The Supreme Court’s newest bankruptcy case, Jevic Holdings Corp. (3/22/17), illustrates three important lessons for secured creditors and lessors. It holds that the dismissal of a Chapter 11 case cannot, without the consent of the affected parties, depart from the statutory priority rules. The Court disapproved this structured dismissal of the Chapter 11 case, even though it implemented multiparty settlements. The Court reserved generally on the legality of structured dismissals and common “first day” orders paying prepetition wages, “critical vendors,” and “roll-ups” of pre-petition secured claims into post-petition DIP financing.
Typically, settlements and compromises are the foundation of Chapter 11. As Chief Justice Taft wrote in another settlement context, “It is important, of course, that controversies be settled right, but there are many civil questions which arise between individuals in which it is not so important the controversy be settled one way or another as that it be settled.” In the bankruptcy context, the Jevic court substantially curtailed flexibility and judicial discretion in settlements – even when the alternatives are economically worse.
The settlement resolved a fraudulent conveyance suit for a leveraged buyout. Lenders and agents and others participating in leverage buyouts risk not just their principal, but also litigation exposure that starts with some cash in the prospective plaintiffs’ litigation pocket. The Unsecured Creditors’ Committee on behalf of the Jevic bankruptcy estate sued the lenders and the agent who financed the pre-bankruptcy acquisition of the trucking company by co-defendant private equity buyers. After three years of litigation in which all lost parts of a motion to dismiss, the Jevic parties sat down to settle.
The first lesson is that financing an LBO and corporate restructuring is risky. The risk extends to forbearance agreements and refinancings as illustrated by the near death experience in the TOUSA litigation and the current SunEdison improvement in position claims and aggressive restructurings as illustrated by the Caesar’s $3 to $5 billion damages estimate in the examiner’s report. The origination fees, collateral and guaranties are too tempting, and meeting one’s production target demanding.
In the first part of the settlement, the secured lender CIT paid $2 million toward the committee’s legal expenses and other administrative expenses.
The guarantor and co-owner paid the second part of the settlement by waiving its lien on $1.7 million of cash. That distribution skipped the priority wage claimants (estimated at $8.3 million) and paid some administrative expenses, taxes and the general unsecured creditors protected by the Committee. The three lower Courts accepted the factual argument that the distribution of the settlement money was not limited by the Code’s priority rules finding that, absent a settlement, no one got any money.
The second lesson rests in the settling defendant’s practical ability to propose that its money skip over affected parties who can consent, e.g., the Chapter 11 professionals, to pay settlement money to creditors. In Jevic, the settling parties and Chapter 11 professionals just paid the wrong – lower priority – tax and general creditors. The opinion did not address this possibility, although the lower courts and parties may get a chance on remand when addressing disgorgement risks for Committee counsel. The sometimes quixotic efforts of the U.S. Trustee to limit “first day” orders and otherwise protect the integrity of the bankruptcy system were vindicated in this narrow situation.
The argument “no harm, no foul” was rejected, at least, in this end-of-case situation because the Supreme Court seemed to disagree with the “no harm” findings. In part, the persistent unpaid priority WARN Act claimants remind all that employees have a big seat at the table – even for closing companies. Remember, as surely this Court did, that Congress enacted Section 1113 to reverse Bildisco’s weakening of employee rights. Congress also enacted Section 507(b)(1)(A)(ii) to make WARN Act claimants administrative expense creditors giving them a seat at the same table as the Chapter 11 professionals.
Third, unless you like attorneys and litigating 11 years after the initial forbearance and nine years after the Chapter 11 filing, take that first loss and exit the bankruptcy as early as possible with what you have and a release that pays the correct creditors.
All litigants are better served if we stick to the rules of the game. Jevic should encourage our clients to consider carefully every early settlement. Do not stick around nine years to see if the rules will change – they won’t! Moreover, LBO financers should pick only winners!