In an argument [transcript] that seemed to tip in favor of employees, this morning the US Supreme Court ventured into the world of structured dismissals in bankruptcy – the practice of agreeing on a distribution of assets that essentially ignores the priorities dictated by the Bankruptcy Code. As the formal statement of the issue put it, the Court grappled with "Whether a bankruptcy court may authorize the distribution of settlement proceeds in a manner that violates the statutory priority scheme."
When Jevic Transportation went into Chapter 11 (reorganization) bankruptcy, it had already laid off its truck drivers, and the drivers filed a class action complaint against Jevic claiming violation of the WARN Act. The drivers' claim was worth about $12.4 million – including an $8.3 million wage claim that had priority under the bankruptcy code. In the bankruptcy code's priority scheme, the drivers' $8.3 million claim would be subordinate to secured claims and certain fees, but would be senior to general unsecured claims.
Jevic owed about $53 million to its lenders, who held a first-priority lien on most of the company’s assets. And $8.3 million of the drivers' $12.4 million claim had priority over other creditors. Yet Jevic had only $1.7 million in cash to distribute to its creditors, and a creditor had a lien on that. Have you noticed that even if the drivers had been given their priority there would not be anything left to pay them?
So the official unsecured creditors’ committee and the secured lender negotiated a settlement under which the lender set aside some money to distribute to unsecured creditors – and cut the drivers out altogether. This "structured dismissal" did not follow the bankruptcy priorities, which would have preferred the drivers' wage claims. All of this was OK according to the 3rd Circuit [opinion here].
Danielle Spinelli, attorney with WilmerHale, argued for the drivers. Justice Sotomayor asked her what the drivers will do if they win, given that there's no money in the estate, and she said they would ask for a conversion to Chapter 7 and that contingency counsel could pursue their claims. Justice Alito suggested that this was inconsistent with what the drivers argued in the 3rd Circuit, but Spinelli insisted that the drivers had always maintained that it would allow them to pursue their WARN Act claims.
Justice Alito then said (gulp), "Something strange seems to have happened between the petition stage and the briefing stage in the case." "There is nothing about structured dismissal in the question that you asked us to take." Spinelli carefully explained that there is "no substantive difference."
Although nothing in the Code permits a structured dismissal, nothing forbids it. And this caught the attention of Justices Breyer and Kagan. Spinelli relied on the structure of the Code, which she says forecloses any inference that Congress meant to permit courts to distribute assets outside of the methods mentioned in the Code.
Sarah Harrington, Assistant to the Solicitor General, arguing for the government as amicus curiae, proposed that the Court adopt a rule that "a bankruptcy court can never resolve a bankruptcy by ordering the distribution of estate assets in a manner that violates the Code's detailed priority system without the consent of the impaired priority claimholder." Period. No exceptions. When asked by Justice Alito whether a bankruptcy court has to approve all settlements, she asserted that "a bankruptcy court does have to approve a settlement that disposes of a claim held by the estate or asserted against the estate."
Justice Sotomayor then returned to Justice Alito's question about whether the question presented in the cert petition did not address the question of structured dismissals now being discussed, saying, "I do think there is a difference." Harrington then suggested that the Court could narrow its holding, which I think the Court will do in any event.
Christopher Landau, attorney with Kirkland & Ellis, argued for Jevic Transportation, and in the middle of his fourth sentence Justice Sotomayor said, "You took away a legal right from them." And then: "I mean, every structured settlement of this kind is trying to exclude one set of creditors. And this is exactly what this did, and it did it in collusion among the senior and junior creditors to the exclusion of the disfavored creditor."
Justice Breyer then pressed hard on the question of "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?" To this Landau said that as a general rule they cannot. But he said there are rare exceptions, such as here where there could be no confirmable Chapter 11 plan because the estate was administratively insolvent. But Justice Kennedy opined that this is not rare at all.
Landau explained that the absolute priority rules simply do not apply before there is a plan. If it's a plan, then priorities must be followed. If it's not a plan, then there is discretion that can be exercised, under Section 363(b). In closing, Landau summarized: "So if, in fact, you have a situation where the settlement or -- and the distribution proposed makes others better without making these folks worse off, there is nothing in the Code that prohibits that."
Ms. Spinelli's rebuttal ended with this: "Respondents' rule would wreak havoc on the basic process of bankruptcy. 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. Debtors could simply reach a deal with junior creditors and distribute property leaving inadequate resources to pay senior creditors."
I think Spinelli's argument will carry the day.
[For recent decisions and pending employment law cases, see US Supreme Court Watch.]
Web site for Ross Runkel, Arbitrator & Mediator: https://www.rossrunkel.com/