Fall 2015, Vol. 21 No. 1

Transcription

1 TABLE OF CONTENTS Articles» Delaware Bankruptcy Court Adopts the "Time" Approach to Lease Rejection Damages By Curtis S. Miller and William M. Alleman Jr. Judge Kevin Carey provides significant guidance to debtors and landlords calculating rejection damages claims. What Level of Specificity Is Needed to Preserve Post-Confirmation Claims? By Siddharth P. Sisodia A challenging endeavor made easy. Is Structured Dismissal a Dismissal of Structure? By Edward Clarkson III Jevic is the first circuit court decision to affirmatively rule on the issue of whether the Bankruptcy Code allows for structured dismissals. ABI Commission Issues Recommendations on Preference Laws By Daniel J. DeFranceschi Read about Chapter 11 reforms in the new report. When Does a Chapter 11 Plan Extinguish a Secured Creditor's Lien? By Zachary I. Shapiro The Second Circuit outlines the circumstances. Equitable Mootness Is Alive and Well By Daniel J. DeFranceschi A recent Third Circuit decision makes it clear. News & Developments» The Apparent Conflict Between the Norris-LaGuardia Act and Section 362 What happens when worlds (almost) collide?

2 ARTICLES Delaware Bankruptcy Court Adopts the "Time" Approach to Lease Rejection Damages By Curtis S. Miller and William M. Alleman Jr. Recently, Judge Kevin Carey of the United States Bankruptcy Court for the District of Delaware issued the first written opinion in the District of Delaware resolving the time versus rent debate and interpreting section 502(b)(6) of the Bankruptcy Code in Delaware, an issue that is important to both debtors and commercial landlords. In In re Filene s Basement, LLC, 2015 Bankr. LEXIS 1350 (Bankr. D. Del. Apr. 16, 2015), Judge Carey held that section 502(b)(6) of the Bankruptcy Code unambiguously caps a landlord s rejection damages claim at the rent reserved for the greater of one year or 15 percent of the remaining term of the lease, not to exceed three years. Id. at *2. Because the landlord in Filene s followed the common practice of calculating its rejection damages claim with reference to 15 percent of the total remaining rent under the lease, the court reduced the rejection damages claim accordingly. Judge Carey joins a growing number of courts that interpret section 502(b)(6) according to its plain meaning, and his decision provides significant guidance to debtors and landlords calculating rejection damages claims under section 502(b)(6) of the Bankruptcy Code. Background Filene s Basement, LLC, Syms Corp., and certain of their affiliates (collectively, the debtors) filed for bankruptcy protection on November 2, As of the petition date, the debtors owned and operated 46 off price retail clothing stores across the country. Many of the stores were located in commercial properties leased by one of the debtors. The debtors rejected all of their real property leases as a part of their restructuring, giving rise to numerous claims by landlords for rejection damages. Section 502(b)(6) of the Bankruptcy Code caps landlords rejection damages claims by providing that a court shall allow such claim in the amount determined by the court, except to the extent that... such claim exceeds (A) the rent reserved by such lease, without acceleration, for the greater of one year, or 15%, not to exceed three years, of the remaining term of such lease U.S.C. 502(b)(6). The Split in Case Law Interpreting Section 502(b)(6) Seizing on a purported ambiguity in section 502(b)(6) and a split in the case law interpreting that section, landlords in Filene s took various approaches to calculating their capped rejection damages claims. Many landlords took the position that the reference to 15 percent in section 502(b)(6) was a measure of the remaining rent under the lease and calculated their capped rejection damages as 15 percent of the total rent reserved remaining for the duration of the lease (the rent approach). The rent approach is generally favored by landlords because it often results in a greater capped claim, especially where the lease contains an escalation clause. The debtors contested the rent approach and argued that 15% in section 502(b)(6) was a reference to the remaining term of the lease. The debtors calculated the capped rejection damages claims Page 2 of 28

