Argument analysis: Narrow reversal in Jevic seems likely

In Czyzewski v. Jevic Holding Corp., potentially the most important of the Supreme Court’s recent bankruptcy cases, the court appears to be on the verge of rejecting priority-skipping structured dismissals as a means of resolving Chapter 11 cases. Today’s argument was broad-ranging and the court was clearly intellectually engaged by the case. Repeated questions from Justices Sonia Sotomayor, Elena Kagan, Stephen Breyer, Anthony Kennedy and Ruth Bader Ginsburg, as well as Chief Justice John Roberts, regarding the scope and implications of a reversal in this case suggested that the court, although rejecting priority-deviating structured dismissals, will tread carefully in framing its opinion to avoid a categorical prohibition on all pre-plan deviations in priority.

For the uninitiated, under the bankruptcy code, there are three ways to end a Chapter 11 case: confirmation of a plan, conversion to a Chapter 7 liquidation or dismissal. The code contemplates that dismissal will return the parties to their prebankruptcy positions, except to the extent the bankruptcy court orders otherwise. In a structured dismissal, however, the bankruptcy court’s dismissal order alters the rights and liabilities of the parties in ways that differ from the three options outlined in the code. Unlike a Chapter 11 plan, a structured dismissal does not require disclosure, voting by affected constituents and bankruptcy-court findings that the plan meets substantive and procedural legal standards, including compliance with the code’s priority rules. Unlike conversion to Chapter 7, a structured dismissal does not lead to a statutorily regulated liquidation consistent with established bankruptcy priorities. And unlike a straight dismissal, a structured dismissal does not simply return the parties to their prebankruptcy positions.

In today’s case, fraudulent-transfer claims against Jevic’s senior secured lenders were resolved by a $3.7-million settlement subject to a structured dismissal in which the priority claims of certain employees based on employment-law violations were skipped over. Had there been a settlement but no dismissal, and had the settlement proceeds been distributed under a plan or in a Chapter 7 liquidation, the workers’ priority claims would have entitled them to $1.7 million. Had there been no settlement but rather a straight dismissal, the fraudulent-transfer claims against the senior creditors would have revested in the workers, so that they could have pursued the claims in state court. In the structured dismissal approved by the bankruptcy court over the workers’ objection, however, the workers received no proceeds, even as junior creditors received a distribution out of the settlement funds, and the fraudulent transfer claims were extinguished.

The courts below approved this structured dismissal on the basis that no good alternative existed. No Chapter 11 plan could be confirmed given the estate’s inability to satisfy outstanding administrative and priority claims (i.e., the estate was “administratively insolvent”), and, in a Chapter 7 liquidation, no one other than the senior secured creditors would receive anything, because the fraudulent-transfer action would have to be abandoned for lack of resources to prosecute. In short, the courts concluded, the workers were no worse off in the structured dismissal, and other constituents were all measurably better off.

Arguing on behalf of the workers, Danielle Spinelli was quickly pressed by Justice Sonia Sotomayor on how reversal would benefit the workers given these realities. Spinelli suggested that in a Chapter 7 case the fraudulent transfer might be pursued by contingency counsel, or, if no contingency fee arrangements could be made, abandoned back to the workers.

Justice Samuel Alito, picking up on procedural arguments made in Jevic’s merits briefing, suggested that by requesting a remedy that would revive the settled fraudulent transfer claims that could not practically be prosecuted, the workers were shifting their position both from what they had asserted before the court of appeals and from the question they had asked the court to review on certiorari, but Spinelli responded that the propriety of priority-deviating structured dismissal was properly before the court. No other justice explicitly or implicitly seemed to disagree.

Spinelli then focused on the inconsistency between the elaborate priority provisions in Chapters 7 and 11 of the bankruptcy code and the absence of any express distributional constraints in connection with settlement or dismissal, suggesting that Congress never intended settlement and dismissal to be a distributional mechanism. Kennedy interjected, pointing out the “for cause” exception in the dismissal statute that appears to authorize the bankruptcy court to alter the effect of dismissal from merely restoring the pre-bankruptcy status quo.  Spinelli, relying on the legislative history of the code and on lower court cases, argued that the “for cause” exception was intended to give the bankruptcy court discretion to protect third-party detrimental reliance on intervening bankruptcy court orders, not to reorder distributional priorities.

Kagan then moved the argument back to a discussion of how broadly or narrowly the court might rule, should it reverse. The discussion remained there for the rest of Spinelli’s opening argument and indeed for most of the ensuing argument in support of the workers offered by Assistant to the Solicitor General Sarah Harrington.

Spinelli was careful to limit the relief sought to a rejection of a priority-deviating case resolution through a structured-dismissal order, distinguishing other types of pre-plan priority deviations, such as critical vendor orders.

Harrington then took the podium. Interestingly, consistent with the federal government’s institutional interests as a large priority creditor in many bankruptcy cases, she argued for a broader holding that would outlaw all priority deviations, including critical vendor orders and other common pre-plan practices. Alito again pressed procedural arguments initially raised in Jevic’s merits briefing, but Harrington, like Spinelli, asserted that the question of a priority-deviating distribution of estate assets outside of a plan was properly subsumed in the question presented on certiorari, and otherwise properly before the court. Although Harrington pressed for a broad ruling, she acknowledged that the court could choose to follow the narrower path set out by Spinelli. One senses from the general tone of the discussion that most of the justices are leery of any holding broader than that expressly sought by the workers.

Christopher Landau, who argued on behalf of Jevic, faced extensive questioning from Breyer and Kagan. Although Jevic’s merits briefing had suggested an absence of bankruptcy court authority over pre-plan settlements, Landau backpedaled from that position in argument, agreeing that when a settlement involves a use of estate assets outside the ordinary course of business (as settlements invariably do), court approval is necessary and appropriate under the flexible standard applicable under Section 363(b) of the code. Moreover, Landau conceded that compliance with bankruptcy-code priorities is properly the most important factor informing the bankruptcy court’s discretion under Section 363, asserting that only a “rare” case such as this one could plausibly warrant bankruptcy-court approval of a priority deviation in the context of a settlement. In Landau’s view, Jevic’s administrative insolvency, combined with a structured dismissal that made no one worse off and everyone but the workers meaningfully better off than they would be in a Chapter 7 liquidation, justified priority deviation. But the justices seemed unconvinced that these factors made this a “rare” case or that the code authorized priority deviations whenever, in Kagan’s terms, the result was, on the facts of the case, “Pareto-superior.”

Breyer lightened the discussion with a hypothetical involving a bankruptcy trustee’s unexpected discovery of a treasure chest that could only be distributed in accordance with the whims of the pirate standing guard (Jean Lafite, in Breyer’s telling). In the end, however, Landau seemed to have difficulty persuading any of the justices (with Alito and Justice Clarence Thomas being possible exceptions) that he had articulated a principle that would meaningfully cabin any discretion the court might recognize under Section 363(b) to approve priority-deviating settlements.

Case-dispositive priority deviations through settlements or structured dismissals may soon be a thing of the past. We should know by June, if not before.