Supreme Court Ends Structured Dismissals in Bankruptcy Cases

Bankruptcy courts do not have the legal power to ignore the claims priority scheme in distributing settlement proceeds in connection with a Ch. 11 dismissal, the Supreme Court held Wednesday.

The 6-2 ruling in the case of Casimir Czyzewski, et al. v. Jevic Holding Corp., et al., found that the Third Circuit and the United States Bankruptcy Court for the District of Delaware incorrectly affirmed a structured settlement that skipped the claims of dissenting midpriority unsecured creditors, who were truck drivers of the trucking company Jevic.

“A distribution scheme ordered 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 primary mechanisms the Code establishes for final distributions of estate value in business bankruptcies,” the Court’s opinion, delivered by Justice Stephen Breyer, stated. “Put somewhat more directly, 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,” the Court said.

In essence, the days of nonconsensual structured dismissals that violate claims priority rules of paying unsecured claims before higher priority claims are over, said Bruce Nathan, Esq., of Lowenstein, Sandler LLP of New York. This ruling will therefore likely change how failed Chapter 11 cases are concluded. Nathan and Wanda Borges, Esq., of Borges & Associates LLC of Syosset, NY, will discuss the consequences of the case during their educational session in June at the 121st annual Credit Congress & Expo in Dallas.

The Court did point out that provisions in the Bankruptcy Code allow courts the flexibility to “make the appropriate orders to protect rights acquired in reliance on the bankruptcy case.” Cases such as In re Iridium Operating, LLC in the Third Circuit, and others, have addressed the interim distribution of settlement proceeds that violate ordinary priority rules, the Court noted. “But in such instances one can generally find significant Code-related objectives that the priority-violating distributions serve.” First-day wage orders that allow payment of employees’ prepetition wages and critical vendor orders that allow payment of essential suppliers’ prepetition invoices, for instance, are other examples of situations “where the distributions at issue would ‘enable a successful reorganization and make even the disfavored creditors better off.’” But that was not the case in Jevic, the court said.

Further, allowing for “rare case” exceptions to the more general rule of the Code’s priority scheme would lead to unacceptable uncertainty, and the Court said that Congress did not intend such an exception.