3 by determining the amount of time that constituted 15 percent of the remaining term of the lease and allowing the rent reserved under the lease for that period of time (the time approach). Both the rent approach and time approach have support in case law. Compare In re Heller Ehrman LLP, 2011 WL , at *4 (N.D. Cal. Feb. 11, 2011) (holding that section 502(b)(6) requires the time approach), In re Blatstein, 1997 WL , at *14 15 (E.D. Pa. Aug. 26, 1997) (finding that the 15% applies to time remaining [on the lease] ), In re Shane Co., 464 B.R. 32, 39 (Bankr. D. Colo. 2012) ( Fifteen percent of the remaining term of the lease is plainly a reference to an amount of time not money. (emphasis in original)), In re Connectix Corp., 372 B.R. 488, (Bankr. N.D. Cal. 2007) (applying the 15 percent calculation to the time remaining on the lease), In re Ace Elec. Acquisition, LLC, 342 B.R. 831, 833 (Bankr. M.D. Fla. 2005) ( The 15 percent limitation of 11 U.S.C. 502(b)(6) speaks in terms of time, not in terms of rent.... ), In re Peters, 2004 WL , at *6 n.20 (Bankr. E.D. Pa. 2004) (following the decision in Iron-Oak), In re Allegheny Int l, 136 B.R. 396, (Bankr. W.D. Pa. 1991) (finding that the 15 percent cap applied to the next succeeding term remaining on the lease ), aff d, 145 B.R. 823, (W.D. Pa. 1992), and In re Iron-Oak Supply Corp., 169 B.R. 414, 420 (Bankr. E.D. Cal. 1994) ( The correct interpretation, however, is that the Congress intended that the phrase remaining term be a measure of time, not rent. ), with New Valley Corp. v. Corp. Prop. Assocs. (In re New Valley Corp.), 2000 WL , at *11 12 (D.N.J. Aug. 31, 2000) (finding that the 15 percent cap applies to remaining rent due), In re Andover Togs, Inc., 231 B.R. 521, (same), In re Today s Woman of Fla., Inc., 195 B.R. 506, (Bankr. M.D. Fla. 1996) (same), In re Gantos, Inc., 176 B.R. 793, (Bankr. W.D. Mich. 1995) (same), In re Fin. News Network, Inc., 149 B.R. 348, 351 (Bankr. S.D.N.Y. 1993) (same), and In re Communicall Central, Inc., 106 B.R. 540, 544 (Bankr. N.D. Ill. 1989) (same). Although some cases refer to the rent approach as the majority view, see, e.g., Connectix Corp., 372 B.R. at 491, the debtors argued that the plain language of section 502(b)(6) and the statute s legislative history and policy support the time approach. In addition, the debtors noted that deeming the rent approach a majority view was misleading, as there was approximately an even split among courts adopting the rent approach and the time approach. The Court s Opinion in Filene s Following briefing and oral argument on the question of the proper interpretation of section 502(b)(6) as it applied to the claim filed by Connecticut/DeSales LLC, Judge Carey issued an opinion agreeing with the debtors that section 502(b)(6) requires application of the time approach. As an initial matter, the court refuted the notion that a majority view existed, stating that a review of the case law reveals that courts appear to be evenly split. There is no clear majority of decisions favoring either the rent approach or the time approach. In re Filene s Basement, 2015 Bankr. LEXIS 1350, at *10 n.9. Moreover, Judge Carey found that the text of section 502(b)(6) unambiguously supported the time approach. Id. at * Citing Third Circuit precedent explaining that a provision is ambiguous when, despite a studied examination of the statutory context, the natural reading of a Page 3 of 28

4 provision remains elusive, Judge Carey found that the natural reading of section 502(b)(6) supported the time approach for several reasons. Id. at *11 (quoting Price v. Del. State Police Fed. Credit Union (In re Price), 370 F.3d 362, 369 (3d Cir. 2004)). First, as a structural matter, when comparing the greater or lesser of two things (i.e., one year or 15% ), the measurements must be parallel that is, time versus time. Id. (quoting Heller Ehrman LLP, 2011 WL , at *2 3). Second, the court noted that the phrase term of a lease commonly refers to the length of a lease based on time rather than rent. Id. at *12 13 (quoting Heller Ehrman LLP, 2011 WL , at *2 3). Third, the statute is generally written in terms of time: the calculation of the cap begins following the earlier of two dates, the date of petition or repossession, [and] the maximum cap is worded in terms of time, three years. Id. at *13 (quoting Heller Ehrman LLP, 2011 WL , at *2 3). Further, the court reasoned that section 502(b)(6) s command to calculate rent reserved without acceleration supports the time approach because the rent approach would render that phrase superfluous. Id. at *14. Indeed, [t]aking 15 percent of all the rent for the remaining term, especially where escalation clauses are present, would be tantamount to effecting an acceleration. Id. (quoting Iron-Oak Supply Corp., 169 B.R. at 420). For these reasons, the court found that section 502(b)(6) unambiguously supported the time approach and, for that reason, there is no need to employ other tools of statutory construction. Id. In addition to finding that section 502(b)(6) unambiguously supports the time approach, the court explained that the legislative history and policy of section 502(b)(6) offer further support for the time approach. Prior to 1934, landlords were precluded from recovering any future rent because such claims were considered contingent and not capable of proof. Id. at *14 15; see Connectix Corp., 372 B.R. at 491; see also Oldden v. Tonto Realty Corp., 143 F.2d 916, 918 (2d Cir. 1944) (explaining that [t]he Bankruptcy Act of 1898 as originally enacted was silent as to the provability of claims for rent to accrue in the future. The courts, however, were virtually unanimous in deciding that rent destined to accrue after the filing of a petition was not capable of proof ; collecting cases). Following the 1938 amendments, the Bankruptcy Act provided that a landlord could recover future rent but limited the claims to the year next succeeding the date of surrender or reentry, whichever occurred first, in a liquidation case, or the three years next succeeding surrender or reentry in a reorganization case. In re Filene s Basement, 2015 Bankr. LEXIS 1350, at *15; see Bankruptcy Act of 1938 (Chandler Act), ch. 575, 52 Stat. 840, 873, 894 (1938); see also 16 Collier on Bankruptcy 502.LH[3][a]. When Congress enacted the Bankruptcy Code in 1978, it maintained the limitations on landlord rejection damage claims from the Bankruptcy Act but used a percentage formula to replace the limitation on recovery of three years rent in rehabilitation cases. In re Filene s Basement, 2015 Bankr. LEXIS 1350, at *15 16; see 11 U.S.C. 502(b)(6)(A); Connectix, 372 B.R. at 492; H.R. Rep. No. 595 at 353. Nothing in the legislative history, however, indicates that Congress intended to depart from calculating the cap based on the rent that would become due within a time period immediately following a statutory trigger date. In re Filene s Basement, 2015 LEXIS 1350, at *15 16; Heller Ehrman LLP, 2011 WL , at *4 5; Connectix Corp., 372 B.R. at 493; Allegheny Int l, 136 B.R. at To the contrary, the House Report on section 502(b)(6) states that [t]he damages a landlord may assert from termination of a lease are limited to the rent reserved for the greater Page 4 of 28

