Get Out! Jevic To Liquidate After Post-SCOTUS Deal Fails
Last Monday (May 21, 2018), the Bankruptcy Court for the District of Delaware converted the chapter 11 bankruptcy of Jevic Transportation Corp. to a chapter 7 liquidation. This means that the ten-year effort to “reorganize” the former trucking company will become a straight liquidation supervised by a trustee.
I put “reorganize” in quotes because everyone knew from the start of the case, in 2008, that the debtor could not reorganize in a conventional sense because the business had already collapsed. Instead, the managers (and the senior lenders) would remain in possession and control of the debtor to engage in an orderly liquidation, which is permitted by chapter 11. Most believed this was better than a straight liquidation under chapter 7 of the Bankruptcy Code because they would have greater expertise in maximizing asset values, and more flexibility in making distributions, than a chapter 7 trustee, who would be a stranger to the company.
This last point—flexibility in distributions—earned the case a trip to the Supreme Court, where a 6-2 majority held last spring that final distributions must follow the Bankruptcy Code’s order of priority strictly, unless (in simple terms) creditors “consent,” e.g., by voting for a deviation under a plan of reorganization, a cross between a contract and a consent decree, and the presumptive way out of chapter 11. But, because management could not muster support for a plan, they had tried to resolve the case through a so-called “structured dismissal,” a procedural concoction that had many features of a plan but none of its protections, such as voting.
The details of Jevic are complex, but the bottom line, in my view, is that Jevic is about two things, although it receives attention only for one. First, SCOTUS affirmed—yet again—that “absolute priority” applies in final distributions in any kind of bankruptcy absent meaningful consent to an alternative. Distributive priority was in dispute here because management and senior creditors did not want to honor the priority payment rights of the debtor’s former truck drivers, who objected to this treatment, and who were the successful petitioners in the Supreme Court. [Disclosure: I was co-counsel to a group of academics who were amici curiae in support of petitioners]. On remand, the parties tried, but could not come to a negotiated deal that respected the Supreme Court’s ruling, so Judge Shannon converted the case to one under chapter 7, which permits no flexibility in distributions.
Absolute priority is important, but not really news, since it has been the law of the land for over one hundred years.
Instead, I think Jevic’s more important, but more subtle, contribution reflects concern about the integrity of the chapter 11 process. Structured dismissals are an effort to create a faster, cheaper way out of chapter 11 than a plan of reorganization, a complex instrument sometimes said to be a combination of a contract and a consent decree. Jevic did not forbid structured dismissals outright, but made clear that courts have to take major objections seriously, or find some other path out of bankruptcy (e.g., a plan or chapter 7 liquidation).
Some worry that those who often call the shots in these cases—lawyers, bankers, distress investors—have created an environment in which they can capture the collectivizing gains of chapter 11—e.g., the “stay” that halts dunning—at the expense of less cohesive and sophisticated stakeholders, such as the drivers in Jevic. Because Congress designed bankruptcy to protect the latter group (as the main beneficiaries of the “estate” created by commencing a chapter 11 bankruptcy case), the former threaten the integrity and legitimacy of the process.
I argue in a forthcoming paper that one implication of Jevic is that bankruptcy judges should be more vigilant in scrutinizing the deals they are asked to approve. For example, the key deals that often hog-tie a debtor are ostensibly “emergency” requests for financing at the outset of the case. These so-called “debtor-in-possession” loans are tricky because corporate debtors need cash to operate during a case, but the loan agreements can give the lenders significant control of the chapter 11 process, as seemingly happened in Jevic.
The Bankruptcy Code and rules set forth tests that the interested parties—often the senior lender and management—must pass to get the loan. For example, they have to show that the debtor has exhausted other financing options. But, because debtors and lenders often rush into bankruptcy at the last minute, and these loans can be fairly complex, judges have little time or capacity to evaluate them (bankruptcy courts are among the busiest in the federal judiciary). Judges depend on the parties’ arguments, but for a variety of reasons, the checks and balances Congress created don’t always work.
I point out that there are ways to deal with this: Judges can approve less than the full amount requested, metering it out over time; they can subject management to examination about efforts to shop for loans; they can open the process up to more market participation; and they can preserve other stakeholders’ capacity to challenge the propriety of the loans once the case is under way.
This is not to suggest that judges are pushovers, that participants are corrupt, or that more scrutiny would be easy. In Jevic, which was a comparatively small case, Judge Shannon was asked to approve one of these loans at the outset under seemingly dire circumstances: the debtor had trucks on the road with freight that had to be delivered. He had to make a hard call, and many of us would have done the same thing under similar circumstances.
Observers and participants sometimes call chapter 11 bankruptcy a “melting ice cube” because the longer the process takes, the more value slips away. This is undoubtedly true in many cases. But the equal and opposite risk is that haste makes waste. One way to view Jevic is that the effort to rush the debtor into a problematic loan agreement at the beginning of the case led to the controversial structured dismissal which, ironically, caused the case to drag on for ten years.
While converting a chapter 11 case to one under chapter 7 is not a happy event, sometimes it is the least bad way out of bankruptcy. Here, perhaps, the most we can say is: better late than never.