The Supreme Court Just Upended Bankruptcy Abuse by Wall Street

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The Supreme Court just overturned decades of Wall Street chicanery that was used to f%$# employees and other ordinary folks:

Czyzewski v. Jevic Holding Corp. is the latest battleground in a 150-year struggle over whether senior creditors whose liens exhaust a bankruptcy estate, and junior creditors or equity holders with control over the bankruptcy proceeding, can combine to use bankruptcy processes to implement a division of value that skips over otherwise out-of-the-money intervening creditors over their objection. In the landmark case of Northern Pacific Railway Company v. Boyd, the court created the “absolute priority rule” to prevent just that eventuality in federal equity receiverships over 100 years ago, before any federal statutory reorganization procedure existed. Ever since and all along, bankruptcy practitioners struggling to make deals and solve practical problems have creatively fought, evaded, and sought to limit the scope of that prohibition. The most fashionable current step in this never-ending bankruptcy dance has been the “structured dismissal.” The court’s opinion in Jevic puts the brakes on this device by making clear that priority deviations implemented through non-consensual structured dismissals are not permitted.

The bankruptcy code provides 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.

Jevic is a trucking company that filed under Chapter 11. During the bankruptcy proceeding, fraudulent-transfer claims against Jevic’s senior secured lenders were resolved by a $3.7-million settlement subject to a structured dismissal in which certain priority claims, based on employment-law violations under the Worker Adjustment and Retraining Notification Act, of truck drivers who worked for Jevic 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 or conversion, the fraudulent-transfer claims against the senior creditors would have revested in the workers or become an asset of the Chapter 7 bankruptcy estate, respectively. 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 lower courts concluded, the workers were no worse off in the structured dismissal, and other constituents were all measurably better off.

Justice Stephen Breyer wrote for the six-member majority (Chief Justice John Roberts and Justices Anthony Kennedy, Ruth Bader Ginsburg, Sonia Sotomayor and Elena Kagan, as well as Breyer himself). Jevic had raised a threshold objection, asserting that the truck drivers did not have standing to bring their claims. Breyer made short work of this argument, noting that it depended on two dubious propositions: that no bankruptcy settlement that included the workers was feasible, and that absent settlement the fraudulent transfer claims could not be prosecuted. The fact that the settling defendant asserted that it would not agree to a settlement that included workers who were separately suing it on WARN Act claims could well have been a bluff; in any event, the court noted, the settling defendant’s independent WARN Act liability had been subsequently resolved, removing that obstacle. Similarly, the bankruptcy court’s prediction that fraudulent-transfer claims with an apparent settlement value of $3.7 million were otherwise worthless was speculative. In short, the workers had standing to object to the structured settlement because a successful objection might result in value for them.

………

Jevic places into serious doubt the continued viability of the already controversial practice of “gifting” — that is, implementing priority deviations out of collateral proceeds through Chapter 11 plans without intervening class consent, or, in Chapter 7 liquidations, by characterizing the distribution as a ”gift” of the secured creditor’s collateral rather than a distribution of estate assets. Although the court’s opinion never refers to the practice of “gifting,” or to the lower court cases adopting or limiting gifting theories, Jevic’s reasoning, especially the primacy it places on the code’s distributional provisions, is in serious tension with that practice. On the other hand, the court’s embrace of the opinion of the U.S. Court of Appeals for the 2nd Circuit in In re Iridium Operating LLC, which approved an interim priority-deviating settlement on a gifting theory, may give gifting proponents heart.

More importantly, however, the court went out of its way to draw a sharp line between interim orders entered by the bankruptcy court in connection with its administration of an ongoing bankruptcy case and the structured dismissal at issue in Jevic. The common Chapter 11 practices of first-day wage orders, critical-vendor orders, roll-ups and interim settlements were all expressly distinguished from the objectionable structured dismissal in Jevic, which, the court expressly noted, involved a final distribution inconsistent with the code’s priority scheme as part of the case’s final disposition. The court’s implicit ratification of these established practices to the extent they serve other reorganization objectives undoubtedly will be embraced by the bankruptcy community.

………

Jevic places into serious doubt the continued viability of the already controversial practice of “gifting” — that is, implementing priority deviations out of collateral proceeds through Chapter 11 plans without intervening class consent, or, in Chapter 7 liquidations, by characterizing the distribution as a ”gift” of the secured creditor’s collateral rather than a distribution of estate assets. Although the court’s opinion never refers to the practice of “gifting,” or to the lower court cases adopting or limiting gifting theories, Jevic’s reasoning, especially the primacy it places on the code’s distributional provisions, is in serious tension with that practice. On the other hand, the court’s embrace of the opinion of the U.S. Court of Appeals for the 2nd Circuit in In re Iridium Operating LLC, which approved an interim priority-deviating settlement on a gifting theory, may give gifting proponents heart.

More importantly, however, the court went out of its way to draw a sharp line between interim orders entered by the bankruptcy court in connection with its administration of an ongoing bankruptcy case and the structured dismissal at issue in Jevic. The common Chapter 11 practices of first-day wage orders, critical-vendor orders, roll-ups and interim settlements were all expressly distinguished from the objectionable structured dismissal in Jevic, which, the court expressly noted, involved a final distribution inconsistent with the code’s priority scheme as part of the case’s final disposition. The court’s implicit ratification of these established practices to the extent they serve other reorganization objectives undoubtedly will be embraced by the bankruptcy community.

The plain English translation of this is as follows:

  • Private equity (PE) firm drives a company that it bought into the ditch.
  • While gleefully taking the company to financial ruin, the PE firm charges many fees, generating profits for themselves, and shafts creditors, share holders, and employees.
    • This is called Fraudulent Conveyance, and it is technically illegal.
  • PE firm closes down without warning, violating the WARN Act, which typically requires 60 days notice.
    • The employees then have a claim in the bankruptcy proceedings, which is senior to most of the unsecured debt in the company.
  • Four things can happen when the company files for Chapter 11 (reorg):
    • A successful Chapter 11 filing.
      • Under Chapter 11, the priority of debt needs to be generally followed, and debtors have the right to object, and have those objections evaluated, and WARN Act claims remain open.
    • An unsuccessful Chapter 11 filing, followed by Chapter 7 (liquidation)
      • Under chapter 7 the priority of debts must be strictly followed, and WARN Act claims remain open.
    • A  straight dismissal, where everything is returned to where it was before the filing.
    • A structured dismissal, in which the court determines that there is a best best deal possible, where SOME of the creditors cut a deal, and people like employees screwed out of wages have no say.

The final option is a favorite of PE firms after they have looted a company into oblivion.

SCOTUS basically ruled the priority of debtors needs to be maintained, AND that the court’s ruling that its decision was the only one that could be beneficial to the greatest possible number of creditors, was complete crap.

Here’s hoping that the PE parasites see further reversals in the not too distant future.

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