Pre-confirmation Settlements and Structured Dismissals

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1 Pre-confirmation Settlements and Structured Dismissals The Honorable Barbara Houser, United States Bankruptcy Judge Northern District of Texas February 25, 2016 Martin A. Sosland Retired Partner Weil, Gotshal & Manges LLP

2 Structured Dismissals Generally The Bankruptcy Code provides for three means of exiting a chapter 11 case: confirmation of a plan of reorganization, conversion to chapter 7 liquidation, or dismissal of the case. The ordinary effect of dismissal is reversion to the status quo ante. 11 U.S.C. 349(b)(3): dismissal of a case revests the property of the estate in the entity in which such property was vested immediately before the commencement of the case under [title 11]. The concept of a structured dismissal is controversial because it is not a plain vanilla dismissal. Because structured dismissals are understood to be dismissals that are preceded by other orders of the bankruptcy court (e.g., orders approving settlements, granting releases, establishing claims reconciliation and distribution procedures) that will remain in effect post-dismissal, they do not necessarily reinstate the prepetition state of affairs. The use of structured dismissals seems to be increasingly appealing to debtors who are confronted with the delay and expense of promulgating a chapter 11 liquidating plan and the uncertainty and additional cost of a chapter 7 conversion. One court has characterized a structured dismissal as the least bad option. 2

3 Structured Dismissals Generally (cont d) The Bankruptcy Code does not expressly authorize structured dismissals. Parties generally rely on 1112(b), 305(a)(1), and/or 105(a) of the Code as authority to grant the requested relief. 1112(b): A party in interest may request that the court dismiss a case for cause. 1112(b)(4) contains a non-exhaustive list justifying cause. Where the estate lacks funds needed to confirm or liquidate under chapter 11, courts have permitted a structured dismissal of the chapter 11 case pursuant to section 1112(b). 305(a): A court may dismiss a case if the interests of the creditors and the debtor would be better served by such dismissal. 105(a): Grants a court equitable powers to enter orders that are necessary or appropriate to carry out the provisions of the Bankruptcy Code. 3

4 Structured Dismissals Generally (cont d) While some view structured dismissals as a useful tool to resolve a chapter 11 case, others view it as an end-run around the protections granted to creditors and the express requirements of the Bankruptcy Code. The Office of the United States Trustee characterizes structured dismissals, as a new permutation of the sub rosa plan. See Nan Roberts Eitel, T. Patrick Tinker & Lisa L. Lambert, Structured Dismissals, or Cases Dismissed Outside of the Code s Structure, 30 Am. Bankr. Inst. J. 20 (March 2011). Objectors argue that they ignore important chapter 11 safeguards including voting, acceptance, disclosure, and the fair and equitable standards, including the absolute priority rule. The ABI commissioners regard structured dismissals as a short-circuit[] around the creditor protections under the disclosure and soliciting provisions of the Bankruptcy Code, Am. Bankr. Inst., Comm n to Study the Reform of Chapter 11, Final Report and Recommendations (2014). The are few published opinions on the issue and until the Third Circuit s recent decision there existed little controlling precedent in any jurisdiction whether structured dismissals are permissible. 4

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6 AWECO Large disputed creditor is litigating against chapter 11 debtor in possession. Debtor proposes to settle litigation and claim against estate by making discounted cash payment to disputed unsecured creditor. Senior secured creditor and priority governmental creditors (DOE and IRS) object, arguing that a junior creditor should not be paid when a senior creditor s ability to be paid in full is uncertain. Senior secured creditors withdraws objection in exchange for replacement lien, governmental creditors continue to object, and Bankruptcy Court, finding that settlement is fair, approves settlement over governmental creditors objections. District court affirms Bankruptcy Court. IRS appeals to Fifth Circuit. Fifth Circuit reverses, holding that a pre-confirmation settlement may not be approved unless it is fair and equitable, meaning, does not violate the absolute priority rule. 6

