In Jevic Holding Corp. v. CIT Group/Business Credit Inc. (In re Jevic Holding Corp.), the US Court of Appeals for the Third Circuit held, as a matter of first impression, that under certain circumstances, a Chapter 11 case may be resolved in a "structured dismissal" that deviates from the priority scheme of section 507 of the Bankruptcy Code.
Jevic Transportation, Inc. (Debtor) was a New Jersey-based trucking company whose equity was purchased by a private equity firm, Sun Capital Partners (Sun), in a leveraged buyout (LBO) in 2006, financed by a group of lenders led by CIT Group/Business Credit Inc. (CIT). However, the Debtor was unsuccessful under new ownership and, in May 2008, its board of directors authorized a bankruptcy filing. The company ceased substantially all its operations, and its employees received notice of their impending terminations on May 19, 2008.
The next day, the Debtor filed a voluntary Chapter 11 petition in the US Bankruptcy Court for the District of Delaware. At the time of the filing, the Debtor owed about $53 million to Sun and CIT, both first-priority senior secured creditors, and over $20 million to its tax and general unsecured creditors, whose interests were represented by the Official Committee of Unsecured Creditors (Committee).
During the bankruptcy proceedings:
A group of the Debtor's terminated truck drivers (Drivers) filed a class action lawsuit against the Debtor and Sun, alleging violations of federal and state Worker Adjustment and Retraining Notification Acts (WARN Acts), under which the Debtor was required to provide 60 days' written notice to its employees before laying them off. These claims were ultimately upheld against Jevic, but dismissed against Sun. The Drivers estimated their claim to be worth about $12.4 million, of which $8.3 million was a priority wage claim under section 507(a)(4) of the Bankruptcy Code entitled to a higher priority than the tax and general unsecured claims.
The Committee filed actions for fraudulent transfer and preferential transfer against CIT and Sun, alleging that Sun, with the assistance of CIT, acquired the Debtor "with virtually none of its own money based on baseless projections of almost immediate growth and increasing profitability." According to the Committee, the LBO hastened the Debtor's bankruptcy. Nearly three years later, the bankruptcy court granted in part and denied in part CIT's motion to dismiss these claims.
In March 2012, representatives of the Committee, CIT, Sun, the Drivers, and the Debtor met to negotiate a settlement of the Committee's claims. By that time, the Debtor's only remaining assets were $1.7 million in cash (which was subject to Sun's lien) and the Committee's action against CIT and Sun.
The Committee, the Debtor, CIT and Sun (but not the Drivers) reached a settlement agreement that contemplated a structured dismissal, under which:
The settling parties would exchange mutual releases of claims and the fraudulent transfer action would be dismissed with prejudice.
CIT would pay $2 million into an account earmarked to pay the Debtor's and the Committee's legal fees and other administrative expenses.
Sun would assign its lien on the Debtor's remaining $1.7 million to a trust, which would pay tax and administrative creditors first and then the general unsecured creditors on a pro rata basis.
The Debtor's Chapter 11 case would be dismissed.
The Drivers and the US Trustee objected to the proposed settlement and structured dismissal, arguing that:
The Bankruptcy Code does not permit structured dismissals.
The Committee breached its fiduciary duty to the estate by "agreeing to a settlement that, effectively, freezes out the [Drivers]."
The bankruptcy court overruled these objections, approved the settlement and dismissed the case. The US District Court for the District of Delaware affirmed the judgment of the bankruptcy court. The Drivers appealed to the Third Circuit, with the US Trustee supporting them as amicus curiae.
The Third Circuit affirmed the rulings of the bankruptcy court and the district court, holding that:
Absent a showing that a structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation or conversion processes, a bankruptcy court has discretion to order a structured dismissal.
Bankruptcy courts may approve settlements that deviate from the priority scheme of section 507 of the Bankruptcy Code only if they have "specific and credible grounds to justify [the] deviation."
