The Secret Life of Priority

For forty years, the central goal of corporate reorganization under chapter 11 of the United States Bankruptcy Code has been to produce a “plan of reorganization” for the distressed corporate debtor.  Often viewed as a “grand bargain” between the debtor and all of its stakeholders, plans require a super-majority vote of creditors, and must pay or provide for all pre-bankruptcy claims against the debtor. They often involve debt-equity conversions, extended payment terms, or simply “haircuts” to advance chapter 11’s larger policy aspiration of preserving going concerns and jobs where possible, and maximizing stakeholder recoveries in any event.

Corporate debtors don’t always succeed in negotiating and confirming a plan, in which case the court may liquidate the debtor’s assets or dismiss the case to permit creditors to pursue their claims in other fora.  But the plan of reorganization has been a central feature of reorganization both because it provides a negotiating framework and, in the absence of consent (through creditor voting), enforces a particular distributive order: “absolute” priority.

Academics have long-debated the merits of plans of reorganization and their underlying distributive logic.  Many believe that “absolute” priority is foundational because it creates predictability ex ante and procedural integrity ex post.  Others, however, worry that plans are costly and courts should have discretion to alter the order of priority (sometimes thought of loosely as “relative” priority) in order to promote efficiency gains.

As I explain in a new paper, The Secret Life of Priority: Corporate Reorganization After Jevic, the U.S. Supreme Court’s recent decision in Czyzewski v. Jevic Holding Corp. (In re Jevic) effectively ended this debate, holding that “absolute” priority governs the resolution of chapter 11 cases.  More subtly, but perhaps more importantly, Jevic also saved the plan of reorganization as the principal vehicle by which to exit chapter 11.  This, in turn, has important procedural implications, which I explore in the paper. The “secret life” of priority, Jevic suggests, is that priority is not only about the order of distributions, but also about the quality of the process by which bankruptcy courts make important distributive decisions.

Priority and the viability of plans were in issue at all in Jevic because the lower courts there had approved a so-called “structured dismissal,” a procedural concoction under which senior and junior claimants sought to split the assets of the debtor, a trucking company, by skipping “mid-priority” wage claims held by the petitioners, the debtor’s terminated drivers.[1]  In reversing the Third Circuit Court of Appeals—one of the most important appellate courts supervising U.S. bankruptcy practice because it reviews Delaware’s influential courts—a 6-2 majority held that final distributions in a chapter 11 bankruptcy must follow the “ordinary” and “basic” priority rules of the Bankruptcy Code absent “the affected creditors' consent.”[2]

Jevic did not forbid all structured dismissals. Instead, the Court held that those in control of a corporate debtor could not use a structured dismissal to evade the basic creditor safeguards of plans: creditor consent or, absent consent, absolute priority. Yet, outside a plan, “consent” is difficult to pinpoint in a chapter 11 reorganization, because these cases can involve hundreds or thousands of creditors and shareholders. In Jevic, it was easy to see the absence of consent, because the mid-priority drivers objected to the structured dismissal. But in many cases, widely dispersed creditors will not understand or have the resources to challenge important actions in a case.  The absence of objections presents a significant risk of false negatives, because it is not clear whether silence signals assent or ignorance.

In principle, the Bankruptcy Code addresses this problem by providing that unsecured creditors will be represented by a committee, whose professionals will be paid by the corporate debtor. But creditors’ committees are problematic representatives because their statutory remit is unclear and they may be in conflict with the claimants they supposedly represent. In Jevic, for example, the creditors’ committee that supported the structured dismissal also represented the truck drivers who opposed it.

The Jevic Court offered no insight into what constitutes “consent” in chapter 11 cases. Instead, I explain that the majority opinion reveals a Court concerned about three process values that proxy for it:

• Participation. Consent requires participation. The Chapter 11 plan is the main mechanism for inducing creditor participation, mainly through voting. Jevic makes it more difficult for structured dismissals to evade plan safeguards, so plans will remain important to the reorganization process. When parties wish to dispense with a plan, they will have to show that creditors had a meaningful opportunity to participate in the resolution process or that the distributions follow absolute priority.
• Predictability. Consent is more plausible—both to reach and to show—if the rules around which parties settle are more predictable. By choosing absolute, rather than relative, priority Jevic narrows the range of possible outcomes and the standards by which they must be assessed.
• Procedural integrity. The Jevic majority warned about risks of collusion, such as senior secured creditors and general unsecured creditors teaming up to squeeze out mid-priority creditors, as had happened in the lower courts there. Requiring consent or absolute priority reduces the likelihood of these forms of misconduct.

Process values of this sort are often lauded in principle and disputed in practice, so it is not clear how aggressively courts will advance Jevic’s reasoning. Because many Chapter 11 cases are effectively resolved through a sale of all assets, creditors will continue to question the rehabilitative logic—and the procedural costs—of chapter 11 plans. The economic pressures that led to the structured dismissal in Jevic will not miraculously abate. Courts after Jevic will have to address both the efficiency demands of creditors and the procedural concerns of the Supreme Court.

Jonathan Lipson is the Harold E. Kohn Professor of Law at Temple University-Beasley School of Law and a guest contributor to the Oxford Business Law Blog. He was also co-counsel to amici law professors in support of petitioners in Jevic.

[1] Czyzewski v. Jevic Holding Corp. (In re Jevic), 580 U.S. _, 137 S. Ct. 973, 979 (2017) rev’g 787 F.3d 173 (3d Cir. 2015).  See also In re Jevic Holding Corp., No. 14-1465, 2017 WL 1880820, at *1 (3d Cir. May 9, 2017) (vacating and remanding Third Circuit opinion).

[2] Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973, 983, 197 L. Ed. 2d 398 (2017).