Structured Dismissal of Chapter 11 Cases Did Not Violate Jevic

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," the impact of the ruling on such relief remains an open question. The U.S. Bankruptcy Court for the Southern District of New York recently examined this issue in In re KG Winddown, LLC, 628 B.R. 739 (Bankr. S.D.N.Y. 2021). According to the court, "[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."

Structured Dismissals

In a typical successful 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.

After a bankruptcy court approves the sale of substantially all of a chapter 11 debtor's assets under section 363(b), a number of options are 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 (other than a case filed under the Securities Investor Protection Act) reinstates the status quo ante by, among other things, reinstating any prebankruptcy 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) 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. 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 by the American Bankruptcy Institute ("ABI") as follows:

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 ABI 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.
• Provisions that, notwithstanding section 349(b), prior bankruptcy court orders survive dismissal and the court retains jurisdiction to implement the structured dismissal order; to resolve certain disputes; and to 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) 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 (November 2015) (referencing use of sections 105, 305, 349, and 1112 as authority).

Section 1112(b)(1) 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 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 ("Collier") ¶ 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 7 case, the order of priority for the distribution of unencumbered assets is determined by section 726 of the Bankruptcy Code. The order of distribution ranges from payments on claims in the order of priority specified in section 507(a), which have the highest priority, to payment of any residual assets to the debtor, which has the lowest priority. Distributions are to be made pro rata to parties of equal priority within each of the six categories specified in section 726. If claimants in a higher category of distribution do not receive full payment of their claims, no distributions can be made to parties in lower categories.

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. 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 are the following: (i) the creditor must receive at least as much under the plan as it would receive in a chapter 7 liquidation (11 U.S.C. § 1129(a)(7)); and (ii) 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 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.

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 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 strictly limiting Jevic to its facts or by finding that the relief sought fell within one of the permitted exceptions articulated by the Court in 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 (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 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 (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").

KG Winddown

In July 2020, former "Kona Grill" restaurant chain companies KG Winddown, LLC and certain affiliates (collectively, "debtors") filed for chapter 11 protection in the Southern District of New York for the second time in two years. On December 22, 2020, the bankruptcy court approved a sale of substantially all of the debtors' assets to secured creditor BSP Agency, LLC and related entities (collectively, "BSP"). The purchase price consisted of, among other things, a credit bid in the amount of the debtors' liability under pre- and postpetition credit facilities ($18 million), a $100,000 cash payment reserved for distribution to general unsecured creditors, cash in an amount sufficient to cover all cure amounts under assumed executory contracts, and the assumption of certain liabilities. The order approving the sale exculpated BSP for acts taken in connection with the sale.

The sale transaction included transition services agreements providing for the transfer of liquor licenses and other permits to BSP for certain restaurants located in Florida, New York, and New Jersey. On May 14, 2021, the debtors filed a motion seeking a structured dismissal of the chapter 11 cases of all debtors except two for which liquor licenses had not yet been transferred. On the filing date of the motion, the debtors' cash balance was approximately $1.14 million, but that decreased to approximately $940,000 two weeks later. In connection with the motion, the debtors' counsel agreed to discount its fees and expenses to the extent necessary to pay other administrative claims in full, but no cash remained to make any distributions to unsecured creditors.

The debtors' motion sought approval of various procedures to implement dismissal, including: (i) notice to all creditors and interest holders; (ii) authorization to pay allowed administrative claims, including U.S. Trustee fees, in full or as agreed otherwise; and (iii) authorization to file a certification requesting dismissal of the remaining debtors' cases once their liquor licenses had been transferred. The debtors also requested an order that, notwithstanding section 349, all prior court orders issued in the chapter 11 cases would remain in full force and effect after dismissal and the court would retain jurisdiction to: (i) resolve any disputes regarding the implementation of its orders; and (ii) adjudicate an adversary proceeding ("Katzoff AP") filed during the case by BSP alleging certain defendants impermissibly interfered in the sale transaction by preventing certain liquor license and domain name transfers.

The U.S. Trustee objected to the dismissal motion, arguing that the motion was: (i) premature because the debtors were not seeking immediate dismissal, but instead asking for approval of a two-step dismissal process conditioned on the liquor license transfers; (ii) unnecessary with respect to the payment of administrative claims; and (iii) improper because the debtors sought a "blanket reservation" of all orders in the case.

