Earlier today, in Czyzewski v. Jevic Holding Corp., the Supreme Court put an end to “structured dismissals” that allow a debtor to leave bankruptcy while circumventing the Bankruptcy Code’s creditor payment priority scheme.

A Chapter 11 debtor generally has three options for exiting bankruptcy: (1) a confirmed plan of reorganization (or liquidation); (2) conversion to Chapter 7 and liquidation of the debtor’s estate; or (3) dismissal of the bankruptcy case entirely. Chapters 11 and 7 both broadly require the debtor’s estate to make distributions to creditors in accordance with a statutorily mandated order of priorities (although Chapter 11 provides more flexibility than Chapter 7 in this respect).

Dismissals, however, are intended to restore the debtor to the pre-bankruptcy status quo. This usually involves revesting the estate’s property with the debtor and allowing creditors to continue their non-bankruptcy collection efforts rather than making dismissals through the bankruptcy case. However, because it is not always possible to restore the pre-bankruptcy state of affairs, the Bankruptcy Code permits the bankruptcy court “for cause” to order a different treatment. Little in the Bankruptcy Code expressly limits what the court may order “for cause” when issuing such a dismissal. Nor does the Bankruptcy Code expressly require adherence to the otherwise applicable claims priority rules when approving distributions in connection with such a dismissal. A “structured dismissal” involves exploiting this ambiguity to achieve results—such as making payments to junior creditors while refusing to pay senior creditors—in a manner not normally permitted by the Bankruptcy Code.

Jevic was just such a case. Less than two years after being purchased by Sun Capital Group, Jevic Holding Corp. filed for Chapter 11 protection. The rapid collapse of the company resulted in a group of truck drivers bringing state and federal Worker Adjustment and Retraining Notification (WARN) Act claims against both Jevic and Sun. The drivers obtained summary judgment on their claims against Jevic (and continued to litigate against Sun). As a result of the Bankruptcy Code’s priority scheme, a substantial portion of their judgment would have been entitled to priority of payment over general unsecured creditors.

Separately, the official committee of unsecured creditors appointed in the Chapter 11 case sued Sun, on behalf of Jevic’s bankruptcy estate, for alleged fraudulent conveyances and preferences relating to the leveraged buyout. Ultimately the committee, the debtor, and Sun reached a settlement calling for a structured dismissal in which: (a) the bankruptcy case would be dismissed; (b) the fraudulent conveyance and preference lawsuit would be dismissed; and (c) certain payments would be made to the Committee’s professionals and general unsecured creditors, but not to the senior-in-priority WARN Act claimants.

The bankruptcy court acknowledged that this arrangement did not comport with the Bankruptcy Code’s priority scheme, but nevertheless approved the settlement and dismissal on the grounds that the priority scheme did not expressly apply to a structured dismissal and the estate faced “dire circumstances.” Both the district court and the Third Circuit affirmed.

The Supreme Court bluntly reversed the courts below, stating:

We turn to the basic question presented: Can a bankruptcy court approve a structured dismissal that provides for distributions that do not follow ordinary priority rules without the affected creditors’ consent? Our simple answer to this complicated question is “no.”

Rarely does a bankruptcy appeal generate such a clear and useful holding. As the court explained, the priority scheme is fundamental to the Bankruptcy Code’s reorganization process. Congress would have given some indication if it intended the power to dismiss a bankruptcy case to be a “backdoor means to achieve the exact kind of nonconsensual priority-violating final distributions that the Code prohibits.” Congress did not. As a result, structured dismissals that violate the Bankruptcy Code’s priority scheme are impermissible. While debtors’ lawyers may lament the loss of a tool—and the leverage over all creditor groups that it provided—Jevic is good for parties interested in the relative predictability and protection provided by the Bankruptcy Code’s creditor priority scheme.