Supreme Court Bars Structured Dismissals of Bankruptcy Cases That Violate the Code’s Priority Distribution Scheme – Could it Affect Your Creditor Position?

supreme court structured dismissalsOn March 22, 2017 the Supreme Court issued its long-awaited ruling regarding the legality of structured dismissals of Chapter 11 bankruptcy cases that would make final distributions of estate assets to creditors in a manner that deviates from the Bankruptcy Code’s statutory priority distribution scheme.1 In Czyzewski v. Jevic Holding Corp., the Court held that such a structured dismissal was forbidden, absent the consent of the negatively affected parties. However, the Court did not bar all distributions of estate assets which violate the priority distribution scheme, suggesting that interim distributions that serve a broader Code objective such as enhancing the chances of a successful reorganization might be allowed, meaning that important bankruptcy tools like critical vendor orders and first-day employee wage orders are still viable.

In Jevic, the debtor was taken over by an investor in a leveraged buy-out (“LBO”), with money borrowed from a bank. The LBO added a significant and ultimately unsustainable level of the debt to the company. Shortly before the bankruptcy, Jevic ceased operations and fired all of its employees. A group of those laid-off employees (the truck drivers) filed a lawsuit against Jevic and the investor for violations of the federal WARN Act.2 The employees prevailed in the WARN Act litigation against Jevic and obtained a $12.4 million judgment, $8.3 million of which was entitled to priority status in Jevic’s bankruptcy case because it was for wages. As the holders of a priority claim, the truck drivers were entitled to be paid before any of the general unsecured creditors in the Jevic bankruptcy. The employees also had a WARN Act claim pending against the investor, the acquirer in the LBO. During the bankruptcy, the unsecured creditors’ committee sued the investor and the bank for fraudulent transfer claims arising from the LBO. While those cases were pending, and during the bankruptcy, several constituencies attempted to negotiate a resolution to the case with a plan of reorganization, but that effort failed. Ultimately everyone but the truck drivers agreed to a settlement regarding the fraudulent transfer claims and distribution of estate property and a structured dismissal of the bankruptcy case.3 The settlement excluded the truck drivers from any recovery, but did provide some recovery to consenting lower-priority unsecured creditors.

The truck drivers and the United States Trustee objected to the structured dismissal since it deviated from the Code’s priority rules. However the Bankruptcy Court approved it, and was affirmed by both the District Court and the Third Circuit Court of Appeals. Those courts reasoned that under the settlement and structured dismissal, there would be at least some recovery to some priority and general unsecured creditors—even if not to the bypassed truck drivers—whereas otherwise no one but the secured creditor would get anything.. The truck drivers could not really complain, those courts concluded, because they would have gotten nothing regardless. Furthermore, those courts did not believe that the absolute priority rule applied to a dismissal.

The Supreme Court, however, reversed the Third Circuit Court of Appeals, and concluded that in a final distribution of estate assets, by whatever mechanism, the Code’s priority rules must be respected, absent the consent of adversely affected parties.

However, the Court narrowly tailored its ruling, stating that strict compliance with the priority rules is only required in a final distribution of estate assets upon the conclusion of the bankruptcy case, whether via liquidation, plan confirmation, sale of assets, or dismissal. The Court noted that during a reorganization case, bankruptcy courts routinely approve interim distributions of estate assets in ways that violate the priority distribution scheme. For example, in almost every chapter 11 case, debtors seek the ability to pay their employees for pre-petition wages that are accrued but unpaid on the petition date. In some cases, debtors also seek critical vendor orders that allow them to pay certain key suppliers the pre-petition amounts due so that those suppliers will continue to ship goods or provide services during the bankruptcy case. The Court distinguished these interim priority-violating distributions from the one at issue in Jevic because the interim distributions served the goal of the bankruptcy system: the rehabilitation of debtors. Priority-violating final distributions made pursuant to structured dismissals do not serve that goal.

