"Straight" Dismissal of Chapter 11 Case Did Not Violate Jevic's Prohibition of "Structured Dismissals" that Do Not Conform with Bankruptcy Code's Priority Scheme

In Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017), the U.S. Supreme Court held that the Bankruptcy Code does not allow bankruptcy courts to approve distributions to creditors in a "structured dismissal" of a chapter 11 case that violate the Bankruptcy Code's ordinary priority rules without the consent of creditors. However, because the Court declined to express any "view about the legality of structured dismissals in general," many open questions remain regarding the structured dismissal mechanism.

A bankruptcy appellate panel for the Ninth Circuit ("BAP") recently addressed structured dismissals in In re Pourteymour, 2023 WL 2929323 (B.A.P. 9th Cir. Apr. 12, 2023). The BAP affirmed a bankruptcy court order granting a "straight dismissal" of a chapter 11 case, finding that, notwithstanding the debtor's pledge on the record to pay some, but not all, unsecured creditors after dismissal of his bankruptcy case, the court's dismissal order complied with all applicable provisions of the Bankruptcy Code.

Structured Dismissals

In a typical chapter 11 case, a plan of reorganization or liquidation is proposed; the plan is confirmed by the bankruptcy court; the plan becomes effective; and, after the plan has been substantially consummated and the case has been fully administered, the court enters a final decree closing the case. Because chapter 11 cases can be prolonged and costly, prepackaged or prenegotiated plans and expedited asset sales under section 363(b) of the Bankruptcy Code have been increasingly used as methods to short-circuit the process, minimize expenses, and maximize creditor recoveries. In chapter 11 cases primarily involving one, or just a few, real estate assets, bankruptcy courts also sometimes authorize nonjudicial foreclosure, enabling a creditor to take title to an estate asset outside of a chapter 11 plan.

After a bankruptcy court approves the sale of substantially all of a chapter 11 debtor's assets under section 363(b) of the Bankruptcy Code (or a nonjudicial foreclosure of real estate assets outside of a chapter 11 plan), three options are generally available to deal with the debtor's vestigial property and claims against the bankruptcy estate, and to wind up the bankruptcy case. Namely, the debtor can propose and seek confirmation of a liquidating chapter 11 plan, the case can be converted to a chapter 7 liquidation, or the case can be dismissed. The first two options commonly require significant time and administrative costs.

Yet outright dismissal of a chapter 11 case may not be the best course of action either, for several reasons. Section 349(b) of the Bankruptcy Code provides that, "[u]nless the court, for cause, orders otherwise," the dismissal of a bankruptcy case generally reinstates the status quo ante by, among other things, reinstating any pre-bankruptcy custodianship, vacating any bankruptcy court order avoiding a transfer or lien, and revesting property of the estate in the debtor. Dismissal of a case is intended to "undo the Bankruptcy case, as far as practicable, and to restore all property rights to the position in which they were found at the commencement of the case." H.R. Rep. No. 95-595, 338 (1977). 

However, because conditions may have changed such that a complete restoration of the status quo is difficult or impossible, section 349(b) of the Bankruptcy Code permits the bankruptcy court, "for cause," to modify the ordinary "restorative consequences" of unconditional dismissal of the chapter 11 case. Jevic, 137 S. Ct. at 979. This power is particularly relevant in cases where the debtor's assets have been sold in a section 363(b) sale or foreclosed upon by a creditor. See H.R. Rep. No. 95-595, 338 (1977) (the intent "to undo the bankruptcy case, as far as practicable, and to restore all property rights to the position in which they were found at the commencement of the case … does not necessarily encompass undoing sales of property from the estate to a good faith purchaser").

Such a conditional dismissal—or "dismissal with strings"—is commonly referred to as a "structured dismissal," which has been defined as:

a hybrid dismissal and confirmation order in that it typically dismisses the case while, among other things, approving certain distributions to creditors, granting certain third party-releases, enjoining certain conduct by creditors, and not necessarily vacating orders or unwinding transactions undertaken during the case. These additional provisions—often deemed "bells and whistles"—are usually the result of a negotiated and detailed settlement arrangement between the debtor and key stakeholders in the case. 

Final Report and Recommendations of the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 (2014), p. 270. 

