U.S. Supreme Court Protects Priority Wage Claims in Decision on “Structured Dismissals”

By Peter D. DeChiara

pdechiara@cwsny.com

Posted April 2017

The U.S. Supreme Court’s much-anticipated decision on “structured dismissals” in Chapter 11 cases handed a signal victory to priority wage claimants.  The high court’s decision flatly forbids any non-consensual dismissal that, in making a final distribution of estate property, provides a recovery to lower-priority creditors without also giving a payout to higher-priority claim holders.  See Czyzewski v. Jevic Holding Corp., Case No. 15-649 (March 22, 2017).

Bankruptcy courts can end a Chapter 11 case by either approving a plan of reorganization, converting the case to a Chapter 7 liquidation, or dismissing the bankruptcy petition.  Traditionally, a dismissal meant reversion to the pre-bankruptcy status quo.  However, an increasingly popular mechanism for resolving Chapter 11 cases has been the “structured dismissal,” which conditions dismissal of a Chapter 11 case on terms negotiated by the parties and approved by the bankruptcy court.

The question before the Supreme Court in Jevic was whether the Bankruptcy Code permits structured dismissals that conflict with the Code’s priority rules.  Generally, under these rules, secured creditors are paid first, then administrative creditors, then creditors holding wage or other priority claims, and then general unsecured creditors.

In Jevic, a company in Chapter 11 bankruptcy reached a settlement agreement with its secured creditors and the unsecured creditors’ committee.  The settlement provided terms for dismissal of the Chapter 11 case, with both the secured and unsecured creditors receiving a distribution of estate assets.  However, a group of employees had a priority wage claim, from a judgment they won against the company for its failure to provide them legally required advance notice of layoffs.  The proposed structured dismissal violated the Code’s priority rules because it gave a distribution to the unsecured creditors but gave nothing to the employees with the priority wage claim.  Nonetheless, the bankruptcy court approved the settlement over the employees’ objection, and dismissed the case pursuant to its terms, reasoning that, without the settlement, creditors other than the secured creditors would most likely have received nothing.

The district court affirmed, and the U.S. Court of Appeals for the Third Circuit did too.  As reported on this blog in July 2015, the Third Circuit held that structured dismissals that deviate from Code priorities are permissible in those “rare” cases where the bankruptcy court finds that they are the best way to serve the interests of the bankruptcy estate and its creditors.

In a March 22, 2017 decision, the Supreme Court reversed.  Without expressing a view on whether structured dismissals in general are lawful, the Court prohibited those that, over the objection of an affected party, contravene the Code’s priority scheme.  Writing for a 6-2 majority, Justice Breyer explained that the Code’s priorities are “fundamental” to bankruptcy and that nothing in the Code permits “nonconsensual priority-violating” dismissals.

Deviating from Code priorities, Justice Breyer asserted, has “potentially serious” consequences for priority creditors.  For example, the opinion noted, priority wage claims “‘alleviate to some degree the hardship that unemployment usually brings to workers and their families’ when an employer files for bankruptcy.”  Slip op. at 17 (citation omitted).

Allowing structured dismissals that deviate from Code priorities, Breyer continued, presents the “risks of collusion, i.e., senior secured creditors and general unsecured creditors teaming up to squeeze out priority unsecured creditors.”  Id. at 17-18.  The Court rejected the Third Circuit’s approach of creating an exception for “rare” cases, reasoning that the lack of precise criteria for what constitutes a “rare” case threatened to turn what was intended to be a narrow exception into the general rule.

The Court made clear that its holding applied only to final distributions of estate assets, and did not apply to payments made during the course of the Chapter 11 case, such as “first day” orders that allow debtors to pay wages owed employees.

Justice Thomas’ dissent (joined by Justice Alito) did not challenge the substance of the majority opinion.  The dissent argued that the Court should have dismissed the case because, the dissenters claimed, no split in the circuits existed on the issue that the Court decided.

By banning “priority skipping” structured dismissals, the Court’s Jevic decision provides definitive resolution to a question that caused much uncertainty in the bankruptcy bar.  The decision provides not just clarity but also solid protection for employees with priority wage claims.  In a structured dismissal that pays out to unsecured creditors, such employees can now no longer be left empty-handed.