Jevic’s ruling will drastically curtail the growing trend of structured dismissals, eliminating some wiggle room bankruptcy stakeholders had in fashioning a resolution to a case outside a plan of reorganization. No longer can recalcitrant groups of creditors be threatened with being squeezed out of any distribution if they won’t cave in and agree to play ball; they can insist on their priority rights. However, the ruling still preserves the flexibility that has developed in chapter 11 cases to allow debtors to attempt to reorganize their business and protect parties that are willing to work with debtors during the bankruptcy.

© 2017 Foley & Lardner LLP

Czyzewski v. Jevic Holding Corp., 580 U.S. ___ (2017); 2017 WL 1066259.

2 The WARN Act is the Worker Adjustment and Retraining Notification Act. Among other things, the WARN Act requires companies to give workers facing a mass layoff at least 60 days’ notice of the layoff, or pay their wages for the 60 day period. 29 U.S.C. 2102.

3 The truck drivers were excluded because they would not agree to drop their WARN Act claims against the investor, who was a party to the settlement.

Payless Expected to File for Bankruptcy in Next Few Weeks

payless bankruptcyAs I mentioned in my article from January, “11 Retailers to Watch for Possible Bankruptcy Filings in 2017,” it looks like Payless is on the verge of a bankruptcy filing.

Bloomberg reports that Kansas-based Payless, Inc. may be filing for bankruptcy protection as early as next week. The retail discount shoe chain has more than 4,000 stores in 30 countries. Speculation is that they will close about 10 to 15% of the stores as it reorganizes.

The company has had difficulties in the increasingly competitive online market. Last year the company attempted to increase revenue with a new master plan for opening more Payless Super Stores with a larger footprint, more in-stock footwear, and heightened shopping experience, according to Footwear News.

The company has about $665 million in debt, according to Reuters. In February, Moody’s downgraded the company debt rating, stating the company shown “weaker than anticipated operating performance.”

With the number stores, a Payless bankruptcy can raise questions for many landlords. If you are a landlord with a Payless it is important to know your rights, now.


Bankruptcy News: Gander Mountain Shooting for Chapter 11 Bankruptcy

Gander Mountain Chapter 11 BankruptcyReuters reports Gander Mountain, the St. Paul based hunting and fishing chain, is preparing to file for bankruptcy. The bankruptcy is reportedly due to aggressive expansion that failed to draw new customers. Gander Mountain is known as America’s firearms superstore.

Gander has faced stiff competition from Bass Pro Shops, Cabela’s, and Dick’s Sporting Goods.

Currently, Gander Mountain has about 160 stores, with about 60 new stores opened or announced since 2012. According to Reuters, the company has a $30 million loan and revolving credit lines for $25 million and $500 million.

If Gander Mountain files, it will be the fifth outdoor retailer to file for bankruptcy in the last year. Others include Sports Chalet, Sports Authority, EMS, and Eastern Outfitters.


The Road Ahead for 2017 – Restructuring & Insolvency in Australia

insolvency Australia Road to 2017It is anticipated that, by the middle of the year, Australia will see the most significant reform to the corporate and personal insolvency environment in two decades. The reforms, which appear likely to be supported by all sides of government, are designed to promote business preservation and allow greater flexibility in order to ‘turnaround’ distressed companies.

In 2014 the process of reform began with the Australian Productivity Commission’s release of an Issues Paper and subsequent Report on Business Set-Up, Transfer and Closure. In December 2015 the draft Insolvency Law Reform Bill (the Bill) was released.

The perception among the business community is that the existing insolvency landscape stifled entrepreneurship and forced distressed companies into insolvency at the expense of restructuring. While some commentators lament the missed opportunity to go further and adopt more comprehensive reforms, consensus is that the new legislation will resolve some of the market’s biggest concerns and will encourage a turnaround culture. It is also likely to generate increased interest in the domestic distressed debt market.

Key elements of the Insolvency Law Reform Act 2016 include:

  1. Reduction of the bankruptcy period from three to one year
  2. Introduction of a ‘safe harbour’ defence for directors. Directors will avoid personal liability for insolvent trading if they appoint an adviser to assist with business turnaround.
  3. Unenforceability of certain ipso facto clauses. The proposed new laws will prevent a party from terminating a contract based solely on an insolvency event. Certain contracts such as prescribed financial contracts may be excluded from this restriction.

