Justices debate creditor collusion, role of settlements in bankruptcy cases

December 9, 2016

U.S. Supreme Court is seen in WashingtonAttorneys for a trucking company and its former drivers who were left out of a deal that resolved the firm’s bankruptcy case squared off Dec. 7 before the justices of the U.S. Supreme Court, who asked about the role of settlements in bankruptcy cases and the threat of collusion among creditors.

The drivers are seeking to overturn a ruling from the 3rd U.S. Circuit Court of Appeals upholding a settlement that resolved Jevic Transportation Inc.’s Chapter 11 case without a formal reorganization plan, a move known as a “structured dismissal.”

The settlement did not pay the drivers anything on their claims for severance pay under the Worker Adjustment and Retraining Notification Act, 29 U.S.C.A. § 2101, which requires employers to provide notice to employees before a mass termination. Instead, all the money was used to pay the Jevic bankruptcy estate’s administrative expenses, taxes or general unsecured creditors.

Wage-related claims have a higher priority under the Bankruptcy Code’s distribution scheme than claims of general unsecured creditors, but they come in below administrative expenses.

Christopher Landau

Jevic’s attorney Kirkland & Ellis’ Christopher Landau

This case presented unusual circumstances that made the settlement the best possible outcome, even though the drivers got nothing, Kirkland & Ellis’ Christopher Landau, who argued for Jevic, said during the one-hour session before the eight justices.

The settlement maximized the recovery for the creditors who did get paid, while leaving the drivers no worse off than they would have been with any other possible outcome, he said.

The Bankruptcy Code gives courts discretion to approve such settlements, he said.

Justice Sonia Sotomayor said she did not see why this case was all that unusual.

“It seems to me that wanting to exclude the claims of one or more creditors is the ordinary situation,” she said. “Every junior creditor wants money. They’re happy to exclude anybody they can … or anybody who will concede to doing it.”

The high court is weighing whether, outside the context of a formal Chapter 11 reorganization plan, a bankrupt company’s assets can be distributed to creditors in a way that differs from the Bankruptcy Code’s rules for the order in which claims are paid.

Wilmer Hale's Danielle Spinelli

WilmerHale’s Danielle Spinelli represented the drivers

Jevic’s position, if adopted, “would wreak havoc on the basic process of bankruptcy,” the drivers’ counsel, Danielle Spinelli of Wilmer Cutler Pickering Hale and Dorr, told the justices.

“If debtors could distribute estate property to creditors at any time without regard to the priority scheme before a plan, there wouldn’t be much left of the scheme,” she said.

Chapter 11 filing

New Jersey-based Jevic fired the drivers around the same time it filed for bankruptcy in May 2008 in the U.S. Bankruptcy Court for the District of Delaware, where the company was incorporated.

At that time Jevic owed more than $20 million in taxes and general unsecured debt, plus another $53 million to Sun Capital Partners IV LLP, which had acquired Jevic in a 2006 leveraged buyout, and CIT Group/Business Credit Inc., which later refinanced Sun’s debt, according to Jevic’s brief opposing Supreme Court review.

Four years later, the Bankruptcy Court, over the drivers’ objections, approved a settlement that resolved a fraudulent-conveyance action that the creditors committee had filed against Sun and CIT. Under the agreement, the Chapter 11 case would be dismissed once the settlement was implemented.

The U.S. District Court for the District of Delaware, and later the 3rd Circuit, affirmed the settlement and dismissal. In re Jevic Holding Corp. et al., No. 08-11006, 2014 WL 268613 (D. Del. Jan. 24, 2014); In re Jevic Holding Corp. et al., 787 F.3d 173 (3d Cir. 2015).

The drivers then petitioned the Supreme Court for review, which was granted.

‘An unconfirmable plan’

Justice Elena Kagan asked why the Bankruptcy Code does not address the applicability of the priority rules to settlements outside Chapter 11 plans.

“Did Congress just not think that this might happen?” she asked.

Settlements were not intended as a method for distributing an estate’s assets, Spinelli replied.

Settlements yield funds that become assets of the bankruptcy estate, which are then distributed to creditors in accordance with priority, she said.

The code provides only two options for distributing estate assets, both of which must abide by the priority scheme — either a confirmed reorganization plan under Chapter 11 or conversion to Chapter 7, after which the estate is liquidated and creditors are paid with those funds, Spinelli said.

If neither of those options is feasible, a case can be dismissed, meaning that no assets are distributed and the parties revert to their prebankruptcy positions, she said.

“No provision of the Bankruptcy Code permits what happened here,” she said. “This was a naked priority violation for its own sake. … Taking value from senior creditors and giving it to junior creditors for its own sake is not permitted.”

Structured dismissals like the one in this case are often used when a debtor and its creditors cannot agree on a reorganization plan, according to Sarah E. Harrington, assistant to the solicitor general, who argued for the U.S. government as amicus curiae in support of the drivers.

“What you have is an agreement that is, in essence, an unconfirmable plan,” she said.

“Congress enacted the priority scheme precisely to prohibit the kind of collusive-looking agreements that happened here, where you have high-priority and low-priority creditors kind of squeezing out the middle creditors,” Harrington said.

The world of 363(b)

The Bankruptcy Code’s priority rules apply only in the context of Chapter 11 reorganization plans, Landau said.

Outside of that context, he said, courts have discretion under Section 363(b) of the Bankruptcy Code, 11 U.S.C.A. § 363(b), to make decisions about the use, sale or lease of estate assets.

“Congress drew a line that the absolute-priority rule as such applies to plans,” he said. “When you are not in the world of plans, you are in the world of 363(b), which has play in the joints.”

Adherence to priority is a major factor judges use when making decisions under Section 363(b) but they have discretion to allow settlements that violate priority under extraordinary circumstances like the ones in this case, he said.

“Let’s just assume that you are right, that … this is one of these extraordinary circumstances in which some people can be made better off and nobody will be made worse off,” Justice Kagan said. “Still, the question is: Where is the authorization for that in the Bankruptcy Code? Because that’s like a big principle. … I think we would have known about it if that’s the way bankruptcy proceedings were supposed to go.”

The lack of a statutory provision allowing approval of settlements that violate priority also troubled Justice Stephen Breyer.

“So where does the bankruptcy trustee or any court get the power to say that a group of people can, in fact, reverse the order in which these assets will be distributed?” Justice Breyer asked. “That is what is bothering me, and presumably the government, and certainly the workers here.”

Czyzewski et al. v. Jevic Holding Corp. et al., No. 15-649, oral argument held (U.S. Dec. 7, 2016).

Related Filing on Westlaw:

Argument transcript: 2016 WL 7117910