The Bankruptcy Court's Ruling

The bankruptcy court granted the debtors' motion to approve the structured dismissals.

Bankruptcy Judge Martin Glenn acknowledged that a bankruptcy court's authority to order a structured dismissal "is the subject of some debate." However, he explained, although Jevic limited the potential scope of structured dismissals, it "'did not entirely close the door,'" provided the proposed dismissal contemplates distributions that do not the violate the Bankruptcy Code's priorities or the parties consent to nonconforming distributions, and dismissal otherwise complies with the applicable provisions of the Bankruptcy Code. KG Winddown, 628 B.R. at 745 (quoting Collier at ¶ 1129.09).

Here, Judge Glenn noted, the U.S. Trustee did not argue that the distributions proposed by the debtors as part of dismissal violated the statute's priority scheme, but merely that the contemplated distribution to administrative claimants was already dictated by the Bankruptcy Code, making court approval an unnecessary "comfort order." Judge Glenn disagreed, writing that, "[w]hile perhaps not required, approval would provide certainty to the Debtors and the creditors, and promote the orderly winding-up of the estates, which is precisely the purpose of the contemplated structured dismissal." Id. at 747.

He also rejected the U.S. Trustee's argument that dismissal was premature. According to Judge Glenn, "[t]he U.S. Trustee has not identified any concrete reason that the proposed two-step process should not be approved, or why [non-pending liquor license transfer] Debtors' cases should not be dismissed before [the remaining] Debtors' cases are dismissed." Id.

In accordance with In re Porges, 44 F.3d 159 (2d Cir. 1995), Judge Glenn concluded that he could dismiss the debtors' chapter 11 cases, yet retain jurisdiction over the Katzoff AP pursuant to section 349.

Finally, Judge Glenn held that, pursuant to section 349, the court had the power to direct that orders entered during the debtors' chapter 11 cases, including the sale order containing the BSP exculpation provision, would survive dismissal. That provision, he noted, was negotiated in reliance that the sale order would survive dismissal under any circumstances and "appears to be precisely the kind of right that should be protected through section 349." Moreover, he emphasized, the U.S. Trustee raised this objection too late, having failed to object to exculpation at the time the court approved the sale.

Outlook

Like many other rulings issued in the aftermath of Jevic, KG Winddown indicates that rumors of the demise of structured dismissals are an exaggeration. To be sure, Jevic clearly prohibits nonconsensual distributions that violate the Bankruptcy Code's priority scheme as part of a structured chapter 11 dismissal. However, priority-scheme-conforming or consensual distributions in connection with a structured dismissal are valid, and interim nonconforming distributions, such as settlement or critical vendor payments (whether or not consensual), may still be authorized provided they serve a recognized bankruptcy purpose.

Bankruptcy courts in the Southern District of New York have been prominent proponents of the continued vitality of structured dismissals post-Jevic. In addition to KG Winddown, Bankruptcy Judge Robert Drain recently approved a structured dismissal of the chapter 11 cases of grocery store chain Great Atlantic & Pacific Tea Co. and certain affiliates (collectively, "A&P") after A&P liquidated substantially all of its assets, leaving it with insufficient funds to confirm a plan. See In re Atlantic & Pacific Tea Co. Inc., No. 15-23007 (RDD) (Bankr. S.D.N.Y. May 15, 2021) [Doc. No. 4810]. The structured dismissal order distributed A&P's assets in accordance with the Bankruptcy Code's priority scheme—after distribution of collateral to secured creditors, administrative claimants received an approximately 20% recovery and junior creditors received nothing. Judge Drain rejected arguments that the cases should instead be converted to chapter 7 liquidations and that Jevic should be interpreted broadly to preclude any proposed plan-like relief that circumvents the Bankruptcy Code's procedural safeguards. According to Judge Drain, the structured dismissal did not violate Jevic because, among other things, the provisions governing the wind-down of A&P's remaining assets did not constitute "plan relief" or an end-run around the Bankruptcy Code's creditor protections.

A version of this article is being published in Lexis Practical Guidance. It has been published here with permission.