5 of one year or [fifteen] percent of the remaining lease term, not to exceed three years. In re Filene s Basement, 2015 Bankr. LEXIS 1350, at *16; H.R. Rep at 353. As a consequence, Judge Carey agreed that [b]ecause there is no clear expression of an intent to change from a time approach to a total rent based formula, it cannot be presumed that Congress intended to make that shift. In re Filene s Basement, 2015 Bankr. LEXIS 1350, at *15 16 (quoting Connectix Corp., 372 B.R. at 493). Further, with respect to the policy of section 502(b)(6), Judge Carey found that the time approach better serves the economic forces Congress was trying to address when it enacted the landlord damage cap. Id. at *16 17 (quoting Connectix Corp., 372 B.R. at 494). Specifically, Judge Carey noted that landlords, unlike other general unsecured creditors, have added protection at the termination of a lease arrangement. Landlords get their property back. Id. at *17 (quoting Connectix Corp., 372 B.R. at 494). The court rejected the reasoning of other courts that the rent approach is more equitable because it allows landlords to recover damages based on rent increases the parties bargained for when they entered into the lease. Id. at *16 17 (citing Gantos, Inc., 176 B.R. at ; New Valley, 2000 WL , at *11 12). The Importance of the Filene s Decision As noted above, the Filene s decision is the first written decision in the District of Delaware interpreting section 502(b)(6) s time versus rent question. Especially in light of the recent trend of retail bankruptcy filings, the decision may provide a significant benefit to debtors seeking to invoke section 502(b)(6) to cap landlords rejection damages, as the time approach generally results in lower claim amounts than the rent approach. The decision also adds to the growing number of courts that have adopted the time approach. Keywords: bankruptcy and insolvency litigation, section 502(b)(6); time versus rent, lease rejection, rejection damages Curtis S. Miller is a partner with Morris, Nichols, Arsht & Tunnell LLP in Wilmington, Delaware. William M. Alleman Jr. is an associate with Benesch, Friedlander, Coplan & Aronoff LLP in Wilmington, Delaware. Page 5 of 28

6 What Level of Specificity Is Needed to Preserve Post- Confirmation Claims? By Siddharth P. Sisodia When will a debtor or trustee have standing to pursue causes of actions after a plan of reorganization has been confirmed? Section 1123(b)(3)(B) of the Bankruptcy Code (11 U.S.C (2006)) is a very important provision within the Bankruptcy Code. This section allows a debtor or a trustee to bring claims and causes of actions against a debtor s creditors or other interested parties after a plan of reorganization has been confirmed. There are, however, varying degrees of interpretations as to the application of the section. This article highlights various bankruptcy and appellate court decisions interpreting section 1123(b)(3)(B) of the Bankruptcy Code. Preservation of Claims under Section 1123(b)(3)(B) A plan of reorganization may provide for the retention of claims to be brought post-confirmation as long as the retention language is sufficient. Figuring out the level of specificity needed to retain claims in a plan has proven to be a challenging endeavor for the circuit courts, bankruptcy courts, and bankruptcy practitioners. In general, when a bankruptcy court confirms a Chapter 11 plan and the plan becomes effective, a debtor loses its debtor-in-possession status and, with it, standing to pursue the estate s claims. Section 1123(b)(3)(B) of the Bankruptcy Code provides that the plan may provide for the retention and enforcement by the debtor, by the trustee, or by a representative of the estate appointed for such purpose, of any such claim or interest. A debtorin-possession or a trustee may preserve standing to bring claims post-confirmation only if the plan expressly provides for the retention and enforcement [of claims] and the [p]lan expressly retains the right to pursue such actions. Dynasty Oil & Gas, LLC v. Citizens Bank (In re United Operating, LLC), 540 F.3d 351, 355 (5th Cir. 2008)). Circuit courts have interpreted the requirement of express retention of claims in the plan with varying levels of specificity. The retention language in the plan has to be specific and unequivocal. Id.; Harstad v. First Am. Bank, 39 F.3d 898, (8th Cir. 1994); see also P.A. Bergner & Co. v. Bank One, Milwaukee, N.A. (In re P.A. Bergner & Co.), 140 F.3d 1111, 1117 (7th Cir. 1998). If the plan contains no preserving language, the post-confirmation fiduciary will not be able to pursue the claims post-confirmation. Harstad, 39 F.3d at In addition, a blanket reservation of any and all claims arising under the Bankruptcy Code is not sufficient. United Operating, 540 F.3d at 356. Conversely, a general reservation indicating the type or category of claims to be preserved is held to be sufficiently specific. Fleet Nat l Bank v. Gray (In re Bankvest Capital Corp.), 375 F.3d 51, 59 (1st Cir. 2004) (collecting cases); United Operating, 540 F.3d at 355. Moreover, there is no need to itemize the parties against whom the claims might be brought. United Operating, 540 F.3d at 355; Alary Corp. v. Sims (In re Associated Vintage Grp., Inc.), 283 B.R. 549, 563 (B.A.P. 9th Cir. 2002). Only preservation of a specific type or category of claim is necessary. United Operating, 375 F.3d at 355. In addition, the blanket reservation in the plan along with identification of specific claims in a disclosure statement might Page 6 of 28