Typical Terms 

Among the provisions commonly included in bankruptcy court orders approving structured dismissals are: 

•        Expedited procedures to resolve claims objections;

•        Provisions specifying the manner and amount of distributions to creditors;

•        Releases and exculpation provisions that might ordinarily be approved as part of a confirmed chapter 11 plan;

•        Senior creditor carve-outs and "gifting" provisions, whereby, as a quid pro quo for a consensual structured dismissal, a senior secured lender or creditor group agrees to carve out a portion of its collateral from the sale proceeds and then "gift" it to unsecured creditors; and

•        Provisions that, notwithstanding section 349(b) of the Bankruptcy Code, prior bankruptcy court orders survive dismissal and the court retains jurisdiction to implement the structured dismissal order, resolve certain disputes, and adjudicate certain matters, such as professional fee applications. 

Sources of Authority 

The Bankruptcy Code does not expressly authorize or contemplate structured dismissals. Even so, sections 105(a), 305(a)(1), 349(b), and 1112(b) of the Bankruptcy Code are commonly cited as authority for the remedy. See, e.g., In re Olympic 1401 Elm Assocs., LLC, 2016 WL 4530602 (Bankr. N.D. Tex. Aug. 29, 2016); In re Naartjie Custom Kids, Inc., 534 B.R. 416 (Bankr. D. Utah 2015); see generally Amir Shachmurove, Another Way Out: Structured Dismissals in Jevic's Wake, Norton Bankr. L. Adviser (Nov. 2015) (referencing sections 105, 305, 349, and 1112 of the Bankruptcy Code as authority for structured dismissals).

Section 1112(b)(1) of the Bankruptcy Code directs a bankruptcy court, on request of a party in interest and after notice and a hearing, to convert a chapter 11 case to a chapter 7 liquidation or to dismiss the chapter 11 case, "whichever is in the best interests of creditors and the estate, for cause." "Cause" is defined in a non-exclusive manner in section 1112(b)(4) to include, among other things, "substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation" and "inability to effectuate substantial consummation of a confirmed plan." 

Section 305(a)(1) of the Bankruptcy Code provides that a bankruptcy court may dismiss or suspend all proceedings in a bankruptcy case under any chapter if "the interests of creditors and the debtor would be better served by such dismissal or suspension." Section 305(a)(1) has traditionally been used to dismiss involuntary cases where recalcitrant creditors involved in an out-of-court restructuring file an involuntary bankruptcy petition to extract more favorable treatment from the debtor. However, the provision has also been applied to dismiss voluntary cases, albeit on a more limited basis. Because an order dismissing a case under section 305(a) may be reviewed on appeal only by a district court or a bankruptcy appellate panel, rather than by a court of appeals or the U.S. Supreme Court (see 11 U.S.C. § 305(c)), section 305(a) dismissal is an "extraordinary remedy." See In re Kennedy, 504 B.R. 815, 828 (Bankr. S.D. Miss. 2014). Section 305(a) has been cited as authority for approving a structured dismissal. See, e.g., Olympic 1401, 2016 WL 4530602, at *3; Naartjie, 534 B.R. at 425-26.

As noted above, section 349(b) authorizes a bankruptcy court to alter the ordinary consequences of dismissal "for cause." See In re Johnson, 565 B.R. 417, 425 (Bankr. C.D. Cal. 2017) ("Although not explicitly authorized by the Bankruptcy Code, structured dismissals (under § 1112(b) and/or § 305(a)) have been found to be implicitly authorized under § 349(b)".).

Section 105(a) of the Bankruptcy Code provides that a bankruptcy court "may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions" of the Bankruptcy Code. However, section 105(a) "'does not allow the bankruptcy court to override explicit mandates of other sections of the Bankruptcy Code.'" Law v. Siegel, 134 S. Ct. 1188, 1194 (2014) (quoting Collier on Bankruptcy ¶ 105.01[2] (16th ed. 2013)).

The Bankruptcy Code's Priority Scheme

The Bankruptcy Code sets forth certain priority rules governing distributions to creditors in both chapter 7 and chapter 11 cases. Secured claims enjoy the highest priority under the Bankruptcy Code. The Bankruptcy Code then recognizes certain priority unsecured claims, including claims for administrative expenses, wages, and certain taxes. See 11 U.S.C. § 507(a). General unsecured claims come next in the priority scheme, followed by any subordinated claims and the interests of equity holders.

In a chapter 11 case, the chapter 11 plan usually determines the treatment of secured and unsecured claims (as well as equity interests), subject to the requirements of the Bankruptcy Code. Under section 1129(a)(7) of the Bankruptcy Code, each creditor must receive at least as much under the plan as it would receive in a chapter 7 liquidation. Additionally, if a creditor does not agree to "impairment" of its claim under the plan—such as by agreeing to receive less than payment in full—and votes to reject the plan, the plan can be confirmed only under certain specified conditions. Among these conditions is the requirement that the plan must be "fair and equitable" (11 U.S.C. § 1129(b)(1)). 

