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When a Priority is Not a Priority

By: Lindsay Lersner

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

            The culmination of a chapter 11 case is typically a plan that provides for payment to creditors in accordance with the priority scheme in Section 507 of the United States Bankruptcy Code (“Code”).[1]  In In re Jevic Holding Corp., the Third Circuit held that in certain rare circumstances, bankruptcy courts have the discretion to approve structured dismissals, which do not comply with Section 507 of the Code.[2]  A structured dismissal is a settlement proposed to the court that provides for the distribution of the debtor’s assets to creditors.[3]  In In re Jevic, the debtor proposed a structured dismissal after reaching a consensus with a majority of its creditors.[4]  The Jevic truck drivers (“Drivers”), former employees of Jevic with a Worker Adjustment and Retraining Notification (“WARN”) claim,[5] however, did not agree to the settlement.[6]  In opposing bankruptcy court approval of the settlement and the structured dismissal, the Drivers argued that (1) the Code does not allow for structured dismissals and (2) the settlement paid the creditors with claims junior to the Drivers’ WARN claims and therefore violated the priority scheme established under Section 507.[7]  Bankruptcy settlements generally follow the absolute priority rule, which requires that creditors be paid in the order of their priority under Section 507.[8]  The bankruptcy court overruled the Drivers’ objection and approved the settlement providing for the dismissal of the debtor’s chapter 11 case upon payment of certain administrative and tax expenses which were lower in priority than the Drivers’ claims.[9]  On appeal, the district court affirmed the bankruptcy court’s decision.[10]  The Drivers appealed again, and the Court of Appeals for the Third Circuit also affirmed.[11]

            As an initial matter, the court of appeals in In re Jevic rejected the notion that the Code does not allow for structured dismissals.  According to the Third Circuit, structured dismissals were indeed permissible under the Code. [12]  But even more ground-breaking, In re Jevic represented the first circuit case in which the court upheld a structured dismissal that did not comply with the priority scheme of Section 507.[13]  In In re AWECO, the Fifth Circuit held that Section 507 must be followed in all cases.[14]  The Second Circuit has concluded that under certain circumstances a court may approve a settlement that deviates from Section 507. [15]  In In re Iridium, however, the Second Circuit decided there was no factual basis to justify the deviation because the record provided no reason for the violation of the priority rule.[16]  While the In re Jevic Court agreed with the In re Iridium Court that exceptions to Section 507 will be rare,[17] and Section 507 will usually be dispositive as to whether or not a structured dismissal is fair and equitable, there are circumstances, such as here in which a bankruptcy court has the discretion to approve a settlement not following Section 507.[18]  Under both In re Jevic and In re Iridium, a bankruptcy court has the discretion to deviate from the priority scheme when it has “specific and credible grounds to justify [the] deviation.”[19]

            The absolute priority rule was drafted and generally has only been applied in the specific context of plan conformation.[20]  The priority rule was codified by Congress to set the order of how different types of creditor claims are paid during plan conformation or restructuring, not settlements.[21]  There are still similarities in the requirements for settlements and the requirements for confirmations, in that both must be fair and equitable.[22]  However, in the settlement context, the courts have interpreted fair and equitable to mean “that bankruptcy courts cannot approve settlements and structured dismissals devised by certain creditors in order to increase their shares of the estate at the expense of other creditors.”[23]  In contrast, for plan confirmations, fair and equitable means that “the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property.”[24]  In terms of confirmations, it is firmly established that the absolute priority rule must be followed.[25]  However, for settlements, there is no such established requirement that the absolute priority rule must be followed to achieve a fair and equitable settlement.[26]

            The purpose of Section 507 is to ensure “the even handed and predictable treatment of creditors.”[27]  The same underlying policy applies to settlements and courts will typically consider whether the priority scheme under Section 507 is being followed in determining whether or not the settlement is fair and equitable.[28]  However, because the statutes and precedents do not require strict conformance with the priority scheme, if a bankruptcy court has “specific and credible grounds to justify … deviation” they may approve nonconforming settlements.[29]  While In re Jevic closely followed the analysis of In re Iridium, In re Jevic offered the first example of “specific and credible grounds”[30] sufficient to justify the deviation,[31] which were grounded in the multifactor test of In re Martin for evaluating settlements.[32]  Through its analysis of the In re Martin multifactor test, the bankruptcy court determined that the factors mandated the approval of the settlement.[33]  The bankruptcy court decided that traditional routes out of chapter 11 were not available, and the settlement in question best served the creditors and the estate.[34]  Interestingly, the Drivers agreed with this contention arguing that even if the creditors and estate were best served; it was irrelevant because the Code did not permit the settlement’s approval.[35]  However, the court found that if the way to best serve the creditors and the estate is a settlement not in conformance with Section 507, then that settlement may be approved.[36]

