How Absolute is the Absolute Priority Rule in Bankruptcy? The Case for Structured Dismissals

By Bruce Grohsgal (Widener University School of Law)

A structured dismissal in a chapter 11 bankruptcy case is a court-approved settlement of certain claims by or against the debtor followed by the dismissal of the case. Courts have held that a bankruptcy court cannot approve a settlement unless it complies with the absolute priority rule, paying senior claims in full before any distribution to junior stakeholders.

The Supreme Court will consider structured dismissals this fall in In re Jevic Holding Corp. The question before the Court is: “Whether a bankruptcy court may authorize the distribution of settlement proceeds in a manner that violates the statutory priority scheme.”

The argument that a structured dismissal always must follow the absolute priority rule, even when a chapter 11 plan is not confirmable, overstates the current statutory reach of the rule. The rule reached its zenith by judicial launch in 1939 in Case v. Los Angeles Lumber, when the Supreme Court construed the statutory term “fair and equitable” to be synonymous with “absolute priority.” Congress has circumscribed the rule repeatedly since: in 1952 under the Bankruptcy Act, in 1978 with enactment of the Code, and in 1986 and 2005.

As a result of these enactments, the absolute priority rule is a special, limited rule that does not pervade the current Code. Indeed, the very reorganization plan—a consensual chapter 11 plan—that the Supreme Court held was not confirmable in Los Angeles Lumber would be confirmable under the current Code.

My article, forthcoming and available here, concludes that Congress has authorized the bankruptcy court to approve a structured dismissal in chapter 11 when it is in the best interest of creditors—such as when a plan is not confirmable—even if distributions do not follow the absolute priority rule. Accordingly, the Supreme Court should resolve the current circuit split by affirming Jevic.

Brief for Amici Curiae Law Professors in Support of Petitioners, In re Jevic

posted in: Cramdown and Priority | 0

By Jonathan C. Lipson (Temple University Beasley School of Law) and Melissa B. Jacoby (University of North Carolina – Chapel Hill School of Law)

Fair treatment of creditors is one of the first lessons of a law school bankruptcy course. Congress created detailed and deliberate rules governing the payment of creditors to resolve a bankruptcy case. When a creditor has a priority claim under the Bankruptcy Code, it must be paid in full before any more junior creditors receive anything at all. This principle is one of the elements of bankruptcy that also fosters predictability.

On the facts of Czyzewski v. Jevic Holding Corp., to be heard this term by the United States Supreme Court, the Bankruptcy Code’s priority structure entitled workers, whose jobs had been abruptly terminated, to an estimated $8.3 million. Instead, they received nothing. An agreement and dismissal order (known collectively as a “structured dismissal”) resolving litigation over a leveraged buyout that contributed to the company’s demise skipped the workers and provided payment to junior creditors because the LBO defendants so insisted. A divided panel of the U.S. Court of Appeals for the Third Circuit approved this arrangement.

Our amicus brief illustrates that nothing in the Bankruptcy Code permits this kind of priority-skipping settlement in the absence of creditor consent. By blessing this arrangement, the Third Circuit majority opinion undercut the Bankruptcy Code’s priority rules and longstanding norms. Although the majority suggested it was limiting this result to rare cases, that majority decision contained neither a workable standard for determining what makes Jevic itself rare, nor guidance on what should trigger deviations in future cases—or how far such deviations may go. Left standing, the holding erodes the predictability and fairness of bankruptcy law and produces perverse incentives: powerful parties regularly will seek to write their own distribution rules through structured dismissal orders or other means.

The full amicus brief may be found here.

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