7 also be sufficient to preserve standing as long as claims are identified in a disclosure statement. Katz v. I.A. All. Corp. (In re I. Appel Corp.), 300 B.R. 564, 570 (S.D.N.Y. 2003), aff d, Katz v. I.A. All. Corp. (In re I. Appel Corp.), 104 F. App x 199, 2004 WL , at *1 (2d Cir. 2004). Both the Fifth Circuit and the Second Circuit have held that courts may consult the disclosure statement in addition to the plan to determine whether a post-confirmation debtor has standing. Spree v. Laguna Madre Oil & Gas, L.L.C. (In re Tex. Wyo. Drilling, Inc.), 647 F.3d 547, 552 (5th Cir. 2011). Even though section 1123(b)(3)(B) of the Bankruptcy Code does not require that the retention language be specific and unequivocal, there is some logic to the requirement. Bergner, 140 F.3d at The Fifth Circuit has held that absent specific and unequivocal retention language in the plan, creditors lack sufficient information regarding their benefits and potential liabilities to cast an intelligent vote. United Operating, 540 F.3d at 355. In Texas Wyoming Drilling, the Fifth Circuit held that the purpose of the rule is to put creditors on notice of any claim [the debtor] wishes to pursue after confirmation and enable creditors to determine whether the proposed [p]lan resolves matters satisfactorily before they vote to approve it. Tex. Wyo. Drilling, 647 F.3d at 550. The rule allows timely and comprehensive resolution of the estate and effective administration and settlement of all of the debtor s assets and liabilities within a limited time. United Operating, 540 F.3d at 355. An ambiguity in the plan s preservation language can also be fatal to the debtor s or trustee s standing to bring claims post-confirmation. Ambiguity in the language may result when the plan s language is not clear as to who the potential defendants are and which claims are preserved. Not all circuits, however, have ruled on whether the ambiguity in the preservation language can be fatal to the litigant s standing. Only the Fifth Circuit has found sufficient standing where the reservation language was ambiguous. Compton v. Anderson (In re MPF Holdings U.S., LLC), 701 F. 3d 449, 456 (5th Cir. 2012) (citing In re Tex. Gen. Petroleum Corp., 52 F.3d 1330, 1336 (5th Cir. 1995)). Using traditional tools of contract interpretation,the Fifth Circuit has held that the ambiguity as to which parties or claims were preserved does not create an inference that no claims are preserved. See Nat l Benevolent Ass n of the Christian Church v. Weil, Gotshal & Manges, LLP (In re Nat l Benevolent Ass n of the Christian Church), 333 F. App x 822, 828 (5th Cir. 2009). The ambiguity only creates an inference that only those parties or claims not covered in the plan s ambiguous language are to be released. Id. A type or category of claim preserved in the plan and the claim subsequently brought postconfirmation is also critical. A litigant has no standing to pursue types of claims different from those types preserved in the plan. Tex. Wyo. Drilling, 647 F.3d at 550. For example, in United Operating, the plan preserved only the types of claims arising under the Bankruptcy Code. United Operating, 375 F.3d at 355.Post-confirmation, the plaintiff tried to bring common-law tort-based claims. Id. The court held that neither the plan s blanket reservation of any and all claims arising under the Bankruptcy Code nor its specific reservation of other types of claims under various Bankruptcy Code provisions were sufficient to preserve the common-law claims. Id. Page 7 of 28

8 Moreover, in at least one case, a debtor argued that it had standing to pursue claims postconfirmation, even though there was no preserving language in the plan, by arguing that section 1141(b) of the Bankruptcy Code preserves the claims to be brought post-confirmation. Harstad, 39 F.3d at 902. Section 1141(b) of the Bankruptcy Code provides that [e]xcept as otherwise provided in the plan or the order confirming the plan, the confirmation of a plan vests all of the property of the estate in the debtor. 11 U.S.C. 1141(b). The debtor argued that because preference claims were not preserved in the plan, they became the property of the debtor, and, therefore, the debtor could bring those actions. Harstad, F.3d at 902. The court did not agree. The court reasoned that if it were to agree with the debtor s argument, section 1123(b)(3) of the Bankruptcy Code would be rendered a nullity. Id. The court reasoned that there is no automatic preservation of claims to be brought post-confirmation under section 1141(b) of the Bankruptcy Code. Id. at 903. Defenses to Post-Confirmation Claims A trustee or debtor-in-possession should also note that, even though a litigant may have standing to pursue the claims post-confirmation, there are at least four defenses that may prohibit litigation of such claims. A defendant can raise all of the following defenses: (1) res judicata, Browning v. Levy, 283 F.3d 761, 772 (6th Cir. 2002); Kelley, 199 B.R. at 703; Sure-Snap Corp. v. State St. Bank & Tr. Co., 948 F.2d 869, 876 (2d Cir. 1991); Associated Vintage Grp., 283 B.R. at ; (2) judicial estoppel, Browning, 283 F.3d at 775; Associated Vintage Grp., 283 B.R. at 566; (3) equitable estoppel, Associated Vintage Grp., 283 B.R. at 567; and (4) laches (statute of limitations), Bankvest Capital, 375 F.3d at 61. Res judicata will bar a subsequent action if the litigant bringing the claim had the knowledge and ability to bring such claim in the prior proceeding. Bankvest Capital, 375 F.3d at 61. The doctrine of judicial estoppel bars a party from (1) asserting a position that is contrary to one that the party has asserted under oath in prior proceedings, where (2) the prior court adopted the contrary position either as a preliminary matter or as part of a final disposition. Browning, 283 F.3d at 775; Teledyne Indus., Inc. v. NLRB, 911 F.2d 1214, 1218 (6th Cir. 1990). There are four basic elements to the defense of equitable estoppel: (1) The party to be estopped must know the facts; (2) the party to be estopped must either intend that its conduct will be acted upon or act in a manner that the party asserting estoppel has a right to believe it is so intended; (3) the party asserting estoppel must be ignorant of the true facts; and (4) the party asserting estoppel must rely on the conduct to its injury. Associated Vintage Grp., 283 B.R. at 567. Page 8 of 28