Section 1129(b)(2) of the Bankruptcy Code provides that a plan is "fair and equitable" with respect to a dissenting impaired class of unsecured claims if the creditors in the class receive or retain property of a value equal to the allowed amount of their claims or, failing that, if no creditor or equity holder of lesser priority receives any distribution under the plan. This is known as the "absolute priority rule." 

The Bankruptcy Code does not expressly state whether these priority rules apply to structured dismissals, and until Jevic, precedent concerning this issue was sparse and inconsistent.

Jevic

In Jevic, the U.S. Supreme Court held that bankruptcy courts may not deviate from the Bankruptcy Code's priority scheme when approving structured dismissals absent the consent of affected creditors—without, however, offering any "view about the legality of structured dismissals in general." Jevic, 137 S. Ct. at 985.

The Court distinguished Jevic from cases in which courts have approved interim settlements resulting in distributions of estate assets in violation of the priority rules, such as In re Iridium Operating LLC, 478 F.3d 452 (2d Cir. 2007). The 6–2 Jevic majority found that Iridium "does not state or suggest that the Code authorizes nonconsensual departures from ordinary priority rules in the context of a dismissal—which is a final distribution of estate value—and in the absence of any further unresolved bankruptcy issues." Jevic, 137 S. Ct. at 985. In this sense, the majority explained, the situation in Iridium was similar to certain "first-day" orders, where courts have allowed for, among other things, payments ahead of secured and certain priority creditors to employees for prepetition wages or to critical vendors on account of their prepetition invoices. Id. 

The Court further explained that "in such instances one can generally find significant Code-related objectives that the priority-violating distributions serve." Id. By contrast, it noted, the structured dismissal in Jevic served no such objectives (e.g., it did not benefit disfavored creditors by preserving the debtor as a going concern and enabling the debtor to confirm a plan of reorganization and emerge from bankruptcy). Rather, the distributions at issue "more closely resemble[d] proposed transactions that lower courts have refused to allow on the ground that they circumvent the Code's procedural safeguards" (citing, among others, certain section 363 asset sales). Id. at 986. 

Jevic's Impact 

Based on Jevic, many courts have refused to approve structured dismissals, settlements, and related transactions that appeared to fit within the scope of Jevic's prohibition of nonconsensual final distributions to creditors that violate the Bankruptcy Code's distribution scheme. See, e.g., In re S-Tek 1, LLC, 2023 WL 2529729, *11 (Bankr. D.N.M. Mar. 15, 2023) (denying a chapter 11 debtor's request for a structured dismissal whereby the lender's collateral would be sold free and clear of liens under section 363(f), the debtor would obtain financing and continue to operate its business, and stating that "the Court has not found any caselaw in which a court authorized a structured dismissal through the sale of a debtor's assets, where the intended purpose of the structured dismissal is to allow the debtor to reorganize and continue business operations"); In re E. Coast Diesel, LLC, 2022 WL 19078763, *4 (Bankr. M.D.N.C. Dec. 29, 2022) (denying structured dismissal of chapter 11 case where priority wage claims were not to be paid in full); In re California Palms Addiction Recovery Campus, Inc., 2022 WL 2116643, *17 (Bankr. N.D. Ohio June 10, 2022) (noting that the chapter 11 debtor's structured dismissal proposal "failed to consider that priority-defying distributions do not comply with Jevic's holding, and cannot be approved"); In re Micron Devices, LLC, 2021 WL 2021468, *10 (Bankr. S.D. Fla. May 20, 2021) (in approving a proposed settlement agreement, noting that "the 'structured dismissals' the Debtor has asked for, first directly and then indirectly—would not pass muster" under Jevic because, among other things, administrative claimants would not be paid in full); In re Bluefield Women's Ctr., P.C., 2021 WL 1245949, *5 (Bankr. S.D. W. Va. Mar. 30, 2021) ("[Certain unsecured creditors] plead, in the alternative, that the 'cause' provision of § 349(b) would allow this Court to approve the structured dismissal…. This Court does not agree. Harkening back to the Supreme Court's decision in Jevic, 'cause' is too slender a reed for this Court to approve disbursement of funds in contravention to the Code's priority scheme."); In re Fleetstar LLC, 614 B.R. 767, 786–87 (Bankr. E.D. La. 2020) ("[T]o the extent the proposed 'dismissal with terms' provides for distributions that disturb the absolute priority rule designated in the Bankruptcy Code without the consent of all affected creditors, this Court is prohibited by the Supreme Court's holding in Jevic from approving such proposal.").

