March 23, 2017
Authored by: Mark Duedall and Leah Fiorenza McNeill
We at the Bankruptcy Cave are not very surprised by the ruling yesterday in Czyzewski v. Jevic Holding Corp. The Supreme Court in Jevic reviewed a Bankruptcy Court’s decision to approve a settlement (with a distribution of proceeds that contravened the Bankruptcy Code’s priority scheme) in conjunction with dismissing the bankruptcy case of the Chapter 11 debtor Jevic Holding Corp. According to the Bankruptcy Court, because the distributions would occur pursuant to a “structured dismissal” rather than a confirmed plan, the failure to follow the creditor priority scheme did not bar approval. In short, the Bankruptcy Court did not confirm a plan of reorganization for the Chapter 11 debtor, in which sufficient creditor support can re-order some of the Bankruptcy Code’s priority scheme. Nor did the Bankruptcy Court convert Jevic’s Chapter 11 case to Chapter 7, in which the Code’s creditor priority scheme can never be changed. Instead, the Bankruptcy Court allowed a “structured dismissal,” a hybrid unrecognized by the Code (but oh so popular among the Delaware set). In a “structured dismissal,” a case is dismissed and, through opaque deal making, cash proceeds of the estate are shifted to some creditors that Congress afforded lower priority (like general unsecured claims in Jevic’s bankruptcy case) despite nothing being paid to higher priority creditors (like unpaid wage claims of truck drivers in Jevic’s bankruptcy case).
Nothing in the Bankruptcy Code allows such re-ordering of creditor priorities as part of a dismissal. Thus, in Jevic, the Supreme Court rejected the proposed “structured dismissal” and sent the case back to the Bankruptcy Court to distribute the money as the Code requires. In summary, Orwell’s adage that “all animals are equal, but some animals are more equal than others” George Orwell, Animal Farm 112 (Signet 1962 edition) (1946) has no place in the Bankruptcy Code, according to the Supreme Court in Jevic.
But a truly astounding part of the Supreme Court’s opinion in Jevic provided (in dicta, we grudgingly admit) strong support for the oft-criticized “critical vendor” theory used in many large Chapter 11 cases to immediately pay seemingly important (i.e., “more equal”) unsecured creditors while other creditors sit and wait.
Specifically, the Supreme Court’s opinion in Jevic went to great lengths to mention the many valid circumstances in which a bankruptcy court “has approved interim distributions that violate ordinary priority rules.” The Court specifically noted “‘first-day’ wage orders that allow payment of employees’ prepetition wages, ‘critical vendor’ orders that allow payment of essential suppliers’ prepetition invoices, and ‘roll-ups’ that allow lenders who continue financing the debtor to be paid first on their prepetition claims.”
The Court noted that such orders are based on findings that these priority-skipping payments “would ‘enable a successful reorganization and make even the disfavored creditors better off.’” (Jevic, citing, inter alia, In re Kmart Corp., 359 F.3d 866, 872 (7th Cir. 2004)). Thus, such payments would (or could? or always? — it is hard to say how strong this dicta is) be allowed due to a “significant offsetting bankruptcy-related justification.”
This was a shocker. Not because we think it is wrong – the Supreme Court is dead right that the exigencies of the initial days in Chapter 11 can permit certain limited payments to pre-petition, unsecured creditors – but because the Court did not have to delve into these theories to decide Jevic. The Supreme Court could simply have stated that nothing in the Code’s “dismissal” provisions allow for priority skipping, and that would be that. But instead, the Court’s expansive reasoning buttresses “critical vendor theory” and similar theories that allow for some creditors to be paid immediately upon a Chapter 11 – if there is a “significant offsetting bankruptcy-related justification.”
In conclusion, Jevic did not surprise us with its ruling, but surprised (and impressed) us with how far it went to provide added support for critical vendor theory. Jevic is, as one may say, a critical case for those in the bankruptcy world.