            In re Jevic provided further support for the notion that structured dismissals are permissible.[37]   While the In re Jevic Court allowed a deviation from Section 507, it also warned these were rare circumstances in which a court would approve a settlement plan not conforming with Section 507.[38]  However, the bar for rarity articulated by the court does not seem as high as the court implies.[39]  The In re Jevic Court allowed a deviation because it was best for the estate and the creditors;[40] in essence, because the In re Martin multifactor test favors settlement, the deviation was permissible.[41]  There is still disagreement among the circuits with some enforcing a per se rule that Section 507 applies to settlements.[42]  Until more decisions involving structured dismissals not in conformance with Section 507 are handed down, there is no definite answer as to whether or not structured dismissals must comply with Section 507.

 

 

 



[1] Official Comm. of Unsecured Creditors ex rel. the bankr. estate of Jevic Holding Corp. v. CIT Group/Business Credit Inc (In re Jevic Holding Corp.), 787 F.3d 173, 186 (3d Cir. 2015).

[2] Id.

[3] See generally id. at 176—77.

[4] Id.

[5]  See Id. at 176 for explanation that under the federal and state WARN statutes, Jevic was required to provide their employee drivers with 60 days written notice before laying them off, which Jevic failed to do.

[6] Id. at 176–77 (“representatives of all the major players-the Committee, CIT, Sun, the Drivers, and what was left of Jevic- convened”).

[7] In re Jevic, 787 F.3d at 176—77.

[8] 11 U.S.C. §1129(b)(2)(B)(ii) (2012).

[9] In re Jevic, 787 F.3d at 177.

[10] Id. at 179.

[11] Id. at 179—86.

[12] Id. at 180 —82.

[13] See generally id. at 179; see also Motorola, Inc. v. Official Comm. of Unsecured Creditors (In re Iridium Operating, LLC), 478 F.3d 452, 446 (2d Cir. 2007); contra United States v. AWECO, Inc. (In re AWECO), 725 F.2d 293, 298 (5th. Cir. 1984) (“Our understanding of bankruptcy law’s underlying policies leads us to make a limited extension of the fair and equitable standard: a bankruptcy court abuses its discretion in approving a settlement with a junior creditor unless the court concludes that priority payment will be respected as to objecting senior creditors.”).

[14] See 725 F.2d at 298.

[15] In re Iridium, 478 F.3d at 464—65 (holding that while it may be permissible to decline to follow Section 507 in rare circumstances, the priorities will usually be dispositive of whether the proposed settlement is fair and equitable).

[16] Id. at 466.

[17] 787 F.3d at 179 (“Although this result is likely to be justified only rarely…”); also see generally In re Iridium, 478 F.3d at 464—65.

[18] In re Jevic, 787 F.3d at 184 (quoting In re Iridium, 478 F.3d at 466)).

[19] Id. at 184.

[20] Id. at 183.

[21] Id. (citing 11 U.S.C. §1129(b)(2)(B)(ii) (2012)).

[22] Id. at 182.

[23] In re Jevic, 787 F.3d at 184.

[24] 11 U.S.C. §1129(b)(2)(B)(ii) (2012).

[25] See 11 U.S.C. §1129(b)(2)(B)(ii) (2012); see also Protective Comm. for Independent Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390 U.S. 414, 441 (1968).

[26] In re Jevic, 787 F.3d at 183.

[27] Id. at 184.

[28] Id. (citing In re Iridium, 478 F.3d at 455).

[29] Id. at 184 (quoting In re Iridium, 478 F.3d at 466).

[30] In re Iridium, 478 F.3d at 466.

[31] In re Jevic, 787 F.3d at 184–85 (“we concluded that the Bankruptcy Court had sufficient reason to approve the settlement and structured dismissal of Jevic’s Chapter 11 case.”).

[32] Id. at 180 (“we gleaned from TMT Trailer Ferry four factors to guide bankruptcy courts in this regard: ‘(1) the probability of success in litigation; (2) the likely difficulties in collection; (3) the complexity of the litigation involved and the expense, inconvenience and delay necessarily attending it; and (4) the paramount interest of the creditors.’”).

[33] See generally id. at 179.

[34] Id. at 186.

[35] See id. at 180. 

[36]  In re Jevic, 787 F.3d at 186.

[37] Id. at 182 (“For present purposes, it suffices to say that absent a showing that a structured dismissal has been contrived to evade the procedural protections and safeguards of the plan conformation or conversion process, a bankruptcy court has discretion to order such a disposition.”).

[38] Id. at 186.

[39] Id.

[40] Id.

[41] See In re Jevic, 787 F.3d at 186.

[42] See In re AWECO, 725 F.2d at 298.