Permissibility of Structured Dismissals
The Third Circuit first held that, in "rare" circumstances, structured dismissals that deviate from the Bankruptcy Code's priority scheme are permissible. The Third Circuit rejected the Drivers' arguments that:
The "only three exits" Chapter 11 provides are plan confirmation, conversion to Chapter 7 and plain dismissal, which under section 349(b) of the Bankruptcy Code, vacates orders and judgments of the bankruptcy court and reinstates the parties to their prepetition state of affairs.
Structured dismissals could potentially render "plan confirmation superfluous" and pave the way for "illegitimate sub rosa plans."
Rather, the Third Circuit concluded that, "absent a showing that a structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation or conversion processes, a bankruptcy court has discretion to order such a disposition." However, the Third Circuit noted that the Drivers did not challenge the bankruptcy court's findings that there was no prospect of a confirmable plan in this case and that conversion to Chapter 7 would not have been effective.
Acknowledging that the Bankruptcy Code does not expressly authorize structured dismissals, the Third Circuit noted that the Bankruptcy Code explicitly allows bankruptcy courts to alter the effect of dismissal "for cause" and does not "strictly require dismissal of a Chapter 11 case to be a hard reset." The Third Circuit's fact-sensitive approach suggests that different facts, such as the prospect of a confirmable plan or an effective conversion to Chapter 7, might require a different result in a future case.
Priority and Class Skipping in Structured Dismissals
The Third Circuit then considered whether settlements in the context of structured dismissals may ever skip a class of objecting creditors in favor of more junior creditors. The Drivers argued that, even if structured dismissals are permissible, they cannot be approved if they distribute estate assets in a manner that violates the priority scheme of section 507 of the Bankruptcy Code which, according to the Drivers, applies to all distributions of estate property under Chapter 11.
The Third Circuit noted the split between the US Courts of Appeal for the Fifth and Second Circuits as to whether the priority scheme of section 507 must be followed when settlement proceeds are distributed in Chapter 11 cases. The Fifth Circuit, in Matter of AWECO, Inc., held that the "fair and equitable" standard that applies to plan confirmations also applies to settlements, and that "fair and equitable" means compliant with the priority system (see 725 F.2d 293 (5th Cir. 1984)).
However, the Second Circuit rejected the Fifth Circuit's reasoning and adopted a more flexible approach in In re Iridium Operating LLC (see 478 F.3d 452 (2d Cir. 2007)). The Second Circuit held that the absolute priority rule "is not necessarily implicated" when a "settlement is presented for court approval apart from a reorganization plan[.]" The Second Circuit held that whether a settlement's distribution scheme complies with the Bankruptcy Code's priority scheme must be the most important factor in a bankruptcy court's determination of whether a settlement is "fair and equitable." However, a noncompliant settlement could be approved when "the remaining factors weigh heavily in favor of approving a settlement[.]"
The Third Circuit adopted the reasoning of the Second Circuit, holding that bankruptcy courts may approve settlements that deviate from the priority scheme of section 507 only if they have "specific and credible grounds to justify [the] deviation" because settlements that skip objecting creditors in distributing estate assets raise "justifiable concerns about collusion." Noting that it was a "close call," the Third Circuit held that the bankruptcy court had sufficient reason to approve the settlement and structured dismissal of the Debtor's Chapter 11 case. The Third Circuit reasoned that this was the "least bad alternative since there was 'no prospect' of a plan being confirmed and conversion to Chapter 7 would have resulted in the secured creditors taking all that remained of the estate in 'short order.'"
This is the first circuit court decision to approve the use of a structured dismissal to resolve a Chapter 11 case and will likely increase their prevalence, at least in the Third Circuit. Despite the fact that the Third Circuit cautioned that structured dismissals that deviate from the Bankruptcy Code's priority scheme are justified only in rare circumstances, this decision provides support for parties in future cases to craft settlements implemented under structured dismissals that may allow more flexibility to resolve a case than a Chapter 11 plan process or conversion to Chapter 7.