One of the Productivity Commission’s more controversial recommendations (and which did not make it into the draft Bill) is the introduction of a duty of receivers “to not cause unnecessary harm to the interests of creditors as a whole.” This and other more substantive reforms will be subject to further consultation as the Government has committed to another review. The passage of the Bill will meanwhile continue to shine a spotlight on the more substantive reforms proposed.

In addition to the commencement of the Insolvency Law Reform Act 2016, certain class action proceedings in the Federal Court of Australia are likely to intensify in 2017 in the lead up to a hearing on common issues in 2018. Squire Patton Boggs advises the applicants and most group members in seven class action proceedings that have arisen out of the rating of several structured financial products by Standard & Poor’s (S&P) and Fitch Ratings (Fitch). These follow a successful settlement reached in similar proceedings against S&P, following a landmark win in the main proceedings and a further appeal to the Full Federal Court.

The majority of the claims in these proceedings arose following the global financial crisis and the collapse of underlying reference entities including Fanny Mae and/or the swap counterparty Lehman Brothers Australia (in liquidation) (LBA). As a large number of Australian organisations held these products, a number of insolvencies resulted from their collapse in value and/or wipe out and Squire Patton Boggs has acted for creditors of LBA in the insolvency proceedings that ensued to recover money for creditors with these claims.

The products that are the subject of these proceedings include a constant proportion portfolio insurance (CPPI) and synthetic collateralised debt obligations (SCDOs) which were assigned credit ratings by S&P or Fitch. The applicants allege that the ratings agencies were negligent and engaged in misleading and deceptive conduct in assigning high ratings to these products. They contend that had the products not received such high ratings, they would not have invested. S&P and Fitch deny these allegations.

These proceedings have had and will continue to have widespread domestic and international significance due to the number of structured financial products that were sold around the world and were rated by the large ratings agencies using similar methodology. Actions against S&P have been filed in other jurisdictions, including by European institutional investors in Amsterdam, setting a global trend that is likely to continue into 2017. This trend involves ensuring the accountability of credit rating agencies in their assignment of ratings to complex financial products, especially in areas where regulators have as yet failed to achieve similar outcomes. As a result, the continuing progress of these class actions in 2017 is likely to produce lasting implications, in particular further consideration as to the regulation of credit rating agencies.

Continue watching this blog throughout the year to come for updates about these and other topics from our offices across Australia, EU and Europe, UK and US.

© Copyright 2017 Squire Patton Boggs (US) LLP

Jevic Holding Corp.: Is The Supreme Court Now Ready To Strike Down Structured Dismissals?

Supreme Court Bankruptcy Structured DismissalsIn a prior post, we discussed the Third Circuit Court of Appeals’ decision in Jevic Holding Corp., where the court upheld the use of so-called “structured dismissals” in bankruptcy cases, and the Supreme Court’s grant of certiorari. On December 7th, the Supreme Court heard oral argument in Jevic.  The Court’s ultimate ruling will likely have a significant impact upon bankruptcy practice.

Under the Jevic structured dismissal, unsecured creditors received a distribution from a settlement reached between the official committee of unsecured creditors and secured lenders.  Wage priority claimants received nothing from the settlement, notwithstanding their senior position under the Bankruptcy Code.  The bankruptcy court approved the structured dismissal, and by extension the distribution provided for in the settlement, and the district court affirmed on appeal.  The Third Circuit also upheld the structured dismissal, holding that the bankruptcy court has discretion to approve structured dismissals except if there is a showing “that the structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation or conversion process.”

Jevic put front and center two competing concerns in bankruptcy.  On its face, the Jevic structured dismissal appears to conflict with the priority rules set forth in section 507 of the Bankruptcy Code, since junior creditors were paid while certain senior creditors were not.  However, the structured dismissal approved in Jevic also arguably maximized creditor recoveries, albeit in a way that skipped over certain senior creditors. The estate was administratively insolvent and without the structured dismissal, the case would have been converted to Chapter 7 and distributions would have been significantly reduced.

