Second Circuit: Settlement Allocating Value to Unsecured Creditors Without Paying Disputed Secured Claim Did Not Violate Supreme Court's Jevic Ruling Prohibiting Priority-Skipping Final Distributions

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, the Court left open the possibility that "interim" distributions during a bankruptcy case (e.g., payments to "critical" vendors at the inception of a bankruptcy case or distributions pursuant to a settlement or a bankruptcy sale of assets), as distinguished from final distributions under a chapter 11 plan, might still be permissible despite not adhering to the bankruptcy priority scheme. In the aftermath of Jevic, many bankruptcy and appellate courts have accordingly considered whether interim non-priority conforming distributions should be approved.

The U.S. Court of Appeals for the Second Circuit weighed in on this issue in In re Nordlicht, 115 F.4th 90 (2d Cir. 2024). The court affirmed lower court rulings approving a settlement and related sale of estate claims that would distribute value to unsecured creditors without first paying disputed secured claims. According to the court, the settlement was reasonable and in the best interests of the estate, and the estate claims could be sold free and clear of the purported secured creditors' interest because their liens were subject to bona fide dispute, and any funds distributed to unsecured creditors pursuant to a conditional indemnity provision did not violate the absolute priority rule.

Structured Dismissals

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, 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.

Because outright dismissal of a chapter 11 case may not be the best course of action, some courts have approved a "structured dismissal" of a case, 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.

Even though the Bankruptcy Code does not expressly authorize or contemplate structured dismissals, many courts have relied on sections 105(a), 305(a)(1), 349(b), and 1112(b) of the Bankruptcy Code as authority for the remedy. See, e.g., In re Johnson, 565 B.R. 417 (Bankr. C.D. Cal. 2017); In re Olympic 1401 Elm Assocs., LLC, 2016 WL 4530602 (Bankr. N.D. Tex. Aug. 29, 2016); In re Petersburg Regency LLC, 540 B.R. 508, 536 (Bankr. D.N.J. 2015); 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 (November 2015) (referencing sections 105, 305, 349, and 1112 of the Bankruptcy Code as authority for structured dismissals).  

Even before the Supreme Court handed down its ruling in Jevic, structured dismissals were controversial because they sometimes involved distributions of estate property to creditors that did not comply with the Bankruptcy Code's distribution scheme. See generally Collier on Bankruptcy ¶ 1112.09 (16th ed. 2024).  

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 class of creditors 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."  

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 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 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. 

In the aftermath of Jevic, many courts have examined what kinds of interim payments can be authorized under the Court's rationale regarding permitted exceptions to its ruling. 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 S-Tek 1, LLC, 2023 WL 2529729, at *11 (Bankr. D.N.M. Mar. 15, 2023) (denying a chapter 11 debtor's request to approve a structured dismissal in a subchapter V case and noting 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 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 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 with essentially a blanket lien covering in excess of the net sale proceeds "neither runs afoul of Jevic nor the Code generally"); In re Fryar, 570 B.R. 602, 610 (Bankr. E.D. Tenn. 2017) ("In light of the Supreme Court's recent ruling in Jevic, parties who seek approval of settlements that provide for a distribution in a manner contrary to the Code's priority scheme should be prepared to prove that the settlement is not only "fair and equitable" …, but also that any deviation from the priority scheme for a portion of the assets is justified because it serves a significant Code-related objective.")  

Nordlicht 

Mark A. Nordlicht (the "debtor") founded and managed Platinum Management (NY) LLC, the general partner and investment advisor to a set of hedge funds named Platinum Partners Value Arbitrage Fund LLP ("PPVA"). In early 2016, two PPVA investors (the "Stadtmauers") requested that PPVA pay out their interest in the funds. Because, PPVA lacked sufficient liquidity to pay the Stadtmauers, PPVA instead issued the Stadtmauers two promissory personally guaranteed by the debtor.

PPVA later defaulted on the notes, but the debtor refused to honor the guaranty. The Stadtmauers then commenced an arbitration proceeding to enforce the guaranty, and on January 10, 2020, were awarded approximately $15 million by the arbitrator. Shortly afterward, the Stadtmauers sued the debtor in federal district court in New York to confirm the arbitral award.

While that action was still pending, the Stadtmauers filed an action on February 5, 2020, in New York state court to collect on the award. In addition to a money judgment against the debtor on the guaranty, the complaint stated causes of action under New York law against the debtor and various affiliated business entities for avoidance of actual and constructive fraudulent transfers, alter ego/veil piercing, and interim ex parte relief in the form of prejudgment orders of attachment against two pieces of real estate allegedly owned by the debtor in New York but held in the name of his wife, Dahlia Kalter. In their complaint, the Stadtmauers alleged that the defendants engaged in a sprawling scheme by which the debtor and his wife transferred millions of dollars in assets to various entities controlled by the debtor in an effort to make the debtor judgment proof and thereby defraud his creditors.  

