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Did the Supreme Court Just Kill the Structured Dismissal in Chapter 11?

Mark W. Sandretto and Jared J. Lefevre
3/28/17

    In Chapter 11 bankruptcies, creditors generally expect one of three outcomes: (1) payment (or not) under a Chapter 11 plan; (2) payment (or not) after the case is converted to a Chapter 7 liquidation; or (3) return to the pre-bankruptcy status quo if the case is dismissed outright. Increasingly, however, parties and courts have been experimenting with a fourth option: "structured dismissals," in which a case is dismissed from bankruptcy with conditions attached, including approval of some in-bankruptcy distributions to creditors. Creditors may prefer a structured dismissal where confirmation of a Chapter 11 plan is unlikely, conversion to Chapter 7 will not result in significant distributions and collection prospects in state court appear dim. A recent U.S. Supreme Court decision, Czyzewski v. Jevic Holding Corp., though, throws doubt on whether creditors should use the structured dismissal model to resolve cases in the future.

    In Czyzewski, the debtor filed bankruptcy after being acquired in a leveraged buy-out. Two lawsuits followed. First, a group of employees sued for violation of the WARN Act, because the debtor failed to give sufficient notice of their terminations. Part of the judgment eventually granted to the employees was treated as a priority wage claim, which entitled them to payment before general unsecured creditors under the Bankruptcy Code. Second, the Unsecured Creditors’ Committee pursued a fraudulent conveyance action against the debtor’s lenders arising from the leveraged buyout. To settle the latter claim, the debtor agreed to a structured dismissal which would make certain payments to unsecured creditors but provided nothing to the employees on their priority wage claim. Relying on its authority to order dismissal "otherwise" and "for cause," the bankruptcy court approved this structured dismissal, a ruling which was affirmed by the district court and the United States Court of Appeals for the Third Circuit (Off. Comm. Of Unsecured Creditors v. CIT Grp./Bus. Credit Inc. (In re Jevic Holding Corp.)).

    By a vote of 6-2, the Supreme Court reversed and remanded. Looking carefully at the Bankruptcy Code, the Court concluded that "[a] distribution scheme ordered in connection with the dismissal of a Chapter 11 case cannot, without the consent of the affected parties, deviate from the basic priority rules that apply under the primary mechanisms the Code establishes for final distributions of estate value in business bankruptcies." Priority, the Court reasoned, is the touchstone of the Code: Chapter 7 requires complete adherence to the Code’s priority rules and, while Chapter 11 permits greater flexibility, a reorganization plan cannot be confirmed if any impaired class of creditors objects. Had Congress intended to permit complete circumvention of the priority rules via a structured dismissal, one presumes it would have said so explicitly in the Code rather than vaguely stating only that a court may order dismissal "otherwise" and "for cause." Or, as Justice Breyer dryly put it, "the word ‘cause’ is too weak a reed upon which to rest so weighty a power." The Court thus rejected the Third Circuit’s holding that a structured dismissal could violate priority only in "rare cases," finding the Circuit’s proposed "sufficient reasons" exception unworkable and unpermitted by the Code.

    So, where does Czyzewski leave the creditor who wants to broker a deal to get paid something with a debtor who cannot get a Chapter 11 plan confirmed but also will not have distributable assets in a Chapter 7? The good news is the Court explicitly declined to pass on the legality of structured dismissals in general and cited with approval In re Buffet Partners, L.P., a case in which a structured dismissal was approved because "not one party with an economic stake in the case" objected to it. Thus, a structured dismissal may still be viable, if no one objects, and if explicit consent is obtained where priority is violated.

    But as any creditor knows, consent may not be easily obtained from interested parties. After all, lack of consent may be why a Chapter 11 plan is not confirmable in the first place. And, given the Court’s reticence, (the two dissenters, Alito and Thomas, dissented on the narrow grounds that the question was premature, but expressed no other disagreement with the Court’s holding), creditors can expect lower courts to be skeptical if not outright resistant to approving structured dismissals in the future. Thus, creditors seeking a structured dismissal in Czyzewski’s wake should endeavor to build consensus among all affected creditors before approaching the court for approval and should avoid priority violations to the extent possible.

    Should you have any questions regarding Czyzewski or any other bankruptcy issue, please contact one of our bankruptcy and creditors' rights attorneys.

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    Disclaimer:  The article in this publication has been prepared by Eastman & Smith Ltd. for informational purposes only and should not be considered legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney/client relationship.

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