The questions posed yesterday to counsel for Petitioners and counsel for Respondents, as well as to government counsel as amicus curiae, were wide-ranging and pointed.  Justice Breyer questioned the statutory basis for the structured dismissal, noting that while no Code provision forbid it, no specific Code provision permitted it either.  Justice Kennedy looked for guidance on the “for cause” standard under section 349(b), which permits bankruptcy courts to modify the effect of dismissal orders.  Justice Sotomayor expressed concern that there was collusion in Jevic among senior and junior creditors to the detriment of other creditors.  Several Justices expressed concern with Respondents’ position that section 363(b) afforded sufficient discretion to the bankruptcy court to approve a distribution that was at odds with the Code’s priority scheme.  According to Respondents, Jevic presented the extraordinary circumstances required by section 363(b) to deviate from the absolute priority rule since no plan was possible and conversion to Chapter 7 would lead to little, if any, distribution.  Justice Sotomayor questioned Respondents’ position that Jevic was a rare case, and Justice Kennedy took a similar position, noting that it is not rare for there to be no prospect of a confirmable plan, a fact cited by Respondents in support of the Jevic structured dismissal.

Predicting the outcome of cases simply from oral argument is imperfect and notoriously dangerous.  Nonetheless, some commentators have opined that a sufficient number of Justices appear to be sufficiently concerned with the Jevic structured dismissal that the Third Circuit’s opinion is in peril.  If the Court reverses the Third Circuit, the question becomes how sweeping the Court’s opinion will be.

A reversal may well imperil so-called “gift plans”, where a secured creditor makes a payment to junior creditor (the “gift”) in order to obtain support for plan confirmation.  The gift allows the junior creditor to obtain a recovery at odds with the Bankruptcy Code’s priority scheme.  If the Court holds that the priority scheme governs all estate distributions, depending upon the scope of the Supreme Court’s opinion, gift plans may not be permitted.

In addition, if the Court rules that the section 507 priority scheme applies to the entirety of a bankruptcy case, such a holding would conceivably threaten the viability of orders that even Petitioners concede are customary in commercial reorganizations, such as wage payment orders and critical vendor orders.  Those represent instances where estate property is distributed in violation of the Code’s priority scheme, but in reliance on the so-called “Doctrine of Necessity,” where payments serve the overall goal of maximizing the debtor’s going concern value to create the possibility of greater distribution to creditors than does liquidation.

In fact, the Court seemed to struggle with how far its ruling should go, asking the parties what was the scope of the holding they wanted the Court to enter.  Counsel for Petitioners was careful to limit the scope of the holding so as to carve out common Chapter 11 practices, such as wage payment and critical vendor orders.  This was in contrast to counsel for the government who said that it was the government’s view that pre-plan distributions in Chapter 11 that violate the priority scheme “are not permissible under any circumstances unless there is consent of the impaired priority claimholder.”  Depending upon the scope of the Court’s opinion, regular and customary Chapter 11 practices, such as critical vendor motions and pre-petition wage motions, may no longer be permitted.

© Copyright 2016 Squire Patton Boggs (US) LLP

Collections in Connecticut Part 1: Pre and Post-Judgement Collection Specifics

Connecticut flag

Collections in Connecticut – how to get paid if you are owed money? Collecting money owed to you or your company can be frustrating.  You or your company are owed money and have not been paid.  What are your legal options?  The following video is the first in a series of three discussing collection law in Connecticut, pre and post-judgment collection specifics and enforcing foreign judgments.

Click here for Part 2 – Prejudgment Remedy – Collections in Connecticut

Click here for Part 3 – Steps in the Connecticut Collection Process

© Copyright 2016 Murtha Cullina

Attorneys Facing An Uphill Battle In Litigation Should Consider Option Value When Arguing Valuation

Let me tell you a sad story; Joe owned a marketing company and earned a prosperous living for several years. Joe’s business was growing rapidly and all seemed right with the world. Then a trusted employee left Joe’s firm, taking with him half of Joe’s customers in violation of his non-compete agreement. Joe’s business slowly suffered and lost customers until eventually his firm declared bankruptcy.

