The Supreme Court’s 2016–2017 term began last week with attention to two bankruptcy issues: Structured dismissals and insider claims.
Structured dismissals occur when a company’s assets in chapter 11 will not generate enough cash to pay priority claims in full and permit
confirmation of a plan. In Czyzewski v. Jevic Holding Corp., the official unsecured creditors’ committee sued the secured lender and negotiated a settlement whereby the lender agreed to set aside money for distribution to unsecured creditors following an agreed (i.e., “structured”) dismissal of the chapter 11 case. The distribution scheme did not follow priorities in the Bankruptcy Code because priority wage claimants received nothing from the lender while lower-ranked general unsecured creditors did. The bankruptcy court approved the settlement and dismissed the chapter 11 case over the wage claimant’s objection and that ruling was upheld in the district court and the Third Circuit.
The Supreme Court granted certiorari to review the Third Circuit’s ruling in Jevic on whether bankruptcy courts can dismiss chapter 11 cases when property is distributed in a settlement that does not comply with priorities contained in Section 507 of the Bankruptcy Code. The Court’s granting of certiorari in this case was not surprising because there has been a long-standing split in the circuits on the issue of structured dismissals. In Jevic, the Third Circuit approved a structured dismissal, following the Second Circuit on this issue. In contrast, the Fifth Circuit barred structured dismissals in a 1984 decision.
The Solicitor General recommended that the Supreme Court review and reverse the Third Circuit, arguing that “bankruptcy is not a free-for-all in which parties or bankruptcy courts may dispose of claims and distribute assets as they see fit” and that “nothing in the Code authorizes a court to approve a disposition that is essentially a substitute for a plan but does not comply with the priority scheme set forth in Section 507.”
On October 3, the first day of the new term, the Supreme Court invited the Acting Solicitor General to file a brief expressing the views of the United States on U.S. Bank NA v. The Village at Lakeridge LLC, which usually indicates a higher probability that the Court will grant certiorari. In Lakeridge, the Ninth Circuit held that a person does not become a statutory insider solely by acquiring a claim from a statutory insider. This issue is important when insiders hold the only unsecured claims because insider claims are not counted for purposes of confirming a cram-down plan over the objection of secured creditors.
In Lakeridge, the corporate debtor had only two creditors: a bank with a $10 million secured claim and the debtor’s general partner, which had a $2.8 million unsecured claim. In order to confirm a plan over the bank’s objection the holder of the unsecured claim would have to vote to accept the plan. But because the general partner was an insider, its vote would not be counted. To solve the cram-down problem, the general partner sold its claim for $5,000 to a close friend of one of the owners of the general partner and the plan called for $30,000 distribution on the unsecured claim. The bankruptcy judge ruled that although the buyer was not itself a statutory insider, it became an insider upon purchasing the claim. On appeal, the Bankruptcy Appellate Panel (“BAP”) agreed that the purchaser was not a statutory insider but reversed the bankruptcy court’s ruling that the purchaser became an insider by purchasing the insider claim. On further appeal, the Ninth Circuit upheld the BAP’s decision, although one judge filed a dissenting opinion on whether the purchaser was, in fact, a non-statutory insider based on the circumstances surrounding its claim purchase.
In the principal holding of the Ninth Circuit’s opinion, the majority in the Ninth Circuit agreed that a person does not become a statutory insider solely by acquiring a claim in good faith from a statutory insider. The opinion noted that the Code distinguishes between the status of a claim and the status of a creditor and that insider status pertains only to the claimant and not the claim. Therefore, the Ninth Circuit stated that status as an insider entails a factual inquiry to be conducted on a case-by-case basis and that to become an insider, a claim buyer must have a close relationship with the debtor and negotiate the relevant transaction at less than arm’s length. The bankruptcy judge had previously determined that the buyer was not an insider based on his conduct and relationship with the debtor and a majority of the Ninth Circuit panel did not find that conclusion to be clearly erroneous. It therefore affirmed the appellate panel.
The dissenting judge agreed that insider status depends on the circumstances of the case but believed that there were enough facts in this case about the relationship between the insider and the purchaser and the purchaser’s rationale for buying the claim to conclude that the purchaser should be treated as a non-statutory insider.