Third Circuit Approves Structured Dismissal Of Chapter 11 Case That Includes Settlement Deviating From Bankruptcy Code's Priority Scheme

A "structured dismissal" of a chapter 11 case following a sale of substantially all of the debtor's assets has become increasingly common as a way to minimize costs and maximize creditor recoveries. However, only a handful of rulings have been issued on the subject, perhaps because bankruptcy and appellate courts are unclear as to whether the Bankruptcy Code authorizes the remedy.

The U.S. Court of Appeals for the Third Circuit recently weighed in on this issue in Official Committee of Unsecured Creditors v. CIT Group/Business Credit Inc. (In re Jevic Holding Corp.), 2015 BL 160363 (3d Cir. May 21, 2015). The court ruled that "absent a showing that a structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation or conversion processes, a bankruptcy court has discretion to order such a disposition." The court also held that "bankruptcy courts may approve settlements that deviate from the priority scheme of [the Bankruptcy Code]," but only if the court has "specific and credible grounds" to justify the deviation.

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.

As a consequence, structured dismissals of chapter 11 cases following section 363(b) sales of substantially all of the debtors' assets have become a popular exit strategy. A "structured dismissal" is a dismissal conditioned upon certain elements agreed to in advance by stakeholders and then approved by the bankruptcy court, as distinguished from an unconditional dismissal of the chapter 11 case ordered by the court under section 1112(b) of the Bankruptcy Code. Structured dismissals have typically been granted in cases where: (i) the debtor has sold, with court authority, substantially all of its assets outside the plan context but is either administratively insolvent or lacks sufficient liquidity to fund the plan confirmation process; or (ii) after approval of a section 363(b) asset sale, the debtor has the wherewithal to confirm a liquidating chapter 11 plan, but costs associated with the confirmation process would likely eliminate or significantly reduce funds available for distribution to creditors.

Typical Terms

Among the common provisions included in bankruptcy court orders approving structured dismissals are the following: 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 of the Bankruptcy Code (vacating certain bankruptcy court orders when a case is dismissed), 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), and 1112(b) are commonly cited as predicates for the remedy.

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 a 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." Dismissal or conversion of a chapter 11 case under section 1112(b) is a two-step process. First, the court must determine whether "cause" exists for dismissal or conversion. Second, the court must determine whether dismissal or conversion of the case is in the best interests of the creditors and the estate. See, e.g., Rollex Corp. v. Associated Materials, Inc. (In re Superior Siding & Window, Inc.), 14 F.3d 240, 242 (4th Cir. 1994).

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)...