9 Finally, in determining whether laches applies, courts ask whether the plaintiff s delay in bringing suit was unreasonable and whether the defendant was prejudiced by the delay. Puerto Rican-American Ins. Co. v. Benjamin Shipping Co., Ltd., 829 F.2d 281, 283 (1st Cir. 1987). The analogous statute of limitations defense determines where the burden of proof falls; if a plaintiff files a complaint within the analogous statutory period, the burden of proving unreasonable delay and prejudice falls on the defendant. Bankvest Capital, 375 F.3d at 61. These defenses would not apply, however, if in an earlier proceeding, the defendant fraudulently concealed or prevented the litigant from asserting or preserving claims. Browning, 283 F.3d at 770. Conclusion Section 1123(b)(3)(B) of the Bankruptcy Code is intended to give notice to the debtor s creditors and other interested parties of all potential claims that can be brought against them postconfirmation. A proper understanding of how specific the retention language needs to be is crucial because in the absence of a proper language in the plan, the debtor risks losing an important interest of the bankruptcy estate. Keywords: bankruptcy and insolvency litigation, section 1123(b)(3)(B), post-confirmation, standing Siddharth P. Sisodia is an associate with DiConza Traurig Kadish LLP in New York City, New York. Page 9 of 28

10 Is Structured Dismissal a Dismissal of Structure? By Edward Clarkson III The Bankruptcy Code, 11 U.S.C , explicitly provides three ways for a debtor under Chapter 11 to exit the bankruptcy case: confirmation of a plan of reorganization, conversion to a Chapter 7 liquidation, or dismissal. However, recently, the United States Court of Appeals for the Third Circuit held that a structured dismissal may be a viable fourth exit option for a Chapter 11 debtor under certain circumstances. Official Comm. of Unsecured Creditors v. CIT Group/Bus. Credit Inc. (In re Jevic Holding Corp.), 787 F.3d 173 (3d Cir. 2015). A structured dismissal is a disposition that winds up the bankruptcy with certain conditions attached instead of simply dismissing the case and restoring the status quo ante. Jevic, 787 F.3d at 177. Structured dismissal orders often include mutual releases, claim reconciliation protocol, gifting of funds from secured lenders to creditors of lower priority, and provisions for a bankruptcy court s continued retention of jurisdiction over certain post-dismissal matters. Although there is no express authority in the Bankruptcy Code that allows for structured dismissals, courts have relied on sections 349(a), 1112(b), 305(a), and/or 105(a) for the authority to enter such relief. Under section 1112(b), a party in interest may move the bankruptcy court to dismiss the case for cause. For cause is further defined by 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. 11 U.S.C. 1112(b)(4). Section 305 states that a court may dismiss or suspend all proceedings in a case if the interests of creditors and the debtor would be better served by such dismissal or suspension. 11 U.S.C. 305(a). Section 105(a) grants a bankruptcy court authority to enter orders that are necessary or appropriate to carry out the provisions of the Bankruptcy Code. Finally, the effect of a dismissal in a Chapter 11 case is governed by section 349, in which all parties to the bankruptcy are returned to their respective positions prior to the date of the petition unless the court orders otherwise for cause. Jevic is the first circuit court decision to affirmatively rule on the issue of whether the Bankruptcy Code allows for structured dismissals. In re Jevic: Background Facts Jevic Transportation, Inc. (together with its parent holding company, Jevic Holding, Inc.) was a trucking company based in New Jersey. In 2006, Jevic was subject to a leveraged buyout led by a subsidiary of Sun Capital Partners substantially financed by CIT Group/Business Credit, Inc. The leveraged buyout consisted of an $85 million revolving credit facility extended by CIT to Jevic so long as Jevic maintained $5 million in assets and collateral. However, due to the downturn in the economy, the leveraged buyout proved unsuccessful. Page 10 of 28

11 On May 19, 2008, Jevic ceased all operations and its employees received notice of their impending terminations. On May 20, 2008, Jevic filed a voluntary Chapter 11 petition in the United States Bankruptcy Court for the District of Delaware. As of May 20, 2008, Jevic owed approximately $53 million to Sun Capital and CIT, which both held first-priority liens on substantially all of Jevic s assets. Further, Jevic owed approximately $20 million to its tax creditors and general unsecured creditors. In June 2008, an Official Committee of Unsecured Creditors was appointed to represent the unsecured creditors. The Lawsuits During the underlying Jevic bankruptcy case, two lawsuits were filed. The first lawsuit was a class action brought by a group of terminated truck drivers against Jevic and Sun Capital, alleging that Jevic and Sun Capital violated both state and federal Worker Adjustment and Retraining Notification (WARN) Acts. The drivers contended that Jevic and Sun Capital were required under the WARN Acts to provide a 60-day written notice to its employees before terminating employment. The bankruptcy court eventually ruled that Sun Capital was not an employer as contemplated by the WARN Acts and therefore was not liable. However, the bankruptcy court ruled that Jevic did violate the WARN Acts and was subject to a claim of $12.4 million. Further, $8.3 million of the $12.4 million claim were likely to be classified as employee wage claims that would be granted special priority under section 507(a)(4). The second lawsuit was brought by the committee, alleging fraudulent conveyance and preference actions on behalf of the bankruptcy estate against Sun Capital and CIT. After the bankruptcy court dismissed a portion of the committee s claims, Sun Capital, CIT, the committee, and the drivers gathered to settle the remaining fraudulent conveyance claims. By the time of the negotiations, Jevic s only remaining assets were $1.7 million in cash subject to Sun Capital s first-priority lien and the fraudulent conveyance action against Sun Capital and CIT. Sun Capital, CIT, and the committee eventually reached the following settlement agreement: (1) Those parties would exchange releases of their claims against each other, and the fraudulent conveyance action would be dismissed with prejudice; (2) CIT would pay $2 million into an account earmarked to pay Jevic s and the committee s legal fees and other administrative expenses; (3) Sun would assign its lien on Jevic s remaining $1.7 million to a trust, which would pay tax and administrative creditors first and then the general unsecured creditors on a pro rata basis; and (4) Jevic s Chapter 11 case would be dismissed. Jevic, 787 F.3dat 177. The settlement did not include any provision or consideration for the drivers; further, the settlement distributed the remaining assets of the bankruptcy estate contrary to the absolute priority rule. Page 11 of 28

