Under the Bankruptcy Code, can a bankruptcy court in a Chapter 11 case approve a settlement that distributes the debtor’s estate to creditors in a way that deviates from the Code’s priority scheme?
Respondents Jevic Holding Corporation et al. (“Jevic”) fired Petitioners Casimir Czyzewski et al., members of a certified class of truck drivers (“the drivers”), when the company filed for bankruptcy in 2008. The drivers were entitled to receive payment on their wage claims before other unsecured creditors received any distribution from Jevic’s bankruptcy estate, but they were skipped over when Jevic’s two largest creditors reached a settlement with Jevic. The drivers argue that the Bankruptcy Code does not authorize a bankruptcy court to approve settlement that differs from the Code’s priority scheme. Jevic counters that the drivers have not presented a case or controversy because the drivers cannot show that a decision in their favor is likely to redress their injury. Further, Jevic argues that the Code does not make the absolute priority rule applicable to Chapter 11 settlements. The outcome of this case could affect the scope of the Bankruptcy Code priority scheme and could disadvantage employees who hold priority wage claims against their bankrupt employer.
Questions as Framed for the Court by the Parties
Whether a bankruptcy court may authorize a distribution of settlement proceeds that violates the priority scheme established by the Bankruptcy Code, over the objection of priority creditors whose rights are impaired by the proposed distribution.
JEVIC FILES BANKRUPTCY
On May 19, 2008, Jevic Holding Corporation (“Jevic”) fired its 1,800 employees—including Petitioners (“the drivers”), a certified class of truck drivers—without warning. The next day Jevic, voluntarily filed for Chapter 11 bankruptcy in the United States Bankruptcy Court for the District of Delaware. Under the Bankruptcy Code, the drivers had claims against Jevic’s bankruptcy estate that needed to be paid in full before any general unsecured creditors could be paid. Jevic also owed major debts to other creditors, however, including $53 million to its first-priority secured creditors, CIT Group and Sun Capital Partners, and $20 million to its general unsecured creditors. In June of 2008, the bankruptcy court appointed an Official Committee of Unsecured Creditors (“the Committee”) to represent Jevic’s unsecured creditors. During these proceedings, the Committee brought a related fraudulent conveyance suit, and the drivers brought a class action lawsuit against Jevic which alleged violations of federal and state Worker Adjustment and Retraining Notification (“WARN”) Acts.
In March of 2012, the relevant parties, including the remainder of Jevic, the Committee, and the drivers, negotiated a structured dismissal, or an ending of the bankruptcy subject to certain conditions. The Committee agreed to release its fraudulent conveyance claims pending against Jevic’s two largest creditors (Sun and CIT), provided that CIT pay $2 million dollars to cover Jevic’s and the Committee’s legal fees and other administrative expenses and that Sun assign its lien on $1.7 million dollars of Jevic’s remaining assets to a trust to pay tax and administrative creditors followed by general unsecured creditors. Under this structured dismissal, the drivers would not receive any payment although they held priority wage claims against Jevic’s bankruptcy estate under 11 U.S.C. § 507(a)(4) and lower-priority general unsecured creditors would receive payment. The drivers also did not get the chance to present their damages claim in bankruptcy court.
The drivers objected to the structured dismissal because it distributed the property of the estate to creditors in violation of the priority scheme set out in §507 of the Bankruptcy Code. The bankruptcy court approved the structured dismissal anyway, citing the “dire circumstances” of having limited options other than the existing settlement and holding that bankruptcy settlements need not comply with the Bankruptcy Code’s priority scheme.
The drivers then appealed to the United States District Court for the District of Delaware and concurrently filed a motion in the Bankruptcy Court to stay its order pending the outcome of the appeal. The Bankruptcy Court denied the request for a stay and Jevic promptly began making payments to priority tax creditors and general unsecured creditors, skipping over the drivers entirely. Soon thereafter, the District Court affirmed the Bankruptcy Court’s approval of the structured dismissal of the bankruptcy case.
The drivers then appealed to the United States Court of Appeals for the Third Circuit to review the Bankruptcy Court’s order. The Third Circuit held that a bankruptcy court could in rare cases authorize Chapter 11 settlements that deviated from the priority scheme so long as there were credible grounds for the deviation; the court concluded this was such a case. The drivers filed for a writ of certiorari to the Supreme Court of the United States on November 16, 2015 the Court granted writ on June 28, 2016.
WHETHER THE BANKRUPTCY CODE PRIORITY SCHEME APPLIES TO SETTLEMENTS
The drivers argue that the Bankruptcy Code does not authorize a bankruptcy court to approve a Chapter 11 settlement or a structured dismissal that violates the priority scheme set out in Bankruptcy Code §§ 507 and 1129(b). The drivers argue that, unless creditors give consent, Chapter 11 settlements, dismissals, and other devices, in addition to Chapter 11 plans, must comply with the priority principles established in these sections.
