Delaware Judge Narrows Jevic to Prohibit Only End-of-Case Priority Skipping

September 20, 2017

Bankruptcy Judge Kevin Gross of Delaware read Jevic narrowly and approved final financing in chapter 11 with a payment for general unsecured creditors but none for unsecured creditors with unpaid administrative or priority claims.

Short Bark Industries Inc., a provider of body armor and apparel for the military, filed a chapter 11 petition in July, aiming for a quick sale of the assets. The company had about $17 million in secured debt, with almost $10 million owing to the senior secured lender.

After filing, the debtor landed a so-called stalking horse bid to sell the business for $3.2 million. The official creditors’ committee objected to the proposed chapter 11 financing provided by the senior secured lender.

Subject to the court’s approval, the lender and the committee settled their disputes over financing. The agreement called for the lender to hold a minimum of $110,000 in sale proceeds in escrow for payment to holders of general unsecured claims but not for holders of unpaid priority or administrative claims.

The U.S. Trustee and a creditor with a disputed priority claim objected to the settlement, based on Czyzewski v. Jevic Holding Corp., 15-649, 2017 BL 89680, 85 U.S.L.W. 4115 (Sup. Ct. March 22, 2017), the Supreme Court decision barring structured dismissals that “deviate from the basic priority rules.”

Ruling on the objection in an opinion delivered from the bench on Sept. 11, Judge Gross said he was initially inclined to disapprove the settlement, saying that the U.S. Trustee lodged a “very strong objection.” The judge said he then rereadJevic, noting how “it was all about a structured settlement.” He quoted Justice Stephen G. Breyer’s opinion proscribing “end-of-case distributions” that “would be flatly impermissible in a chapter 7 liquidation.”

Judge Gross characterized Justice Breyer as disapproving Jevic’s priority-skipping distribution because there was no “significant, offsetting, bankruptcy-related justification.”

In contrast, Judge Gross said the settlement in Short Bark “enables the debtors to continue with their businesses . . . and the employment of 500 plus people, while preserving the committee’s right to bring actions against insiders.”

Judge Gross had been told that administrative claims would be paid by using the chapter 11 financing. He said there was “little, if any, assurance” that the creditor with the disputed priority claim “would receive any distribution, were the settlement to be denied.”

The decision by Judge Gross appears to limit Jevic to a prohibition against priority-skipping distributions occurring at the end of the case, when it is clear that priority and administrative claims will not be paid. If his rationale holds up, settlements could avoid Jevic’s fate by being accelerated to an earlier time in the chapter 11 case.

If Judge Gross is reversed and priority-skipping settlements are barred at all stages of reorganization, chapter 11 may devolve into an exercise only for the benefit of secured creditors.

On the other hand, bankruptcy judges could largely, but not entirely, ensure compliance with the rules of priority by using early-stage, priority-skipping settlements combined with financing orders that guarantee payment of administrative claims, leaving only priority creditors with no assured recovery. For those overlooked creditors, perhaps estate claims could be carved out in a settlement for their benefit, but the effect would look much like a chapter 11 plan having less than full compliance with Section 1129.

In Short Bark, estate claims were not extinguished by the financing but were preserved, leaving the possibility that priority claimants could receive proceeds from successful suits either in a chapter 11 plan or a distribution in a subsequent chapter 7 case.

If there is a flaw in Short Bark’s logic in relation to Jevic, perhaps it’s because the proposed financing assured the ability to continue the business and the committee’s objection to financing wouldn’t necessarily be fatal were there no settlement.

Justice Breyer explicitly allowed first day orders departing from the rules of priority, such as authorizations to pay prepetition wages and claims of so-called critical vendors that are designed to continue the business as a going concern. If there is an appeal, Short Bark will raise the question of whether priority skipping somewhat later in the case is permissible if structures are already in place assuring continuation of the business long enough to sell the assets.

For bankruptcy judges, the choice is difficult. Should they impose the Bankruptcy Code priority rules stringently, or allow an outcome that benefits the largest numbers of creditors?

In Short Bark, the creditors’ committee was represented by Lowenstein Sandler LLP.


Did you know that ABI's upcoming Annual Spring Meeting — to be held April 19-22 at the Marriott Marquis in Washington, D.C. — will have a special session on how to respond to the Jevic decision in your daily practice? Find out more information and register today at abiasm.org!

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