12 Both the drivers and the United States Trustee objected to the settlement. The drivers objected to the settlement because the distribution enumerated in the settlement violated the absolute priority rule and the committee breached its fiduciary duty by entering into a settlement that did not include the drivers. The United States Trustee also objected to the settlement on the basis that it violated the absolute priority rule. Further, the United States Trustee objected to the settlement on the grounds that the Bankruptcy Code does not explicitly grant the bankruptcy court power to enter structured dismissals. The bankruptcy court overruled all of the objections and approved the settlement using the multifactor test found in In re Martin, 91 F.3d 389 (3d Cir. 1996), for evaluating settlements under Federal Rule of Bankruptcy Procedure In an oral ruling, the bankruptcy court made findings of fact that the dire circumstances of the debtor meant there was essentially no chance of reorganization as the secured creditors were under-secured and the case was administratively insolvent. Further, the bankruptcy court determined that if the case was converted to a Chapter 7, Sun Capital held a first-priority lien on the remaining $1.7 million in Jevic s estate. A Chapter 7 trustee would not have the funds to adequately litigate the fraudulent conveyance claim. Essentially, the bankruptcy court found that the settlement was better than any other likely alternative. The drivers and the United States Trustee appealed to the United States District Court for the District of Delaware, and the district court affirmed the bankruptcy court s approval of the settlement and dismissal of the case. The drivers and the United States Trustee appealed to the Third Circuit. The Holding The Third Circuit was asked to decide two related issues: (1) whether the Bankruptcy Code allowed structured dismissals; and, (2) if yes, whether the structured dismissal must follow the absolute priority rule. As a preliminary matter, the Third Circuit began its analysis by noting that the bankruptcy court correctly applied the Martin factors favoring settlement. Also, the Third Circuit noted that the appellants did not dispute that the bankruptcy court generally followed the law with respect to dismissal and dismissed the case for cause under section 1112(b)(1). At the time of the settlement, the bankruptcy estate had already dwindled to $1.7 million subject to Sun Capital s first-priority lien with no other assets. There was no hope of reorganization. The Bankruptcy Code Allows for Structured Dismissals The Third Circuit then turned to the question of whether the Bankruptcy Code allows structured dismissals. The Third Circuit conceptualizes structured dismissals as simply dismissals that are preceded by other orders of the bankruptcy court... that remain in effect after dismissal. Jevic, 787 F.3d at 181. Page 12 of 28

13 The Third Circuit held that the Bankruptcy Code did not expressly authorize structured dismissals. However, the Third Circuit also held the following: And though Section 349 of the Code contemplates that dismissal will typically reinstate[ ] the pre-petition state of affairs by revesting property in the debtor and vacating orders and judgments of the bankruptcy court, it also explicitly authorizes the bankruptcy court to alter the effect of dismissal for cause in other words, the Code does not strictly require dismissal of a Chapter 11 case to be a hard reset. 11 U.S.C. 349(b); H.R. Rep. No. 595 at 338 ( The court is permitted to order a different result for cause. ); see also Matter of Sadler, 935 F.2d 918, 921 (7th Cir. 1991) ( Cause under 349(b) means an acceptable reason. ) Jevic, 787 F.3d at 181. The drivers argued that allowing structured dismissals overestimates a bankruptcy court s authority to enter settlement agreements under Rule 9019 and may pave the way for illegitimate sub rosa plans. Further, the drivers contended that neither dire circumstances nor section 105 of the Bankruptcy Code allows a bankruptcy court to evade the Bankruptcy Code s requirements. The Third Circuit emphasized that even the drivers admitted that a plan of reorganization could not be confirmed and a conversion to Chapter 7 would net no benefit to any unsecured creditor. Because of this fact, the Third Circuit held that, absent a showing that the structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation or conversion process, a bankruptcy court has discretion to order such a disposition. Jevic, 787 F.3d at 182. To be clear, the Third Circuit expressly stated that this appeal does not require us to decide whether structured dismissals are permissible when a confirmable plan is in the offing or conversion to a Chapter 7 might be worthwhile. Id. at 181. Structured Dismissals Do Not Have to Follow the Absolute Priority Rule The Third Circuit then turned to the question of whether a structured dismissal must follow the absolute priority rule. The Third Circuit held that bankruptcy courts may approve settlements that deviate from the priority scheme of 507 of the Bankruptcy Code only if they have specific and credible grounds to justify [the] deviation. Id. at 184 (quoting In re Iridium Operating LLC, 478 F.3d 452, 466 (2d Cir. 2007). The drivers contended that the absolute priority rule applies to all distributions of the estate under Chapter 11 and not just in a plan of reorganization distribution context. Moreover, the drivers argued that the requirement that plans of reorganization be fair and equitable should also apply to settlements and compromises. Page 13 of 28