Jevic counters that although the plain text of § 1129(b)(2)(B)(ii) states that a Chapter 11 plan must follow the Code’s absolute priority rule, no provision in the Code makes the priority scheme applicable to settlements. Jevic asserts that even the title of § 1129, “Confirmation of plan,” makes it clear that Congress intended the priority schemes to apply only to Chapter 11 plans and not settlements. Jevic further asserts that in light of how detailed and meticulous the Bankruptcy Code is, if Congress intended the absolute priority rule to apply to Chapter 11 settlements, it would have expressly stated so in one of the provisions of the Code.
The drivers, however, argue that under the Code, a debtor may exit Chapter 11 bankruptcy proceedings in only one of three ways: (1) by confirming a Chapter 11 plan of reorganization; (2) converting the proceedings to a Chapter 7 liquidation; or (3) dismissing the case altogether. The drivers assert that none of these alternatives allows deviation from the Code’s priority scheme. The drivers contend that although the Code allows flexibility in designing the terms of a Chapter 11 plan and even authorizes the court to distribute estate assets outside of the plan in select instances, even in these cases the court must still follow the overall priority scheme. Accordingly, the drivers argue that because the Code’s priority scheme cannot be altered under either a confirmed plan, a Chapter 7 liquidation, or a dismissal, parties should not be able to circumvent the priority scheme through a structured dismissal or a settlement either.
On the other hand, Jevic argues that as long as the Chapter 11 plan follows the priority system as the Code requires, it should not matter if various pre-plan components of Chapter 11 proceedings, including settlements, follow the priority system.
WHETHER SPECIFIC PROVISIONS CAN OVERRIDE GENERAL PROVISIONS
The drivers contend that the courts should interpret the Bankruptcy Code holistically so that its individual provisions are compatible with the rest of the Code. The drivers assert that, as a matter of statutory interpretation, the Code’s general provisions cannot override its specific priority scheme provisions that apply to Chapter 11 plans. The drivers point out several examples of precedent in which the Court had refused to read a general provision of the Code in a way that would have been inconsistent with a more specific provision. The drivers suggest that the priority scheme of the Code makes up the specific provisions that, rather than the more general settlement provisions, govern the distribution of Jevic’s assets in this case.
Jevic argues that the contention that specific provisions override general provisions actually defeats the drivers’ argument because none of the “specific” provisions that the drivers reference (such as § 1129(b)) pertains to settlements. Jevic argues that the drivers essentially rely on the Code’s general priority scheme provision under § 507 to circumvent specific provisions of § 1129, which mandates that the priority scheme applies to plans and not to settlements. Jevic argues that if specific provisions, such as §§ 507 and 103(a), impose the priority scheme broadly to all Chapter 11 matters, including settlements, Congress would not need to specify in § 1129 that the absolute priority rule applies to Chapter 11 plans. Thus, specific provisions such as § 1129 that exclude settlements from their scope actually override the general priority scheme provision of § 507. Accordingly, Jevic argues that finding that a Chapter 11 settlement need not follow the Code’s priority system is more in line with the Code, especially because there is also no common law basis for applying the Code’s priority scheme to settlements.
WHETHER THE CODE PROVIDES COURTS WITH RIGHTS TO APPROVE CHAPTER 11 SETTLEMENTS
The drivers argue that a bankruptcy court’s power to approve settlements under Federal Rule of Bankruptcy Procedure 9019 or § 363 of the Bankruptcy Code does not allow the court to violate the Code’s priority scheme through a structured dismissal. The drivers argue that because Rule 9019 is merely a procedural rule, it cannot modify the substantive rights granted by the Code’s priority scheme. The drivers contend that while § 363 (the provision allowing a debtor-in-possession to sell estate property in the ordinary course of business) might authorize a debtor to make settlements outside of a plan, it does not authorize the court to make any distributions that would violate the priority scheme.
Jevic agrees with the drivers that Federal Rule of Bankruptcy Procedure 9019 cannot provide a substantive standard for the court’s review of settlements because it is merely a rule of procedure, and the substantive standard allowing the courts to review settlements must come from the Code. Jevic asserts, however, that no substantive provision in the Code permits the courts to review settlements in such a way. Jevic argues that because no provision in the Bankruptcy Code authorizes bankruptcy courts to review or approve settlements, the drivers’ assertion that bankruptcy courts must reject Chapter 11 settlements that deviate from the priority system is ungrounded. ,
CASE OR CONTROVERSY?
