On March 22, 2017, the U.S. Supreme Court, in Czyzewski et al., v. Jevic Holding Corp., et al., confirmed that the Bankruptcy Code does not permit “priority skipping” in Chapter 11 structured dismissals. In doing so, the court held that, although the code does not explicitly provide what, if any, priority rules apply to the distribution of estate assets in a Chapter 11 structured dismissal, “[a] distribution scheme 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…code.”

Factual Background of Jevic

In the case in question, New Jersey-headquartered trucking company Jevic Transportation filed for Chapter 11 following a failed leveraged buyout. Jevic owed $53 million to its senior secured creditors and more than $20 million in taxes and to general unsecured creditors. Jevic’s Chapter 11 filing generated two significant legal actions:

• A claim from its employees that Jevic, and others, had violated state and federal Worker Adjustment and Retraining Notification (WARN) Acts
• An action for fraudulent conveyance brought by the official unsecured creditors’ committee against Sun Capital Partners, Jevic’s private equity owner, and its secured lender, CIT Group Jevic’s former employees prevailed at summary judgment on their WARN Act violation claims and were awarded, among other things, $8.3 million for wage claims.

Jevic negotiated a settlement of the fraudulent conveyance action with Sun, CIT and the committee. The settlement agreement provided for dismissal of the fraudulent conveyance action; CIT’s contribution of $2 million to pay the committee’s legal fees and expenses; Sun’s assignment of its lien on Jevic’s remaining assets, worth $1.7 million, to a trust for the payment of taxes, administrative expenses and distribution to Jevic’s unsecured creditors and dismissal of the Chapter 11 case.

In short, the settlement proposed to dismiss the bankruptcy case while providing distributions to Jevic’s secured creditors and general unsecured creditors, but providing no distributions to the $8.3 million WARN wage claims that had priority over unsecured claims under Chapter 11 plan principles.

The Jevic Rulings

The Bankruptcy Court approved the settlement and dismissal over the objections of the wage claimants and the U.S. Trustee. The court recognized that the settlement and dismissal violated the ordinary priority rules of the code, but held that, without the settlement and dismissal, there would be no meaningful distribution for any creditor. Therefore, it ruled, approval of the structured dismissal was appropriate. The district court affirmed the decision, holding the priority rules of the code were “not a bar to the approval of the settlement as it is not a reorganization plan.”¹ The 3rd U.S. Circuit Court of Appeals affirmed the decision on appeal.

The case advanced to the U.S. Supreme Court, which reversed the decision and held that the Bankruptcy Court could not order a structured dismissal that distributes estate assets in a manner contrary to the code’s priority rules without the consent of the affected creditors. Relying on the legislative history of the code and its plain language, the court noted that “we would expect to see some affirmative indication of intent if Congress actually meant to make structured dismissals a backdoor means to achieve the exact kind of nonconsensual priority-violating final distributions that the code prohibits in Chapter 7 liquidations and Chapter 11 plans.” Additionally, the court observed that the dismissal under the code “seek[s] a restoration of the pre-petition financial status quo.” Accordingly, approval of a dismissal that permits “priority skipping” did not, in the court’s view, preserve the pre-petition status quo.

Jevic’s Impact on Modern Bankruptcy Practice

The Jevic holding is narrow — it does not prohibit structured dismissals, it only prohibits non-consensual structured dismissals that violate the code’s priority principles. However, the court’s strong adherence to congressional intent and the objectives of the code combined with its rejection of the Bankruptcy Court’s attempt to reach a resolution to address Jevic’s “dire circumstances” suggest that bankruptcy courts may take a more structured, rules-driven approach rather than relying on equitable or “best under the circumstances” reasoning in approving out-of-plan distributions. Although Jevic concerned the distribution of estate assets, the court’s strong priority protection ruling opens the door to new arguments attacking the distribution of non-estate assets in “gifting” plans or structured asset sales that do not follow the code’s priority scheme.

Gifting plans involve a senior creditor “gifting” a distribution to junior creditors when the plan does not provide a full recovery to intermediate priority creditors. Some courts reject gifting plans because they deviate from the code’s absolute priority rule, which prohibits distributions to junior creditors unless senior creditors are paid in full or consent to the distribution.² However, other courts permit gifting plans reasoning the absolute priority rule is not violated because the junior creditor’s distribution comes from the senior creditor’s pocket, not the estate.³ The intermediate creditor has no entitlement to receive the senior creditor’s property; it only has claims against property of the estate.⁴

Similarly, structured asset sales under Section 363 of the code permit the purchaser of estate property to condition its asset purchase upon the ability to provide payments to junior creditors out of the purchaser’s pocket, not the estate. For example, in ICL Holding Co., a secured lender credit bid to acquire all of the debtors’ assets in a Section 363 sale.⁵

As part of the sale, the secured lender agreed to make cash payments to escrow accounts to fund the debtors’ professional fees and distributions to unsecured creditors because after the sale was completed, it was clear the debtors would have no assets to fund distributions to any of its creditors. The escrow account was available to fund the wind-down of the debtors’ Chapter 11 cases, including the professional fees of the debtors and any official unsecured creditors committee. The creditors’ committee objected to the credit bid sale, but those objections were resolved through a settlement where the secured lender agreed to place an additional $3.5 million into an escrow account that would provide distributions to unsecured creditors.

The federal government also objected and claimed that the sale and the settlement violated the code’s priority rules by permitting distributions to unsecured creditors, leaving the government’s higher priority tax claims unpaid. The government appealed the “skipping” of its tax claims to the 3rd Circuit.

The question on appeal was “whether certain payments by a §363 purchaser (here an entity formed by the secured lenders of the debtors) in connection with acquiring the debtor’s assets should be distributed according to the code’s creditor-payment hierarchy.”⁶ The 3rd Circuit held that because “neither of the two payments went into or came out of the bankruptcy estate… the cash was not subject to the code’s distribution priority.”⁷

Section 363 permits a debtor to sell its assets outside a plan of reorganization, and, as the 3rd Circuit observed, this type of sale has become a “tool of choice to put a quick close to a bankruptcy case” because “[i]t avoids time, expense and, some would say, the Bankruptcy Code’s unbending rules.”⁸ The perception that a 363 sale is a tool to circumvent the code’s unbending priority rules may very well be one of the “backdoor means to achiev[ing] the exact kind of nonconsensual priority-violating final distributions that the code prohibits in Chapter 7 liquidations and Chapter 11 plans” that the Supreme Court criticized in the Jevic settlement.

Jevic sends a strong signal to Bankruptcy Courts and parties that the Supreme Court is unimpressed with such efforts to circumvent the code’s priority rules. Going forward, plan proponents should expect Jevic’s priority protection ruling to feature prominently in objections to gifting plans and other non-plan structures that seek to provide distributions appearing to conflict with the absolute priority rule.

Footnotes

1. In re Jevic Holding Corp., 2014 WL 268613, *3 (D. Del., Jan. 24, 2014).
2. In re DBSD North America, Inc., 634 F.3d 79 (2d Cir. 2011).
3. In re SPM Manufacturing Corp., 984 F.2d 1305 (1st Cir. 1993), rehearing en banc denied, Feb. 24, 1993).
4. Id. at 1313.
5. In re ICL Holding Co., Inc., 802 F.3d 547 (3d Cir. 2015),
6. Id. at 549
7. Id.
8. Id.