14 The Third Circuit acknowledged that both settlements and plans of reorganization must be fair and equitable and that fair and equitable in a plan of reorganization context must comply with the absolute priority rule. However, the Third Circuit expressly stated that [w]hen Congress codified the absolute priority rule..., it did so in the specific context of plan confirmation, see 1129(b)(2)(B)(ii), and neither Congress nor the Supreme Court has ever said that the rule applies to settlements in bankruptcy. Id. at 183. The Third Circuit then turned to two cases that have discussed whether section 507 must be followed when settlement proceeds are distributed in a Chapter 11. First, the court reviewed Matter of AWECO Inc., 725 F.2d 293, 295 (5th Cir. 1984). The United States Court of Appeals for the Fifth Circuit held that the fair and equitable standard applies to settlements, and fair and equitable means compliant with the priority system. The Third Circuit then reviewed and adopted the less rigid standard set forth iniridium.the United States Court of Appeals for the Second Circuit held that whether a particular settlement s distribution scheme complies with the Code s priority scheme must be the most important factor for the bankruptcy court to consider when determining whether a settlement is fair and equitable under Rule 9019, but a noncompliant settlement could be approved when the remaining factors weigh heavily in favor of approving a settlement[.] Jevic, 787 F.3d at 183 (quoting Iridium, 478 F.3d at 464). However, the Third Circuit emphasized that under most circumstances, compliance with the Bankruptcy Code s priority scheme will usually be dispositive of whether a settlement is fair and equitable. The majority summarized by saying we believe the Code permits a structured dismissal, even one that deviates from the 507 priorities, when a bankruptcy judge makes sound findings of fact that the traditional routes out of Chapter 11 are unavailable and the settlement is the best feasible way of serving the interests of the estate and its creditors. Id. at Judge Scirica s Dissent Circuit Judge Scirica concurred with the majority in stating the law but dissented as to the outcome. Judge Scirica does not depart from the majority that structured dismissals are authorized by the Bankruptcy Code and, in some extraordinary instances, may deviate from the absolute priority rule. Instead, Judge Scirica does not believe that this appeal warrants a departure from the absolute priority rule because this is not an extraordinary instance. First, Judge Scirica wrote that the parties to the settlement could have simply followed the absolute priority rule and that Sun Capital was diverting funds from the drivers to avoid funding litigation against itself. Second, Judge Scirica wrote that the settlement was at odds with one of the Bankruptcy Code s core goals, to maximize value to the estate. Judge Scirica stated that the release of Sun s first-priority lien on the $1.7 million collateral and the $2 million settlement of the estate s cause of action equates to $3.7 million and did not go to maximize the value of estate as a whole. Instead, Judge Scirica believed, the settlement only enriches certain creditors and not the bankruptcy estate as a whole. Page 14 of 28

15 Judge Scirica focused primarily on distinguishing Iridium from the case at bar. In Iridium, the unsecured creditors committee brought suit against a group of secured lenders. The proposed settlement deviated from the absolute priority rule in two instances. First, the proposed settlement contemplated splitting the estate s cash between the secured lenders and a litigation trust set up to fund a different estate action against a certain priority administrative creditor. Second, the settlement provided that any remaining funds left in the litigation trust would go to the unsecured creditors and skip that certain administrative creditor. The Second Circuit held that this violation of the absolute priority rule was permissible in the first instance, but the court remanded the case down to the lower court for a determination on the second instance, stating that the record does not explain why the remaining balance of the litigation trust should not be distributed according to the absolute priority rule. Judge Scirica ultimately concluded that he would have remanded the case back to the bankruptcy court with the direction to distribute the proceeds in accordance with the absolute priority rule. Other Cases Since Jevic was published, only In re Naartjie Custom Kids, Inc., 2015 WL No (Bankr. Utah July 13, 2015), has decided whether structured dismissals are allowed by the Bankruptcy Code. In Naartjie, the debtor began its Chapter 11 case as a reorganization case, but the debtor quickly decided to liquidate its business. The debtor in Naartjie moved the bankruptcy court to enter a structured dismissal order under sections 305(a), 349(b), and 105(a), and Rule 1017(a). The debtor in Naartjie claimed that a structured dismissal was appropriate because there were no causes of action to prosecute, there were no pending adversary proceedings, the claims reconciliation process would be completed before the case was dismissed, proper notice was given, and no party with an economic stake objected to the structured dismissal. The bankruptcy court in Naartjie decided that a bankruptcy court has the authority to alter the effects of dismissals under section 349(a) and enter a structured dismissal. The bankruptcy court in Naartjie went on to decide that if cause is shown that a structured dismissal will better serve the interests of the creditors and the debtor, then the bankruptcy court may alter the effect of dismissal. The bankruptcy court in Naartjie emphasized that no economic stakeholders objected to the dismissal and that the dismissal benefited both the debtor and the creditors. In dicta, the bankruptcy court in Naartjie stated that if there was an objection to the structured dismissal, then the outcome of the court s decision might have been different. Though decided before Jevic, In re Buffet Partners, L.P., 2014 WL (Bankr. N.D. Tex. July 28, 2014), followed an approach similar to the approach in Naartjie. In Buffet Partners, the bankruptcy court approved a structured dismissal, emphasizing that not one party with an economic stake in the case had objected to the dismissal in this manner. Page 15 of 28