Jevic argues that this dispute should be dismissed for lack of jurisdiction because it is not a case or controversy within the meaning of Article III, §§ 1, 2 of the Constitution. Jevic contends that the drivers have not presented a case or controversy within the meaning of Article III because even if the drivers get a decision in their favor, they will not get any remedy. Jevic asserts that the drivers have admitted during lower court proceedings that their desired remedy—converting the case to Chapter 7 bankruptcy—will not benefit the drivers because they will not be able to recover any money. Jevic contends that the bankruptcy court below found that the settlement was the least worst option because it would allow some unsecured creditors to get a recovery. Because the drivers would not be able to recover in either case, Jevic asserts that the drivers are simply seeking an advisory opinion on whether the Bankruptcy Code’s priority scheme applies to Chapter 11 settlements.
Although the drivers do not directly address this issue, they suggest that if the proposed settlement was rejected and the case was dismissed, the drivers could have pursued their own fraudulent conveyance claims against one of the secured creditors, Sun Capital Partners, and, thus, recovered something.
WAGE CLAIM PRIORITY: AN IMPORTANT INDUCEMENT
The drivers argue that giving priority to unpaid employee wage claims is an important inducement to employees: it prevents them from abandoning a failing business for fear of not being paid. Without such a guarantee, employees would be more inclined to leave if they suspect that their employer plans to file for bankruptcy, worsening the business’s chance at recovery. In addition, the drivers argue that Congress intended the priority rules to alleviate some of the hardship employees face when a business enters bankruptcy; if bankruptcy courts do not enforce the priority rules, the harshest impact will be on employees because they do not have another source of income. The National Employment Law Project et al., in support of the drivers, argue that allowing bankruptcy courts to deviate from the priority scheme, even on rare occasions, will have a detrimental impact on employees in bankruptcy negotiations; the threat of being skipped over will pressure priority creditors to give in to unfavorable settlement terms and the judge would not have the power to overturn such “consensual” settlements.
In contrast, Jevic asserts that the drivers should be “careful what they wish for” because under the current regime, courts routinely approve the payment of pre-petition wages to employees at the outset. Jevic contends that employees like the drivers would be worse off under a strict application of the priority scheme because they would not be able to jump ahead of other priority and secured creditors, and they would not receive any compensation until those creditors are paid in full. A group of law professors emphasizes that a reversal of the Third Circuit’s decision would actually do more overall harm than good because it would result in a loss of money from the bankruptcy estate and would negatively impact more than 1,000 general unsecured creditors.
CIRCUMVENTION OF CONGRESSIONAL INTENT OR EXPANSION OF SCOPE
The drivers contend that if bankruptcy courts can authorize a settlement agreement that violates the Bankruptcy Code’s priority scheme, the courts will in effect be authorizing parties to do through settlement what Congress specifically prohibited parties from doing directly: circumvent the priority scheme. Furthermore, the drivers maintain that allowing such priority-violating structured dismissals raises the concern that debtors and senior creditors will collude to “squeeze out” objecting intermediate creditors when distributing estate assets. The drivers maintain that the primary purpose of the Bankruptcy Code—to equitably distribute estate property to creditors—is better realized by diligently enforcing the priority scheme. The states of Illinois et al., in support of the drivers, agree that enforcing the priority scheme “is necessary to fully protect the creditors.” The states contend that taxing authorities, for example, might be left in the cold with “amorphous” priority rules.
Jevic contends that the priority rule has never been absolute and the priority scheme has always been shrouded with exceptions necessary for corporate reorganization, such as the exception for “critical vendors” who receive payments for their pre-petition invoices before other creditors are paid. Law professors in support of Jevic argue that the rule advanced by the drivers would not only foreclose these exceptions but also expand the scope of the absolute priority rule. They further contend that such an expansion would have dangerous unintended consequences. For example, a ruling for stringent application of the absolute priority rule may mean that debtors in an individual Chapter 11 case would not be permitted to keep some of their assets if all other creditors have not been paid in full.
FACILITATION OF SETTLEMENT
The drivers argue that longstanding clear-cut rules regarding priority of asset distribution facilitates settlement by making both the law and litigation outcome more predictable to all parties. The states also note that a dependable structure with clear-cut rules is necessary for parties to properly determine their positions and effectively negotiate.
On the contrary, Jevic argues that giving the bankruptcy courts flexibility by allowing them to depart from the priority distribution scheme would facilitate settlement.
The drivers argue that “flexibility” will not facilitate settlement but “rather it would simply redistribute settlement proceeds away from the priority creditors whom Congress intended to protect.” The drivers state that if the Court holds that settlements between creditors can violate the priority of another creditor over that creditor’s objection, the bargaining power of every intermediate creditor will be compromised in future cases.
Jevic maintains, however, that a holding in favor of the drivers would allow a single holdout creditor to block a potential settlement agreement that benefits the debtor and maximizes the payment made to other creditors.
- Rebecca Hollander, You Can Go Your Own Way… Unless the Supreme Court Reverses Jevic, Bankruptcy & Restructuring Law Monitor (Nov. 10, 2016).
- Matthew J. Stockl, Stakes Are High In Supreme Court Review Of Jevic, Law 360 (July 2016).