The U.S. Supreme Court will hear the case of Czyzewski v. Jevic Holding Corp. during the new term that began last week.  The questions it presents are relatively simple.  First, can a bankruptcy court, in dismissing a case under the U.S. Bankruptcy Code, permit parties to “structure” the dismissal to include substantive provisions regarding the distribution of assets of a debtor’s bankruptcy estate, instead of simply dismissing the case and leaving parties to their remedies under applicable non-bankruptcy law?  If yes, then can such provisions effect a distribution of those assets in a manner that contravenes the Bankruptcy Code’s priority scheme?  Most observers anticipate that the Court will focus on solely on the second question, and issue a fairly narrow ruling.  A ruling on the first question, however, would be far broader and could have as significant an impact on Chapter 11 bankruptcy practice as any case that the Court has decided in decades.

The facts of Czyzewski are straight-forward.  Jevic was a New Jersey trucking company; it filed for bankruptcy under Chapter 11 of the Bankruptcy Code following a failed leveraged buyout.  Jevic never attempted to reorganize; it ceased operations immediately prior to its bankruptcy filing and terminated nearly all of its driver employees.  Its secured lender, CIT Group, held a lien on virtually all of its assets, which were worth far less than the amount owed on the loan.  The drivers filed WARN Act claims for unpaid wages against Jevic and Sun Capital, its private equity sponsor.  Sun also held a portion of the secured debt.  An official committee of unsecured creditors was appointed, which commenced fraudulent conveyance and equitable subordination litigation against CIT and Sun.

Three years later, the case was in a place that has become all too familiar to Chapter 11 practitioners. All of the assets had been sold off and the proceeds distributed to the secured lenders.  Nothing remained of the Jevic bankruptcy estate except $1.7 million in cash (which was subject to the secured lenders’ lien) and the litigation claims against CIT and Sun.  The case was effectively at an impasse.  A plan could not be confirmed, because there were insufficient funds to pay all of the expenses of administration of the Chapter 11 case, such as the fees of professionals for Jevic and the creditors’ committee.  The only other means specified by the Bankruptcy Code of resolving a Chapter 11 case are either a conversion to a liquidation under Chapter 7, or a dismissal of the case under Section 349 of the Bankruptcy Code.  Under either of those approaches, however, professional fees would not have been paid, and no recovery would have been received by any creditors other than CIT or Sun.

Another path was taken. The case was dismissed, but the dismissal was structured in such a way so as to incorporate a settlement among Jevic, CIT, Sun, and the creditors’ committee.  Such “structured dismissals” have become increasingly common over the past several years.  As a proliferation of secured financing has resulted in more cases lacking sufficient unencumbered assets to finance an exit from Chapter 11 through plans of reorganization or liquidation, structured dismissals have been utilized by creative practitioners to wind down what would otherwise be irresolvable morasses.  Under the Jevic structured dismissal, CIT and Sun agreed, in exchange for a release of the litigation, to allow the $1.7 million in cash plus another $2 million they contributed to be used to pay administrative expenses and to provide a small distribution for general unsecured creditors.

The drivers, however, were not part of the settlement, because they refused to release their WARN Act litigation against Sun. They therefore received nothing, even though their claims for unpaid wages against the Jevic bankruptcy estate were entitled to priority treatment ahead of general unsecured claims.  The bankruptcy court nevertheless approved the settlement and the structured dismissal, finding that there otherwise was “no realistic prospect” of a recovery to any parties but CIT and Sun.  The U.S. Court of Appeals for the Third Circuit affirmed.

The Supreme Court granted certiorari on the question of whether a structured dismissal in a chapter 11 case can incorporate a settlement that diverges from the Bankruptcy Code’s priority scheme. It is possible, however, that the Court may first look at the broader issue of whether a dismissal that is “structured” is even a permissible means of resolving a chapter 11 case.

These issues could lead the Court to resolve a basic question that has driven arguments on the Bankruptcy Code for decades. It’s a debate between lawyers and judges who take a pragmatic view of the Bankruptcy Code, versus those who adhere strongly to the “plain meaning” rule of statutory interpretation.  The first group believes that the Bankruptcy Code was intentionally designed by Congress to be as flexible as possible and, while unstated, also was intended to be built upon and carry forward any number of long-standing practices derived from decades, and in some instances centuries, of commercial law.  In this view, the Bankruptcy Code was specifically intended to allow parties to develop solutions to difficult issues which do not fit within the strict parameters of the statute.

Jurists and practitioners on the other side contend that bankruptcy judges must defer to the plain meaning of the Bankruptcy Code and are not at liberty to approve solutions to problematic situations, such as a structured dismissal for resolving a log-jammed chapter 11 case, which go beyond those specifically provided by Congress. In Czyzewski, the drivers contend that because there is no express authority for structured dismissals under the Bankruptcy Code, the proposed deal among the other parties must fail.  The Third Circuit acknowledged the lack of statutory authority; however, it affirmed the lower court decisions as the “least bad alternative”, and ruled that a dismissal under Section 349 of the Bankruptcy Code could be accompanied by other court orders giving effect to a settlement, providing releases, and disposing of loose ends which otherwise would require continued litigation in another forum.

The second issue delves even deeper into the heart of the Bankruptcy Code. The “absolute priority rule” means that in a plan of reorganization, creditors with claims which would be entitled to seniority in the event of a straight liquidation must get paid ahead of creditors whose claims would be junior in priority.  The Third Circuit was troubled by the fact that general unsecured creditors would receive some small payment while the drivers with higher priority claims would be paid nothing.  The Court nevertheless upheld the settlement.  It determined that under a settlement, parties could deviate from the Bankruptcy Code’s priority scheme if “specific and credible grounds” so justified.  The dispositive factor in this instance was that under the only realistic alternative, no parties other than CIT and Sun would have received anything.  Although the Jevic bankruptcy estate held litigation claims, there were no assets to fund them.  Under any viable scenario, the drivers were receiving $0.  The only real question was whether such non-payment should obviate the possibility of any other party receiving any funds.  The Third Circuit declined to find “that our national bankruptcy policy is quite so nihilistic[.]”

The Court, as demonstrated by its recent decision in Baker Botts v. Asarco, leans strongly toward the plain meaning rule of statutory interpretation in bankruptcy cases, which suggests that the Court will reverse the Third Circuit here.  The main suspense in the outcome of Czyzewski lies not in the outcome per se, but rather in whether the Court rules broadly or narrowly.  A narrow ruling addressing only the second question here, overturning the ruling below based on the proposed recovery to general unsecured creditors ahead of the drivers and their claims for unpaid wages, would be significant but not too remarkable.  The Court could go further, however, and altogether invalidate structured dismissals due to the lack of specific authority.  Such a ruling could markedly alter the chapter 11 landscape.  The Supreme Court, however, has evidenced little concern in recent times for the extent to which its rulings in bankruptcy cases conflict with established practices, such as when it invalidated a long-standing jurisdictional scheme a few years ago in Stern v. Marshall.

One of the hallmarks of Chapter 11 has been the consistent ability of practitioners and judges to adapt it to situations that lie well outside of the intentions of the drafters of the Bankruptcy Code, such as in asbestos and other mass tort cases, or mega-cases such as the GM and Chrysler bankruptcies, and which likely would otherwise defy resolution. For better or worse, a broad ruling by the Court in Czyzewski would limit creative uses of the Bankruptcy Code, and substantially affect the manner in which difficult Chapter 11 cases are approached and resolved.