How Absolute Is the Absolute Priority Rule in Bankruptcy? The Case for Structured Dismissals

105 Pages Posted: 30 Sep 2016 Last revised: 6 Jun 2017

See all articles by Bruce Grohsgal

Bruce Grohsgal

Widener University - Delaware Law School

Date Written: September 29, 2016

Abstract

This article challenges the view that the absolute priority rule applies to a “structured dismissal” in a chapter 11 bankruptcy case, namely a court-approved settlement of certain claims by or against the debtor followed by the dismissal of the case. Under that view, the bankruptcy court cannot approve a settlement that makes a distribution to holders of junior claims unless it also provides for payment of all senior claims in full. The Supreme Court will consider the question this fall in Czyzewski v. Jevic Holding Corp. (In re Jevic Holding Corp.). The question before the Court is: “Whether a bankruptcy court may authorize the distribution of settlement proceeds in a manner that violates the statutory priority scheme.”

The argument that a structured dismissal always must follow the absolute priority rule, even when a chapter 11 plan is not confirmable, overstates the current statutory reach of the rule. The rule reached its zenith by judicial launch in 1939 in Case v. Los Angeles Lumber, when the Supreme Court construed the statutory term “fair and equitable” to be synonymous with “absolute priority.” Congress has circumscribed the rule repeatedly since: in 1952 by amending the Bankruptcy Act, in 1978 with enactment of the Code, and in 1986 and 2005 by amending the Code.

As a result of these enactments, the absolute priority rule is a special, limited rule that does not pervade the current Code. Indeed, the very reorganization plan — a consensual chapter 11 plan — that the Supreme Court held was not confirmable in Los Angeles Lumber would be confirmable under the current Code.

This article concludes that Congress has authorized the bankruptcy court to approve a structured dismissal in chapter 11 when it is in the best interest of creditors — such as when a plan is not confirmable — even if distributions do not follow the absolute priority rule. Accordingly, the Supreme Court should resolve the current circuit split by affirming Jevic.

Keywords: bankruptcy, absolute priority rule, chapter 11, Jevic, structured dismissals, revesting, for cause, best interest of creditors

JEL Classification: K10, K20

Suggested Citation

Grohsgal, Bruce, How Absolute Is the Absolute Priority Rule in Bankruptcy? The Case for Structured Dismissals (September 29, 2016). William & Mary Business Law Review, Vol. 8, 2017; Widener University Delaware Law School Legal Studies Research Paper Series No. 16-16. Available at SSRN: https://ssrn.com/abstract=2845430

Bruce Grohsgal (Contact Author)

Widener University - Delaware Law School ( email )

4601 Concord Pike
Wilmington, DE 19803-0406
United States

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