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8 The Facts May 20, 2008: Jevic Transportation, Inc. and certain of its affiliates commenced a chapter 11 proceeding in the United States Bankruptcy Court for the District of Delaware. Upon filing, Jevic owed approximately $53 million to its first-priority secured creditors certain entities affiliated with CIT Group and Sun Capital Partners and more than $20 million to its tax and general unsecured creditors. May 21, 2008: A group of terminated Jevic truck drivers commenced a class action alleging violations of federal and state Worker Adjustment and Retraining Notification (WARN) Acts. December 31, 2008: The Creditors Committee filed a fraudulent conveyance action against CIT and Sun in connection with Sun s leveraged buy-out of Jevic prior to its bankruptcy filing. The buy-out was financed by a group of lenders led by CIT. 8

9 The Facts (cont d) June 22, 2012: Settlement agreement among the Creditors Committee, CIT, and Sun. The agreement provided for: Dismissal of the fraudulent conveyance action with prejudice Contribution by CIT of $2 million towards certain administrative expenses Assignment by Sun of its lien on Jevic s remaining assets to a trust, which would pay tax and administrative creditors first and then general unsecured creditors A structured dismissal of Jevic s bankruptcy case Notably, the settlement did not include the drivers, even though they had an uncontested WARN Act claim against Jevic According to the drivers, a significant portion of their claim constituted a priority wage claim under 507(a)(4) of the Bankruptcy Code a higher priority than claims of the tax and trade creditors. In addition to asserting their WARN Act claims against Jevic, the debtor, the drivers were suing Sun in its capacity as Jevic s equity owner, asserting Sun was liable as a single employer for the WARN Act claims. Sun was not willing to allow the drivers to participate in a settlement fund it was contributing (by releasing its liens) unless the drivers released their claims against Sun. The drivers were not willing to do so. The drivers and the United States Trustee objected to the settlement, arguing that the Bankruptcy Court had no legal authority to approve a structured dismissal, at least to the extent it deviated from the priority system of the Bankruptcy Code. 9

10 The Lower Court Decisions and Questions Before the Third Circuit The Bankruptcy Court approved the settlement and dismissal, and the District Court affirmed. The questions presented to the Third Circuit included: Whether Bankruptcy Courts have discretion to approve structured dismissals If structured dismissals are permissible, whether Bankruptcy Courts have the power to approve settlements, in the context of structured dismissals, which deviate from the priority scheme of the Bankruptcy Code 10

11 The Third Circuit s Ruling as to Structured Dismissals, Generally While recognizing that the Bankruptcy Code does not expressly authorize structured dismissals, the Third Circuit disagreed with the drivers insistence that a dismissal must be a reversion to the status quo ante. Although 349 of the Code contemplates that a dismissal will typically reinstate the prepetition affairs by revesting property in the debtor and vacating orders and judgements of the bankruptcy court, the Code also authorizes bankruptcy courts to alter the effects of dismissal for cause. The Code does not strictly require dismissal of a chapter 11 case to be a hard reset. In limited circumstances, structured dismissals are appropriate. The Court did not decide the question of whether structured dismissals are permissible when a confirmable plan is in the offering or conversion to chapter 7 might be worthwhile. A Bankruptcy Court has discretion to order a structured dismissal only absent a showing that a structured dismissal has been contrived to evade the protections and safeguards of the plan confirmation or conversion processes. 11

12 The Third Circuit s Ruling as to Deviation from the Priority Scheme Contrasts with the Fifth Circuit s Decision in AWECO Does 507 s priority scheme apply to the distribution of settlement proceeds in chapter 11 cases? 5th Circuit: AWECO held that the fair and equitable standard required for plan confirmation applies to settlements and fair and equitable means compliance with the absolute priority rule. Bankruptcy courts within the Fifth Circuit have approved structured dismissals implementing settlements that do not violate the absolute priority rule. See, e.g., In re Buffet Partners, L.P., 2014 WL (Bankr. N.D. Tex. July 28, 2014). The Third Circuit agreed with the Second Circuit s approach in Iridium: Whether a settlement s distribution scheme complies with the Bankruptcy 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. A noncompliant settlement could be approved when the remaining factors weigh heavily in favor of approving the settlement. No such exception exists in the Fifth Circuit. 12