Lower Courts Interpret U.S. Supreme Court's Jevic Decision

            In Czyzewski v. Jevic Holding Corp., the United States Supreme Court made clear that bankruptcy courts cannot approve structured dismissals that provide for distributions in violation of the Bankruptcy Code’s priority scheme without the consent of the affected parties.[1]  For an in-depth analysis of the Jevic decision, please read our previous blog post by clicking here.             It has not taken long for Jevic to begin affecting settlement agreements in bankruptcy courts across the country.  For example, hardly a month after the Jevic decision, a bankruptcy court in the Eastern District of Tennessee struck down a proposed settlement agreement because the settlement agreement proposed a distribution whereby one creditor would be preferred in violation of the priority scheme set forth in Section 507 of the Bankruptcy Code.[2]  In In re Fryar,[3] the proposed settlement called for a bank to receive a distribution in full satisfaction of its $350,000 lien on real property worth only $200,000.  Thus, under the proposed settlement, the bank would receive a $150,000 distribution on its unsecured claim before other creditors with higher statutory priority received distributions, such as the Internal Revenue Service (“IRS”) which had a pre-existing tax lien on the debtor’s property.  Further, the bank would be paid in full for its general unsecured claim, while the other general unsecured creditors would have received a pro-rata share of the amount remaining in the bankruptcy estate once all other higher priority claims were paid.            The court found that the proposed $350,000 distribution to the bank violated the Bankruptcy Code’s priority scheme.  In so holding, the court found that the proper distribution of the $350,000 under the Bankruptcy Code should go first to satisfy the IRS’ lien, and the remaining proceeds would then be distributed to priority unsecured creditors before finally being distributed to general unsecured creditors on a pro-rata basis.  While the court noted that under Jevic, if all of the affected creditors (i.e., the priority and general unsecured creditors who would otherwise be statutorily entitled to an earlier distribution absent the proposed settlement) consented to the proposed settlement, the court may have approved the settlement; but since three creditors who were entitled to a higher priority under the bankruptcy code objected, the court had no choice but to deny the settlement as it was currently structured.            In In re Constellation Enterprises LLC,[4] a bankruptcy court denied a settlement agreement because it did not comply with the strictures of Jevic and the Bankruptcy Code’s priority scheme.  The proposed settlement agreement would have created a general unsecured creditor litigation trust (the “Litigation Trust”) with lawsuit rights assigned to it by a company formed by the debtor’s secured noteholders.  Additionally, the agreement also would have given the Litigation Trust $2.05 million for payment of the creditor committee’s professionals’ fees.        The two creditors, along with the U.S. Trustee and the IRS, objected to the proposed settlement agreement.  The objecting parties claimed that this proposed settlement—which would create the Litigation Trust—bypassed creditors with higher priority under the Bankruptcy Code, thereby leaving these higher priority creditors to receive little or no distributions.[5]        In denying the proposed settlement, the bankruptcy judge orally ruled that while he “den[ied]the settlement motion” with “some reluctance,” he was “constrained to do so by the facts [of the case] and by the law.”  Notably, the judge also stated that he believed the debtor’s bankruptcy was “headed to . . . dismissal or conversion [to chapter 7]” and not to a successful reorganization under chapter 11.         Thus, the decision in Fryar and Constellation illustrate that after Jevic, bankruptcy courts appear to require settlement agreements to either (i) comply with the Bankruptcy Code’s priority scheme or (ii) require that all negatively affected creditors consent to a distribution that contravenes the Bankruptcy Code’s priority scheme. [1]Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017).[2] 11 U.S.C. § 507 (West).[3]  1:16-BK-13559-SDR, 2017 WL 1489822 (Bankr. E.D. Tenn. Apr. 25, 2017).[4]Constellation Enterprises LLC, Case No. 1:16-bk-11213 (Bankr. D. Del. May 16, 2016).[5] 11 U.S.C. § 507.