Joe sued his former employee and asked for damages related to the value of his firm. Joe’s attorney argued to the court for compensation based on the value of Joe’s firm that was destroyed by the employee. Yet the attorney left out one critical question when arguing the case; how should the law account for the fact that Joe’s business was growing rapidly until the employee left?

Perhaps Joe had several big accounts that he might have been able to sign had the employee not engaged in unfair trade practices. Without taking these factors into account, Joe’s attorney is under-representing the value of Joe’s claim and leaving compensation on the table for no reason.

In finance, this idea of the possibilities that could plausibly occur in the future is called an embedded option or a real option and it is extremely useful in a variety of cases from divorce proceedings and business bankruptcies to merger disputes and matters of economic harm. In the scenario above, Joe’s firm had the ability to potentially continue to grow and become even more successful than it was at the time before Joe’s employee left. Hence the damage done to Joe is greater than simply the lost historical value of the firm. He has also lost the possibility of much more value in the future.

The crux of modern asset valuation is based on a concept called the time value of money. Essentially the idea is that because money received in the future is worth less than money received today, we can value assets or a business based on their associated cash flows and an appropriate discount rate. This approach forms the basis of everything from stock valuation on Wall Street to proper methods for computing interest rates in bankruptcy. This facet of valuation is well understood. But what about the future opportunities or chances of cash flows that are uncertain?  That’s what embedded options address.

The concept of embedded options might seem abstract or even too nebulous for many judges to buy into in a court case, but the reality is that real options have significant value and are often a subject of serious financial negotiations. Particularly for small firms, real options are often important and serve as the basis for various types of convertible debt and warrant grants.

As a finance professor and frequent consultant to companies on matters of asset valuation and financial forecasting, I have long taken it for granted that the techniques used in the finance profession were well understood and universally applied across many other industries including the law. I was very surprised to learn when I started doing expert consulting work, this is not the case. Lawyers often neglect to ask for damages based on real options in their cases. This leaves an important tool out of the litigation toolbox.

In discussing real options thus far, it might seem like they are primarily useful for parties alleging damages, yet they can also be useful for defendants as well. In particular, defendants need to understand how real options are valued and also understand the four appropriate metrics for calculating economic harm as it relates to options (compensating variation, equivalent variation, Paasche indices, and Laspeyres indices). I’ll talk more about these in a future column though.

When valuing real options, there are various statistical techniques that can be used. The math is not necessarily important here, but the concepts are. Essentially, real options increase in value in situations where there is greater uncertainty, and when interest rates in the broader economy rise. Those conditions make real options an exciting tool in today’s courts. With the Fed finally starting to raise interest rates, real options should become marginally more valuable. More importantly, situations with significant amounts of uncertainty lead to greater volatility in intrinsic asset prices.

These volatile situations are often the very situations that lead to court cases for attorneys – a business deal that went wrong leads to a bankruptcy but could have led to a hugely successful company, a merger agreement could result in substantial cost savings for both firms or substantial value destruction for investors and is being challenged by shareholders, a wrongful death case for an individual in the prime of their lives leaves so many possible futures unexplored. Thanks to new statistical techniques and greater computing power, these situations and others can be effectively modeled through computer simulations and valued by economists in ways that would have been unimaginable a decade ago.

Representing clients fairly and to the best of one’s ability in court is the foremost duty of an attorney. To do that, attorneys need to understand the tools of business and the cutting-edge techniques being used in asset valuation. Failing to use these tools is not only a disservice to clients, but a severe hindrance to the attorney as well. In a competitive legal market, the Joes of the world will flock to those attorneys that free themselves to position their clients for maximum success in court.

Article By Dr. Michael McDonald of Fairfield University Dolan School of Business

© Fairfield University Dolan School of Business