However, other courts have approved such dismissals or transactions by reading Jevic as strictly limited to its facts or by finding that the relief sought fell within one of the permitted exceptions articulated by the Jevic Court. See, e.g., In re Veg Liquidation, Inc., 931 F.3d 730, 739 (8th Cir. 2019) (unequal distribution of the proceeds from a section 363 sale to unsecured creditors with equal priority was not prohibited by Jevic); In re Old Cold LLC, 879 F.3d 376, 388 (1st Cir. 2018) (refusing to apply Jevic to disturb an asset sale under section 363(b) and ruling that section 363(m) rendered statutorily moot an appellate challenge to a sale to a good-faith purchaser); In re KG Winddown, LLC, 628 B.R. 739, 741 (Bankr. S.D.N.Y. 2021) (approving structured dismissals that did not violate the Bankruptcy Code's priority scheme and stating that "[Jevic] left the door open where such dismissals do not violate the absolute priority rule and otherwise comply with the applicable provisions of the Bankruptcy Code …. [and] [h]ere, the Debtors' request for structured dismissals fits neatly through that open door"); In re Atlantic & Pacific Tea Co. Inc., No. 15-23007 (RDD) (Bankr. S.D.N.Y. May 15, 2021) (noting that the structured dismissal of the debtor's chapter 11 case in accordance with the Bankruptcy Code's priority scheme did not violate Jevic because, among other things, the provisions governing the wind-down of the debtor's remaining business and assets did not constitute "plan relief" or an end-run around the Bankruptcy Code's creditor protections); In re Goodrich Quality Theaters, Inc., 616 B.R. 514, 521 (Bankr. W.D. Mich. 2020) (relying on the "competing bankruptcy principles" identified in Jevic, namely preservation of going-concern value and prospects for reorganization, to approve critical vendor payments), as supplemented, 2020 WL 1180534 (Bankr. W.D. Mich. Mar. 9, 2020); In re Claar Cellars, LLC, 2020 WL 1238924, *7 (Bankr. E.D. Wash. Mar. 13, 2020) (holding that the debtor's use of cash collateral to pay in part a prepetition, allegedly secured debt owed to an affiliated debtor did not violate Jevic); In re ACI Concrete Placement of Kansas, LLC, 604 B.R. 400, 407 (Bankr. D. Kan. 2019) (holding that enforcing a "carve out" from a secured creditor's collateral for payment of professional fees did not violate Jevic); In re Daily Gazette Co., 584 B.R. 540, 546 (Bankr. S.D. W. Va. 2018) (a proposed disbursement following a section 363 sale that would result in an orderly payment of administrative claims, such as attorneys' fees and U.S. Trustee fees, followed by payment to an undisputed secured creditor whose claim exceeded amount of the net sale proceeds, "neither runs afoul of Jevic nor the Code generally"). 

Pourteymour 

In November 2020, real estate investor Ramin Pourteymour (the "debtor") filed for chapter 11 protection in the Southern District of California to prevent foreclosure on three parcels of real property encumbered by mortgages securing loans provided by a bank (the "lender") exceeding $10 million. The properties were later valued at approximately $9.7 million. 

The lender filed secured claims in the chapter 11 case in the amount of approximately $10.2 million and an unsecured claim in the amount of approximately $1.4 million based on the debtor's personal guaranty of the loans. In July 2021, the bankruptcy court granted the lender relief from the automatic stay to foreclose on one of the properties, which it then acquired by means of a credit bid in foreclosure. 

After the lender foreclosed, the debtor filed a motion to dismiss his chapter 11 case under section 1112(b) of the Bankruptcy Code, arguing that the loss of the foreclosed property (and in particular, its rental income) was "cause" for dismissal because it was a "material change of circumstances" that prevented him from confirming a chapter 11 plan. The debtor also argued that: (i) dismissal was in the best interests of creditors because it would avoid further expense, and if the case were dismissed, he would pay creditors over time; and (ii) liquidation of his remaining assets under chapter 7 would result in increased tax liability. The debtor proposed that any order dismissing the case should include language obligating him, as a condition to dismissal, to use unencumbered estate assets deposited in various accounts to pay property taxes, administrative fees. and prepetition arrearages on the remaining mortgage debt. 

The Office of the United States Trustee opposed the motion, contending that conversion of the chapter 11 case to a chapter 7 liquidation would better serve creditors because it would permit a neutral chapter 7 trustee to evaluate and possibly settle potential litigation against the lender, thereby realizing the true value of the estate's assets. The lender also opposed the motion to dismiss. It argued that creditors would be better served by an orderly liquidation of the debtor's assets, and that the debtor's proposed structured dismissal would violate Jevic.

