Third Circuit Approves Structured Dismissal of Chapter 11 Despite Noncompliance with Absolute Priority Rule

In re Jevic Holding Corp., 2015 WL 2403443, __ F.3d __ (3d Cir. May 21, 2015)

Section 507’s Absolute Priority Rule always applies – or does it? After last month’s precedential opinion issued by the Third Circuit Court of Appeals, apparently that isn’t always the case. In a matter of first impression within the Third Circuit, the Court determined that the Absolute Priority Rule is not necessarily implicated outside the context of plan confirmations. At the same time, the court became the first circuit court to determine that bankruptcy courts have the discretion to approve structured dismissals in connection with a Rule 9019 settlement, so long as the ultimate result does not evade the safeguards of the plan confirmation or conversion process.

Background

Jevic, a former New Jersey trucking company, was acquired in a 2006 LBO by Sun Capital Partners (“Sun Cap”) and financed by a group of lenders headed by CIT Group. In May 2008, Jevic ceased operations, notified its employees of their imminent termination, and filed a voluntary Chapter 11 petition in the Bankruptcy Court for the District of Delaware.

In the meantime, a group of former Jevic employees (the “WARN claimants”) initiated a class action lawsuit against Jevic and Sun Cap, alleging violations of the federal Worker Adjustment and Retraining Notification (“WARN”) Act and its New Jersey analogue. At the same time, the Official Committee of Unsecured Creditors brought a fraudulent conveyance action against Sun Cap and CIT in connection with the LBO.

The key players soon reached a settlement that provided for a release of claims between and among the Committee, Jevic, CIT, and Sun Cap in exchange for dismissal of the fraudulent conveyance action; for CIT to pay $2 million into an account to pay legal fees and other administrative expenses; for Sun Cap to assign its lien on the bankruptcy estate’s cash to a trust to pay tax, administrative, and general unsecured creditors; and for dismissal of the Chapter 11 case. The WARN claimants, however, were left out of the settlement, as Sun Cap refused to pay them as long as they maintained their WARN action. The WARN claimants and the U.S. Trustee objected to the settlement, arguing that it called for distribution of property of the estate to lower priority creditors under section 507’s distribution scheme; that the Bankruptcy Code does not permit structured dismissals; and that the Committee breached its fiduciary duties to the estate by leaving the WARN claimants out of the settlement.

In an oral opinion, Chief Judge Brendan L. Shannon approved the settlement and dismissal, concluding that the “dire circumstances” of the case– specifically, the lack of any realistic prospect of a distribution to any unsecured creditors if the settlement was not approved –mandated approval. Moreover, the Bankruptcy Court determined that there was no chance of approval of a Chapter 11 plan, and that conversion to Chapter 7 was impracticable both in terms of cost and the settling parties’ willingness to participate in a settlement in that context. The Bankruptcy Court also concluded that no fiduciary duties had been violated, that the settlements under Rule 9019 need not comply with the Absolute Priority Rule, and that the settlement was fair and equitable under the factors established by In re Martin, 91 F.3d 389 (3d Cir. 1996).

The WARN claimants appealed to the District Court, which rejected their contentions, holding that the Bankruptcy Court had correctly applied the Martin factors and had correctly ruled regarding the fiduciary duties and absolute priority rule issues. The District Court noted that even had the Bankruptcy Court erred, however, the WARN claimants’ appeal was equitably moot because the settlement had been “substantially consummated.” See Jevic Holding Corp., 2014 WL 2688613, at *2 (D.Del. Jan. 24, 2014). The WARN claimants appealed to the Third Circuit, with the U.S. Trustee joining in the appeal as amicus curiae.

Analysis

In a 2-1 panel split, the Third Circuit upheld the District Court’s order and the panel rejected the WARN claimants’ contention that structured dismissals are never permissible and must always comply with Section 507’s priority scheme. See In re Jevic Holding Corp., 2015 WL 2403443 (3d Cir. May 21, 2015).

Noting that the Code does not explicitly permit structured dismissals and that the only statutory ways out of a Chapter 11 case are plan confirmation, conversion to Chapter 7, or reversion to the status quo ante via dismissal “with no strings attached,” the panel stated that “structured dismissals are simply dismissals that are preceded by other orders . . . that remain in effect after dismissal.” Further, the Code, per Section 349, explicitly authorizes Bankruptcy Courts “to alter the effect of dismissal ‘for cause,’” such that “a hard reset” as contemplated by the WARN claimants was unnecessary. At bottom, bankruptcy courts have discretion to approve structured dismissals unless they are effectively sub rosa plans – that is, they are “contrived to evade the procedural protections and safeguards of the plan confirmation or conversion process.”

The Court next discussed whether settlements approved in the context of structured dismissals may ever disregard the Absolute Priority Rule by skipping a class of objecting creditors in favor of less senior creditors. Agreeing with the Second Circuit’s opinion in In re Iridium Operating LLC, 478 F.3d 452 (2d Cir. 2007), the panel noted that in determining whether a proposed settlement is “fair and equitable,” compliance with the Absolute Priority Rule will “usually be dispositive” because the policy behind the rule, “evenhanded and predictable treatment of creditors,” applies with equal force to both settlements and plans. The panel gave bankruptcy courts some leeway, however, to exercise their discretion depending on the facts of each case, by holding that they may approve settlements that do not follow the Absolute Priority Rule “’only if they have specific and credible grounds to justify [the] deviation.’”

The panel went on to conclude that the Bankruptcy Court had “sufficient reason” to approve the settlement and dismissal in this case because it was the “least bad alternative” – that is, there was no prospect of a confirmable plan and conversion would have resulted in the secured creditors taking what was left in the Estate. Outside of the settlement, there was no chance of the unsecured creditors receiving a meaningful distribution. Faced with the Hobson’s choice of accepting a settlement that strayed from the Code’s priority scheme or allowing the WARN claimants’ lawsuit to deplete the Estate, the Bankruptcy Court made a judgment call within its discretion in approving the settlement and dismissal.

Key Takeaways

This decision is significant for a number of reasons, especially considering the relative dearth of case law from courts of all levels across the nation addressing the issues discussed. The Third Circuit is the first circuit court to explicitly acknowledge that structured dismissals are permitted in some cases. Of particular note is the panel’s refusal to adopt a hard and fast rule that such structured dismissals are disallowed per se.

In the rare case where the traditional routes out of a Chapter 11 are closed off and a settlement will best serve the interests of the estate and its creditors as a whole, structured dismissals that deviate from the Absolute Priority Rule are justifiable. The Third Circuit’s decision grants further discretion to bankruptcy courts to approve alternatives to plan confirmation, conversion, or plain dismissal when the unique circumstances of a case justify such a decision.

Jason D. Angelo is an Associate in McElroy, Deutsch, Mulvaney & Carpenter, LLP’s Bankruptcy Practice Group and is admitted to practice in Delaware and New Jersey.