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Supreme Court Decides Against Structured Dismissals In Chapter 11 Cases

Bankruptcy

03/22/2017

By: Joseph Briggett

On March 22, 2017 the Supreme Court decided a bankruptcy case that has been followed closely by restructuring attorneys, Chapter 11 professionals and financial institutions. In Czyzewski v. Jevic Holding Corporation, the Court considered whether a case arising under Chapter 11 can ever be resolved by way of a “structured dismissal.” The Court held that a bankruptcy court cannot approve a structured dismissal that allocates value contrary to the priority scheme of the Bankruptcy Code.    

Generally, the Chapter 11 process allows distressed businesses or individuals to reorganize their financial affairs and, hopefully, to emerge in a better state of financial health. Ordinarily, the Bankruptcy Code’s priority system is safeguarded through the Chapter 11 plan confirmation process, which protects the many stakeholders through notice, public hearings, voting and court adjudication. If that process fails, the case is most often converted to Chapter 7 for a court-supervised liquidation. Until Jevic, the structured dismissal was viewed as a viable third option. Following Jevic, restructuring attorneys will in most instances not be able to elude these requirements through a structured dismissal. 

The debtor in Jevic was a trucking company based in New Jersey. Jevic Operations had stayed afloat through out-of-court restructuring prior to bankruptcy. In May 2008, under substantial pressure from secured creditors, Jevic Operations filed its Chapter 11 petition. Almost simultaneously with the bankruptcy filing, Jevic ceased its operations and terminated all of its employees.

In the Chapter 11 case, both the debtor’s employees and the court-appointed committee of unsecured creditors filed lawsuits against the debtor and other third parties. Eventually, the debtor reached an impasse. Rather than convert to Chapter 7 for liquidation, however, the debtor applied for and was granted a dismissal. The dismissal order imposed several conditions and ordered, among other things, payments, assignment of liens and release of claims.  The dismissal was granted over the objection of its employees, who, of course, appealed the ruling.

Generally, the Bankruptcy Code authorizes three ways to end a Chapter 11 case: 1) confirmation of a Chapter 11 plan, 2) conversion to a Chapter 7 liquidation or 3) dismissal. Dismissals were at issue in Jevic. The Bankruptcy Code generally provides that dismissals in Chapter 11 cases result in a return to the status quo. While status quo is the general rule, Section 349 of the Bankruptcy Code provides that the Court may, for good cause, “order otherwise.” Importantly, such a structured dismissal does not entail a statutorily regulated liquidation, consistent with legislative bankruptcy priorities, as in a Chapter 7 conversion. And the key element of a “structured” dismissal (as opposed to a “straight” dismissal) is that it does not simply return the parties to their pre-bankruptcy positions. It adjudicates and affects their rights.

The Court in Jevic decided the meaning of the key language in the dismissal statute permitting bankruptcy courts to “order otherwise.” In a twist relevant to New Orleans restructuring attorneys, Justice Breyer questioned counsel at oral argument on whether a debtor in bankruptcy could violate the priority rules if it discovered that Jean Lafitte’s gold was buried beneath its property. In Justice Breyer’s hypothetical, the third party demanded terms contrary to the Bankruptcy Code’s priority scheme in order to cooperate with the Debtor’s bankruptcy process to help unearth Jean Lafitte’s gold.

Justice Breyer ultimately wrote the opinion of the Court, which held that the structured dismissal exceeded the bankruptcy court’s authority under Section 349. Justice Breyer considered the key protections in the Chapter 11 process.  Specifically, the process demands disclosure, voting by constituents, and the court’s findings that the plan meets particular legal standards, including compliance with the Bankruptcy Code’s priority rules. The statutory scheme contemplates that if these requirements are not met, the alternative is conversion to Chapter 7 liquidation.

With this framework in mind, Justice Breyer inquired whether the power to “order otherwise” contained in Section 349 could be a “backdoor” to elude both the plan process and a Chapter 7 conversion. If allowed, Justice Breyer regarded this proposition as a significant departure from the statutory scheme. For that to be the case, he would expect to find some affirmative indication from Congress that this third option was intended. And he found no clear affirmative indication from Congress of that intent. Justice Breyer therefore interpreted the “order otherwise” language more narrowly. In his and the Court’s view, Section 349’s authority to “order otherwise” is intended only to give courts flexibility to protect rights acquired in reliance on the bankruptcy case. It does not allow for structured dismissals that allocate value in a manner that is contrary to the statutory priority scheme. 

The Court’s ruling will, for sure, hinder businesses’ and restructuring professionals’ ability to navigate through the Chapter 11 plan process. The “backdoor” of a structured dismissal is either no longer available, or it is very narrow. Restructuring attorneys should heed this ruling and will need to be prepared with exit strategies through a confirmed Chapter 11 plan or conversion to Chapter 7.

 


 

Lugenbuhl represents a wide array of constituencies in Chapter 11 reorganization proceedings, including acting as counsel for numerous corporate and partnership Chapter 11 debtors, as well as committees, trustees, secured and unsecured creditors, bondholders and equity holders. More information about Lugenbuhl’s bankruptcy practice is available here.

The content of this article is not intended to serve as an exhaustive review of the laws, statutes or issues related to bankruptcy restructuring cases and is not intended to provide legal advice. The opinions expressed through this article may not reflect the opinions of the firm, individual attorneys or clients.