According to the debtor, the proposed structured dismissal of his chapter 11 case would provide for the payment of all arrearages, administrative claims, and unsecured claims, other than the lender's unsecured guaranty claim, which the debtor disputed. Such a dismissal, he argued, would not violate Jevic because the disputed lender claim "was within the same class as other unsecured creditors," and therefore "no claims would be paid out of priority." Alternatively, the debtor proposed to reserve the lender's pro rata share of amounts to be distributed to other unsecured creditors—anticipated to result in an 89% recovery—pending the resolution of the debtor's objection to the lender's unsecured claim. 

The bankruptcy court ruled that there was cause to dismiss or convert the chapter 11 case based in part on the material change in circumstances caused by the foreclosure sale of one of the properties. However, the court found that the best interests of creditors would not be best served by conversion of the case to chapter 7.

Moreover, the bankruptcy court concluded that both of the structured dismissal alternatives proposed by the debtor "would violate either the holding or the spirit of Jevic." Applying a balancing test to decide whether to convert or dismiss the case under section 1112(b) of the Bankruptcy Code, the court determined that a "straight" dismissal of the debtor's chapter 11 case—rather than a structured dismissal—would best serve the interests of creditors and the estate. Accordingly, the court's dismissal order simply provided that, upon dismissal, property of the estate would revest in the debtor pursuant to section 349 of the Bankruptcy Code. The bankruptcy court expressly took no position on the debtor's proposal to pay creditors from unencumbered assets post-dismissal.

The lender appealed to the BAP.

The Bankruptcy Appellate Panel's Ruling

The BAP affirmed the ruling below, concluding that the: (i) bankruptcy court's dismissal order did not violate Jevic because it provided for a "straight dismissal" rather than a structured dismissal of the debtor's chapter 11 case; and (ii) the bankruptcy court did not abuse its discretion in concluding that dismissal of the chapter 11 case was in the best interests of creditors and the estate. 

The BAP rejected the lender's argument that the dismissal order violated Jevic by not requiring payment of the lender's unsecured claim upon dismissal because the absolute priority rule would preclude the debtor from retaining substantial assets without paying the lender's claim under a chapter 11 plan. According to the BAP, "[t]he Bankruptcy Code does not impose the same burdens and requirements on dismissal as confirmation." Pourteymour, 2023 WL 2929323, at *6. It also noted that, upon dismissal of the debtor's chapter 11 case, "[the lender] retained its rights and remedies under state law and dismissal merely returned the parties to the prepetition financial status quo." Id. 

The BAP also rejected the lender's argument that the dismissal order "provided for an implied structured dismissal because Debtor confirmed that he would pay some unsecured creditors even if the Dismissal Order was unconditional." According to the BAP, the debtor's statements about paying creditors did not alter the effect of the dismissal order, "which plainly provides for a straight dismissal." Id. Moreover, the BAP explained, the bankruptcy court handled the dismissal dispute "commendably" and did not improperly rely on the debtor's pledge to pay unsecured creditors in concluding that straight dismissal of the chapter 11 case was warranted in the best interest of creditors and the estate. In that regard, the BAP noted that the bankruptcy court's written dismissal order governed the terms of dismissal, not statements made by the court or the parties during argument on the dismissal motion.

In conclusion, the BAP held that "[t]he Dismissal Order does not violate the holding of Jevic because it provides for a straight dismissal in accordance with § 349, and it neither expressly nor impliedly conditions dismissal on payments to creditors." Id. at *7.

Outlook

The Supreme Court's ruling in Jevic does not categorically prohibit structured dismissals of chapter 11 cases, but it does prohibit structured dismissals conditioned on distributions to creditors that violate the Bankruptcy Code's priority scheme where there are no "significant Code-related objectives that the priority-violating distributions serve." Consequently, bankruptcy courts continue to approve structured dismissals that do not violate Jevic's mandate. They will likely continue to do so because there are circumstances in which a structured dismissal, rather than a straight dismissal or conversion of a chapter 11 case to chapter 7, appears to better serve the interests of creditors and the estate.

Pourteymour does not fit neatly into this category of such cases because, despite the debtor's pledge to pay unsecured creditors upon dismissal, the bankruptcy court's order dismissing the chapter 11 case was not a structured dismissal. It was not expressly conditioned on the payment of creditors (either in accordance with statutory priorities or otherwise) and was therefore consistent with section 349 of the Bankruptcy Code. Nevertheless, the bankruptcy court's unpublished (and therefore nonprecedential) ruling provides useful guidance regarding structured dismissals. It also demonstrates the pitfalls of relying on representations made by the parties on the record rather than the express language of a court order or judgment.

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