Third Circuit Holds Structured Dismissal Deviating from Bankruptcy Code Priority Scheme May Be Utilized in Appropriate Circumstances

On May 21, 2015, the United States Court of Appeals for the Third Circuit answered the long-asked question of whether structured dismissals are permissible under the Bankruptcy Code with a resounding yes. In so ruling, the Third Circuit stated: “[W]e believe the Code permits a structured dismissal, even one that deviates from the § 507 priorities, when a bankruptcy judge makes sound findings of fact that the traditional routes out of Chapter 11 are unavailable and the settlement is the best feasible way of serving the interests of the estate and its creditors.” The opinion provides much awaited guidance on the availability of structured dismissals as a mechanism to conclude a case.

The appeal stemmed from a bench ruling by the Honorable Brendan Linehan Shannon of the United States Bankruptcy Court for the District of Delaware approving a settlement and structured dismissal in the chapter 11 proceedings of In re Jevic Holding Corp., Case No. 08-11006, and a subsequent affirmation by the United States District Court for the District of Delaware.

The appeal related to two adversary proceedings filed during the case and a resulting settlement in one such proceeding. In the first adversary proceeding, the creditors’ committee (on Jevic’s behalf) filed a fraudulent conveyance action against CIT Group and Sun Capital Partners. In the second adversary proceeding, certain of Jevic’s former employees filed an action against Jevic and Sun alleging violations of federal and state Worker Adjustment and Retraining Notification (WARN) Acts. The WARN claimants asserted a claim of not less than $12.4 million, of which $8.3 million was asserted as a priority wage claim.

Ultimately, Jevic, the committee, Sun and CIT reached an agreement to resolve the fraudulent conveyance action and the chapter 11 cases. The settlement provided for, among other things, mutual releases and dismissal of the fraudulent conveyance action, Sun assigning certain liens to a trust for distribution to tax and administrative claimants first and then general unsecured creditors, and dismissal of Jevic’s chapter 11 cases. Following failed settlement negotiations, the WARN claimants were left out of the settlement.

The WARN claimants and the U.S. Trustee objected to the settlement and structured dismissal, arguing that skipping the WARN claimants’ priority claim in the settlement violated the Bankruptcy Code’s priority scheme. The U.S. Trustee further argued, as it has in other cases, that the Bankruptcy Code does not permit structured dismissals as a mechanism to conclude a case.

In its bench ruling approving the settlement, the Bankruptcy Court noted that although no provision of the Bankruptcy Code specifically contemplated structured dismissals, the relief was warranted due to dire circumstances including a lack of realistic prospect of a chapter 11 plan and the impracticability of a chapter 7 case due to a lack of funding. The WARN claimants appealed the Bankruptcy Court’s approval of the settlement and dismissal; however, while the appeal was pending, the settlement was consummated. The District Court affirmed.

On appeal, the parties focused on the authority of the Bankruptcy Court to approve a structured dismissal and the ability to “skip” certain higher priority creditors in a settlement. In holding that the Jevic structured dismissal was appropriate, the Third Circuit stated that, “structured dismissals are simply dismissals that are preceded by other orders of the bankruptcy court (e.g., orders approving settlements, granting releases and so forth) that remain in effect after dismissal. The Third Circuit further recognized that a bankruptcy court may, for cause, alter the otherwise hard reset effect of a dismissal. The Third Circuit did, however, limit its ruling to appropriate circumstances where a structured dismissal was necessitated by the facts and where a chapter 11 plan or worthwhile chapter 7 conversion was not possible.

On the issue of class skipping, the Third Circuit agreed with the Second Circuit’s view in In re Iridium Operating LLC, 478 F.3d 452 (2d Cir. 2007), that although the Bankruptcy Code’s priority scheme does not extend to settlements, the policy concern of evenhanded and predictable treatment of creditors is implicated by settlements that skip distributions to objecting creditors. Therefore, the Third Circuit held that a bankruptcy court should only approve a settlement that deviates from the Bankruptcy Code’s priority scheme if there are “specific and credible grounds to justify [the] deviation.”¹

The opinion clarifies the law regarding structured dismissals in the Third Circuit and provides important guidance to both practitioners and courts in the Third Circuit regarding when structured dismissals may be utilized.

———

¹ Judge Scirica concurred in part and dissented in part. Although agreeing with the majority on the general proposition that settlements presented outside of a plan of reorganization may deviate from the Bankruptcy Code’s priority scheme only in “extraordinary circumstances,” Judge Scirica disagreed with the factual determination that this case properly fit into the narrow exception whereby departure is warranted. Indeed, Judge Scirica expressed the opinion that a viable alternative compliant with Code priorities existed and therefore, the governing determination—“whether the settlement’s deviation from the priority scheme was necessary to maximize the value of the estate” rather than select creditors—was not satisfied.

Copyright © Morris, Nichols, Arsht & Tunnell LLP. These materials have been prepared solely for informational and educational purposes, do not create an attorney-client relationship with the author(s) or Morris, Nichols, Arsht & Tunnell LLP, and should not be used as a substitute for legal counseling in specific situations. These materials reflect only the personal views of the author(s) and are not necessarily the views of Morris, Nichols, Arsht & Tunnell LLP or its clients.