions on behalf of the estate arising out of a leveraged buyout of the debtor that subsequently turned sour. Importantly, the settlement and the structured dismissal in Jevic provided for a violation of the absolute priority rule. In particular, certain proceeds of the settlement payment made to the estate would be paid to general unsecured creditors even though priority wage creditors would receive nothing.

It is plain that this result would be impossible in a chapter 11 plan setting under the cramdown procedures of Section 1129(b), which provide that the absolute priority rule must be obeyed with respect to any class of creditors that rejects the plan (though it may be violated with respect to classes of creditors that accept the plan). It is also plain that such "class-skipping" could not occur in a chapter 7 liquidation, where strict adherence to the absolute priority rule is mandated at all times.

The Supreme Court in Jevic reasoned that in light of the emphasis on adhering to the priority scheme in the chapter 11 plan context and the chapter 7 liquidation context, the Bankruptcy Code would need to specifically authorize violations of the priority scheme in the context of dismissals in order for them to pass muster. Judge Breyer for the majority felt that the word "cause" in Section 349 was simply not a sufficiently specific authorization of priority violations, terming it as "too weak a reed upon which to rest so weighty a power." See, Jevic, slip op. at p. 14. Further, unlike first day wage orders or critical vendor orders, the Court found there to be no furtherance of a reorganization or other bankruptcy purpose in the priority-violating structured dismissal, since it was occurring at the end of the case. Id. at pp. 15-16.

The Supreme Court also concluded that the reasoning of the Third Circuit, which held that priority-violating structured dismissals could be appropriate in "rare cases," created an exception that threatened to swallow the rule. Id. at p. 17.

While the Supreme Court professed to express no opinion on the legality of structured dismissals in general (slip op. at p. 14), the Jevic decision clearly lays out the ground rules for parties seeking court approval of a structured dismissal going forward. That is, parties must either propose a structured dismissal that strictly obeys the absolute priority rule, or they must obtain the consent of any class of creditors that does not receive the treatment afforded to it under the absolute priority rule.

It will be interesting to follow subsequent decisions in the structured dismissal space. In particular, how will the consent of a so-called "skipped class" be obtained? And, how are its members even determined, given that there is no plan on file that classifies creditors? Does the movant need to classify all creditors in its dismissal motion and then affirmatively go out and obtain their approval? And, is that approval determined by the voting rules applicable to plans in Section 1126 of the Code? Since structured dismissals are sought by motion, it is likely that parties seeking approval of structured dismissals will argue that failure to object constitutes the necessary consent. Indeed, this has some basis in the Jevic opinion, as the Court in distinguishing the Buffet Partners case from the Northern District of Texas noted that there, no one with an economic stake in the case had objected. Jevic, slip. op. at p. 14. Thus, the issue of how to determine the consent of a skipped class will likely only arise if a party in that class does lodge an objection.

Further, the Jevic case in effect grafts one subset of plan confirmation standards onto the structured dismissal framework – the standards and case law surrounding the absolute priority rule. Will other plan confirmation standards also be grafted onto the structured dismissal framework? One can imagine objecting parties arguing bad faith under Section 1129(a)(3), or that creditors must do better in the dismissal than they would in a hypothetical chapter 7 liquidation under Section 1129(a)(7) (the so-called best interests of creditors test). If courts allow other plan confirmation considerations such as these to ride the coattails of the absolute priority rule into the structured dismissal world, it may have the effect of obviating much of simplicity, ease, and benefit of structured dismissals. In that scenario, a Supreme Court opinion that clarifies the law on structured dismissals may have the effect of also undermining even those dismissals that would pass muster under the new standards by making them less desirable.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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