16 Conclusion Savvy bankruptcy practitioners will soon be testing the limits of Jevic and seeking approval of structured dismissals in other jurisdictions. Time will tell whether other circuits will adopt the structured dismissal in limited circumstances as the Third Circuit did. Courts seem to be more flexible with structured dismissals when no party with an economic interest objects, but the question becomes more difficult when there are objections and whether the structured dismissal adheres to the absolute priority rule. Note that an en banc review of the Jevic appeal has been sought, and the Third Circuit may modify its previous position. Keywords: bankruptcy and insolvency litigation, structured dismissal, absolute priority rule, section 349 Edward Clarkson III is an associate with Munsch, Hardt, Kopf & Harr in Dallas, Texas. Page 16 of 28

17 ABI Commission Issues Recommendations on Preference Laws By Daniel J. DeFranceschi After three years of work by numerous bankruptcy professionals, the Commission to Study the Reform of Chapter 11 of the American Bankruptcy Institute (ABI) issued its Final Report and Recommendations (cited below as the ABI Report). The report provides a valuable and comprehensive framework for the discussion of Chapter 11 bankruptcy reform that some believe is needed to keep pace with the changing dynamics of modern Chapter 11 practice. The commission s goal in producing the report was to study and propose reforms to Chapter 11 and related statutory provisions that will better balance the goals of effectuating the effective reorganization of business debtors with the attendant preservation and expansion of jobs and the maximization and realization of asset values for all creditors and stakeholders. ABI Report, supra, at 3. According to the commission, this study was undertaken [i]n light of the expansion of the use of secured credit, the growth of distressed-debt markets and other externalities that have affected the effectiveness of the current Bankruptcy Code. Id. The proposed reforms related to preference litigation are of particular relevance to bankruptcy litigators. The underlying rationale for preference claims is well known and understood as providing for more equitable distributions and maximizing estate values. The power of the trustee to pursue preference claims under section 547 of the Bankruptcy Code preserves value for the estate and tempers the run on the debtor that may occur immediately prior to a bankruptcy filing. ABI Report, supra,at 148. But those exposed to preference litigation also understand that the preference laws may be misused. At the very least, there is a perception among preference defendants and others of such misuse of the current preference laws. According to the report, there is strong frustration with current preference law. Id. at 150. At hearings before the commission, there was testimony that some trustees pursued preference actions with little diligence and without regard to the merits of the underlying claim. Id. Further, it was suggested that some trustees appear to file preference actions not necessarily to recover the alleged preference, but to extract a settlement payment. Id. The commission considered several approaches to the perceived abuses to the preference law and ultimately decided on the following recommendations. The first recommendation is to amend the Bankruptcy Code to preclude the trustee from issuing a demand letter or filing a preference complaint unless the trustee has taken certain steps designed to ensure that a valid preference action is being pursued. Thus, the commission recommended that such a demand or a complaint should not be issued unless, based on reasonable due diligence, the trustee believes in good faith that a plausible claim for relief exists against such party under section 547, taking into account the party s known or reasonably knowable affirmative defenses under section 547(c). Id. at 148. While some trustees may already take such measures before bringing a preference action, that practice is not the norm. With increased pressures on trustees to recover as much as possible from preference actions sometimes at the urging of a post-petition secured creditor who was granted a lien on preference Page 17 of 28

18 claims and recoveries and sometimes because the only distribution for general unsecured creditors may be from preference recoveries the slippery slope of trustees bringing as many preference claims as possible has developed. While such an approach may well cast a net of recovery around many preference defendants who should be sued, it often traps pre-petition transferees who have solid defenses and probably should not have been sued in the first place. Explicitly requiring the trustee to satisfy these standards also addresses the reality that many preference defendants do not have the resources to mount an effective defense against such claims through trial, particularly where the amount in issue would not warrant incurring the costs attendant to protracted litigation. In this regard, one could argue that the Federal Rules of Bankruptcy Procedure already provide a basis to stop trustees from filing implausible preference claims. Rule 9011 provides that presenting a preference complaint to the court comes with a certification that, to the best of the presenting person s knowledge, information, and belief, formed after an inquiry reasonable under the circumstances, such complaint is not being presented for any improper purpose and the claims have evidentiary support. Fed. R. Bankr. P. 9011(b). Sanctions are available against offending parties. Fed. R. Bankr. P. 9011(c). Of course, the use of Rule 9011 requires motion practice, which costs money that many preference defendants do not want to spend on preference litigation. For that reason, amending the preference laws to impose the proposed affirmative obligations on the trustee before bringing a preference demand or complaint may address a serious perceived problem with the current preference laws, particularly if the standard is clear and doesn t lead to additional satellite litigation over the trustee s compliance. The commission proposes bringing the preference pleading requirements into alignment with recent United States Supreme Court precedent. Thus, the commission recommends that the preference laws be amended to require that the trustee must plead with particularity factual allegations in the complaint that establish a plausible claim for relief under section 547. ABI Report, supra, at 148. Mere legal conclusions or speculative allegations should not be sufficient to support a preference complaint. Id. This recommendation is in accord with current federal pleading standards under Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 556 U.S. 662 (2009). In Twombly, an antitrust case, the Supreme Court held that the plaintiff had failed to allege facts necessary to support a claim of horizontal conspiracy among telecom providers, but in so doing, the Supreme Court did away with the relaxed interpretation of the pleading standard under the Federal Rules of Civil Procedure that derived from prior Supreme Court precedent that a complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief. Conley v. Gibson, 355 U.S. 41, (1957). In Twombly, the Court held that Federal Rule of Civil Procedure 8 required sufficient factual content in the complaint to plausibly suggest a violation of antitrust law. In Ashcroft, the Supreme Court extended the plausibility standard to all federal court complaints and not just antitrust actions. The next proposed reform to the preference laws recommended by the commission would increase the dollar amount for the defense against preference claims provided by section Page 18 of 28