After the state court granted the ex parte relief, the Stadtmauers filed notices of attachment on the two parcels of real property, which were later confirmed by the state court over the debtor's objection that service of the attachment notices was improper. 

On June 29, 2020, the debtor filed a chapter 7 petition in the Southern District of New York, whereupon the state court action was stayed. That action was later removed to the bankruptcy court as an adversary proceeding. 

In October 2020, the Stadtmauers filed a proof of secured claim against the bankruptcy estate in the amount of the $15 million arbitral award. The proof of claim stated that the claim was secured because a sheriff's levy pursuant to the state court's order of attachment endowed them with judicial liens on the properties. 

The chapter 7 trustee negotiated a settlement with the other defendants in the adversary proceeding (consisting of the original corporate defendants, among others), and the debtor's mother, Barbara Nordlicht, who was not a party in the lawsuit, of all claims that could be asserted on behalf of the chapter 7 estate in exchange for $1.5 million. In November 2020, the trustee sought bankruptcy court approval of the settlement. 

The Stadtmauers objected to the proposed settlement and counteroffered $2 million to purchase the claims. The trustee initially agreed to the Stadtmauers' proposal and sought bankruptcy court approval of the sale of the estate's claims free and clear of any competing interests under sections 363(b) and 363(f) of the Bankruptcy Code, subject to higher and better offers. 

On April 22, 2021, the defendants and Barbara Nordlicht submitted a counteroffer to purchase the claims whereby Barbara Nordlicht would: (i) pay $2.5 million to the estate to be distributed to unsecured creditors; (ii) reimburse the estate for any costs arising from defending against the Stadtmauers' claims related to their asserted liens; and (iii) fully indemnify and hold harmless the estate to the extent that Barbara Nordlicht would pay an additional $2.5 million to the estate in the event that the Stadtmauers prevailed on their causes of action and collected on any portion of the $2.5 million as higher-priority secured creditors. 

At the sale hearing, the Stadtmauers declined to increase their offer and argued that the transaction could not be approved because it provided for payments to unsecured creditors without providing for full payment of the Stadtmauer's secured claims, thereby constituting a priority-skipping distribution prohibited by Jevic. 

The bankruptcy court overruled the Stadtmauers' objection, concluding that their liens were in bona fide dispute and ruling that the claims could be sold free and clear of the disputed liens under section 363(f)(4) of the Bankruptcy Code as part of the trustee's settlement with the defendants and Barbara Nordlicht. The bankruptcy court approved the settlement and sale on June 2, 2021. 

The Stadtmauers appealed the order to the district court, which affirmed, ruling that: (i) the trustee had the authority to settle claims that were estate property; (ii) the settlement did not violate Jevic in light of the bona fide dispute regarding the validity of the Stadtmauers' judicial liens; (iii) in approving the settlement, the bankruptcy court properly applied the factors set forth in In re Iridium Operating LLC, 478 F.3d 452 (2d Cir. 2007), in determining that the proposed settlement did not fall "below the lowest point in the range of reasonableness"; and (iv) the bankruptcy court did not commit any error of law or clear error of fact in finding that the April 22, 2021, offer was better than the Stadtmauers' previous $2 million offer. 

The Stadtmauers appealed the district court's ruling to the Second Circuit. 

The Second Circuit's Ruling 

A three-judge panel of the Second Circuit affirmed the district court's decision.  

Writing for the panel, U.S. Circuit Judge Robert D. Sack explained that the chapter 7 trustee had the power to settle or sell the debtor's causes of action because such claims were property of the bankruptcy estate pursuant to section 541(a)(1) of the Bankruptcy Code, which defines "estate property" to include "all legal or equitable interests of the debtor in property as of the commencement of the [bankruptcy] case." Only the trustee had that power, he explained, because such causes of action—for actual and fraudulent conveyance and alter ego/veil piercing—were "general claims" belonging to the estate rather than the "personal claims" of individual creditors (here, the Stadtmauers) or, in the case of the veil piercing cause of action, a remedy that the trustee was powerless to sell under applicable non-bankruptcy law. Nordlicht, 2024 WL 3818696, at **7–12. 

The Second Circuit panel rejected the Stadtmauers' argument that the state court attachment orders gave them valid judicial liens on the two New York properties. Judge Sack agreed with the lower courts that the estate's claims could be sold and settled by the trustee free and clear of the Stadtmauers' purported secured interest under section 363(f)(4) of the Bankruptcy Code because that interest was subject to bona fide dispute.  

