The U.S. Supreme Court’s recent opinion in Czyzewski v. Jevic Holding Corp. matters to hedge funds pursuing a distressed assets strategy, because the Justices have now made it more clear than they had before that the absolute priority rule under the U.S. bankruptcy code’s chapter 11 is … absolute. It isn’t a suggestion.
The take-away is that those entities financing acquisitions, including hedge funds that may be seeking alpha through unconventional loans, should not do so in the expectation that should there be a default, or should an unforeseen global financial crisis arise, there will be the safety net of a quick in-and-out structured lending dismissal to allow the entity to take back equity or assets of the debtor. Hedge funds or others who might be tempted by such a thought, who might also think that it is possible through such a structured dismissal to pay off those junior creditors whose assistance may be needful for the continuing operation of an entity in such a case, at the expense of someone in the middle, will have to think again.
Failure, and Two Lawsuits
But let’s delve into the facts. This case came about because a PE concern, Sun Capital Partners, bought out the trucking company, Jevic, in 2006, using money it borrowed from CIT Group. In those go-go days, the presumption was that the rising housing and derivatives-enabled tide would keep all ships afloat, however heavily laden. But when the financial crisis hit, Jevic Transportation went to bankruptcy court. It filed there on May 16, 2008, just one month after the failure of Bear Stearns.
In that context, Jevic filed, and it sent its employees termination notices.
Almost immediately, this move elicited two lawsuits. First, Casimir Czyzewski and other employees as a class alleged violation of the Worker Adjustment and Retraining Notification Act (so named because someone really wanted it to have the acronym WARN). The employees won a judgment worth $12.4 million. Not all of those millions were created equal, though: for purposes of the Supreme Court ruling, the important fact is that $8.3 million of that judgment consisted of a priority wage claim under the bankruptcy statute and (in the words of the Supreme Court upon review), that claim was “therefore entitled to payment ahead of general unsecured claims against the Jevic estate.”
Separately, the bankruptcy court allowed a committree of Jevic’s unsecured creditors to file a fraudulent conveyance lawsuit against Sun and CIT for fraudulent transfer, that is, contending that they had “hastened Jevic’s bankruptcy by saddling it with debts that it couldn’t service.”
Workers Bear the Burden of Structured Dismissal
The bankruptcy court in this matter issued a “structured dismissal” of the chapter 11 petition that meant stiffing the workers, the WARN judgment creditors. Why did it do this? In short, it found that there was no preferable alternative. The estate had dwindled in value to the point where it couldn’t even satisfy oustanding administrative and priority claims. The situation could be improved somewhat by a resolution of the fraudulent-conveyance lawsuit against Sun and CIT on terms that would require either or both of them to pay money into the estate, but that would requirement either their consent or the continued expenditure of resources on litigation.
Normally, administrative insolvency would have called for a movement away from chapter 11, into chapter 7 liquidation,. But in this case, the bankruptcy court found, the workers also would have gotten nothing, other junior creditors would have gotten nothing, and the fraudulent transfer action would have had to have been abandoned in the absence of the resources necessary to pursue it.
The bankruptcy court, then, approved a structured dismissal of the litigation that involved a deposit of $2 million by CIT into an account earmarked to pay the unsecured creditor’s committee for its costs; the transfer of a lien held by Sun on Jevic’s remaining $1.7 million into a trust, which would pay low priority unsecured creditors; the dismissal of the fraudulent conveyance action; and the dismissal of the chapter 11 bankruptcy itself. That court, and the district court and then the appeals court, all found that this was the best available distribution, and no worse for the class-action workers than the alternative liquidation [although no better, because they get nothing on either time line.]
Appeals Court Bought it, SCOTUS Did Not
The appellate court said that “in rare cases like this one, [we] approve structured dismissals that do not strictly adhere to the Bankruptcy Court’s priority scheme.”
The Supreme Court would have none of it. “[We] cannot find in the violation of ordinary priority rules that occurred here any significant offsetting bankruptcy-related justification,” Justice Breyer wrote. The justification that was offered, if allowed here,m would not be rare, and would have deleterious systemic effects even if it were.
As Charles M. Tatelbaum, of the Florida law firm Tripp Scott, has written, “unsecured creditors, labor unions, ands other subordinated debt holders will be empowered with enhanced bargaining power should the need for a bankruptcy reorganization arise.”