In fact, Judge Sack went further. He explained that, regardless of whether the debtor was properly served with the notices of attachment, those notices were void because applicable New York law provides that a levy is void 90 days after service unless the sheriff has taken custody of the property or collected on the debt, or the court has granted an extension of the 90-day period, none of which occurred. Id. at *14 (citing N.Y. C.P.L.R. 6214(e)). In addition, he reasoned, that deadline was not tolled upon the debtor's bankruptcy filing under section 108(c) of the Bankruptcy Code because the New York properties were held by non-debtor holding companies. The Second Circuit panel was not persuaded by the Stadtmauers' argument that another provision in New York law—N.Y. C.P.L.R. 6216—without any 90-day deadline should apply to their attachments on the real property, finding that the Stadtmauers had waived the argument by failing to raise it properly in the bankruptcy court. Id. at *15.  

The Second Circuit panel ruled that the bankruptcy court did not abuse its discretion by approving the settlement in accordance with the factors set forth in Iridium. Judge Sack explained that the bankruptcy court properly found, based on "numerous infirmities … in the Stadtmauers' theory that they held valid judicial liens giving them first priority in recovering on their fraudulent-conveyance and alter-ego claims," and the existence of "potential bankruptcy law defenses," that the settlement's future benefits, including greater recovery by the estate, indemnification, and reimbursement of the estate's legal fees, outweighed the possibility that the Stadtmauers might prevail in the adversary proceeding. Id. at **17–18. He also noted that the paramount interests of creditors were better served by the proposed settlement, evidenced by, among other things, the absence of any objections to it by any creditors other than the Stadtmauers. Id. at *18. 

The Second Circuit also rejected the argument that the settlement violated the "basic system of priority" in bankruptcy cases, "as articulated in Jevic." 

Judge Sack explained that the Stadtmauers appeared to be making two separate arguments in support of this contention: (i) the $2.5 million to be paid to the estate by Barbara Nordlicht for distribution to unsecured creditors impermissibly skipped over the Stadtmauers' secured claims; and (ii) the $2.5 million indemnity guaranteed by Barbara Nordlicht also violated Jevic's priority scheme because those funds should first be used to satisfy the Stadtmauers' secured claims. Both arguments, he emphasized, were meritless.

Initially, Judge Sack observed that "[w]e leave aside the issue whether Jevic, which analyzed a structured dismissal of a bankruptcy action [sic], applies to sale hearings under sections 363(b) and (f) at all." He wrote that "[w]e assume without deciding that it does." Id. at *19. Even so, the Second Circuit panel agreed with the lower courts that "[u]ntil the [Stadtmauers] have established in the underlying bankruptcy proceedings that their liens are valid, their claims are not secured … [a]nd as unsecured creditors, they have no priority over other unsecured creditors." Id. 

In Jevic, Judge Sack emphasized, the Supreme Court rationale was premised on the "principled view" that final distributions of estate assets, such as distributions made as part of a structured dismissal, must adhere to the Bankruptcy Code's priority scheme. The Court expressly noted that this limitation likely does not apply to "interim distribution[s] of settlement proceeds" as it would be more "difficult to employ the rule of priorities [there] because … the claims against [the estate] are not yet fully resolved." Id. (quoting Jevic, 580 U.S.at 467) (internal quotation marks omitted). 

According to Judge Sack, that was precisely the case here. He explained that the bankruptcy court repeatedly emphasized that approval of the settlement at the sale hearing was not a final disposition of the claims against the estate. Thus, Judge Sack wrote, "[a]ny distribution of proceeds from the Settlement were … interim distributions, evading Jevic's application of ordinary priority rules." Id. He further noted that the Stadtmauers were "free to pursue precisely the recourse that the petitioners in Jevic could not: assert the validity and priority of their claims at a later stage in the bankruptcy litigation." Id. 

Finally, the Second Circuit panel ruled that the settlement's indemnity provision also did not offend Jevic and the Bankruptcy Code's priority scheme because, in the event the Stadtmauers succeeded in their claim that they hold valid, higher priority liens: (i) the $2.5 million paid for the claims represented the value of such claims, and the Stadtmauers' liens would therefore be satisfied upon receipt of that amount; and (ii) the bankruptcy estate had no interest in, and the Stadtmauers' lien therefore could not extend to, any payments that might be made to unsecured creditors pursuant to the indemnity provided by non-debtor, non-party Barbara Nordlicht. 

Outlook 

The Second Circuit's ruling in Nordlicht is emblematic of the challenges faced by bankruptcy and appellate courts in the aftermath of the Supreme Court's ruling in Jevic. Most courts have found a way to steer clear of Jevic's proscription by either limiting the decision to its particular facts or concluding that a proposed priority-aberrant distribution falls within one of the exceptions outlined by the Court. The principle significance of Nordlicht is that it illustrates the flexibility afforded to bankruptcy courts to approve negotiated settlements or asset sales (or other similar deals) that are essential either to the orderly liquidation of estate assets to maximize creditor recoveries or to create adequate support for confirmation of a chapter 11 plan.