supreme court sealBy Christopher M. Cascino and Gerald L. Maatman, Jr.

Seyfarth Synopsis:  A bankruptcy court overseeing an employer’s Chapter 11 bankruptcy proceeding allowed the employer to pay certain unsecured creditors before paying Worker Adjustment And Retraining Notification Act (“WARN”) creditors – workers who had sued the company – monies owed pursuant to a judgment, even though the bulk of the WARN monies owed were for back wages that hold priority over other unsecured claims under the Bankruptcy Code.  The bankruptcy court allowed the employer to pay the other unsecured creditors pursuant to a settlement agreement between the other unsecured creditors, the secured creditors, and the employer because, according to the bankruptcy court, the other unsecured creditors would not receive any monies absent the settlement, while the WARN creditors would not recover any compensation under or absent the settlement.  Both the district court and U.S. Court Of Appeals For The Third Circuit agreed with the bankruptcy court. In Czyzewski v. Jevic Holding Corp., No. 15-649, 2017 U.S. LEXIS 2024 (U.S. Mar. 22, 2017), the U.S. Supreme Court reversed, finding that the bankruptcy court’s conclusion that the WARN plaintiffs could not recover was questionable and, more significantly, that the bankruptcy court could not alter the Bankruptcy Code’s distribution scheme at the expense of the WARN creditors absent their consent.

Employers undergoing Chapter 11 bankruptcy and WARN litigation should take note that unpaid wage claims will take priority over the claims of other unsecured creditors absent the consent of WARN creditors.

Case Background

Sun Capital Partners (“Sun”), a private equity firm, purchased Jevic Transportation Corp. (“Jevic”), an employer, in a leveraged buyout using monies borrowed from third-party CIT Group (“CIT”).  In the buyout, both Sun and CIT used Jevic’s stock as collateral to finance the purchase.

Two years after the buyout, Jevic declared bankruptcy under Chapter 11.  Immediately prior to filing for bankruptcy, Jevic, without the notice required under WARN, told its employees that it was terminating their employment.  During the bankruptcy, these employees sued, and the bankruptcy court entered a $12.4 million judgment in their favor, making them creditors of Jevic.  The bankruptcy court determined that $8.3 million of this $12.4 million was owed for priority wage claims.  While the WARN creditors argued that Sun was also liable for this judgment as a joint employer with Jevic, the bankruptcy court ultimately ruled against them, finding that Sun was not their employer.

Also during the bankruptcy, other unsecured creditors sued Sun and CIT, arguing that they were the beneficiaries of preferential transfers of Jevic’s assets.  While this lawsuit was pending, Jevic’s assets were depleted to $1.7 million in cash, subject to a lien by Sun, and the preferential transfer lawsuit.

Sun, CIT, Jevic, and the other unsecured creditors decided to settle the fraudulent transfer lawsuit.  At the time the case was settled, the WARN creditors’ joint employer case was still pending, so Sun insisted that any settlement could not include a payment to the WARN creditors or their counsel, as Sun feared the WARN creditors’ counsel would use such payments to fund litigation against Sun.  Under the settlement agreement, CIT agreed to pay $2 million to cover the legal fees and administrative expenses of the other unsecured creditors, while giving Jevic’s remaining $1.7 million to pay taxes, administrative expenses, and pro rata distributions to the other unsecured creditors.  Also pursuant to the settlement, Jevic agreed to dismiss its Chapter 11 bankruptcy case.

Sun, CIT, Jevic, and the unsecured creditors petitioned the bankruptcy court to approve the settlement and dismiss the Chapter 11 case.  The WARN creditors opposed, arguing that the settlement violated the normal priority rules by giving other unsecured creditors priority over the WARN creditors.

While the bankruptcy court agreed that the settlement violated standard priority rules, it found that, because it was dismissing the Chapter 11 case rather than approving a Chapter 11 plan, it did not have to follow the priority rules contained in Chapter 11.  It found authority to do so in Chapter 11’s dismissal provision, § 349(b)(1), which provides that, with dismissal, parties are restored to the status quo ante unless a bankruptcy judge, “for cause, orders otherwise.”  Further, it found that, regardless of the settlement, the WARN creditors would not receive any distributions, while the settlement left the other unsecured creditors in a better position than they would be absent the settlement.  Both the district court and Third Circuit agreed.  The WARN creditors sought certiorari, which the Supreme Court granted.

The Court’s Decision

In a March 22, 2017 opinion authored by Justice Breyer, the Supreme Court reversed.  The Supreme Court began its analysis by considering Jevic’s argument that the WARN creditors lacked standing because they would not have recovered anything if the settlement was not approved.  The Supreme Court found this argument unpersuasive because it relied on two questionable propositions: first, that without violation of the ordinary priority rules, there would be no settlement and, second, that the fraudulent conveyance lawsuit had no value.  2017 U.S. LEXIS 2024, at *19.  With respect to the  first argument, the Supreme Court found it unpersuasive given that Sun ultimately won on the joint employer issue.  Id. at *19-20.  With respect to the second, the Supreme Court found the assumption that the fraudulent conveyance lawsuit had no value questionable in light of the fact it settled for $3.7 million.  Id. at *20.  The Supreme Court thus concluded that the WARN creditors had something to lose if the settlement was approved, and therefore had standing to challenge it.  Id. at *21.

The Supreme Court then turned to the question of whether a bankruptcy court can dismiss a Chapter 11 plan in a way that does not follow the ordinary priority rules without the affected creditors’ consent.  Id.  It decided that it cannot for several reasons.

First, the Supreme Court observed that the distribution scheme contained in the Bankruptcy Code is “fundamental to the Bankruptcy Code’s operation,” and that one would expect more than “statutory silence” to authorize departures from the scheme.  Id. at *22-23.  Second, the Supreme Court concluded that Chapter 11 § 349(b)(1), in providing that the parties are restored to the status quo ante in a dismissal unless a bankruptcy judge, “for cause, orders otherwise,” only allows a bankruptcy judge to “make appropriate orders to protect rights acquired in reliance on the bankruptcy case,” which approval of the settlement did not do.  Id. at *24-25.  Finally, the court concluded that the consequences of allowing a departure from the normal distribution scheme were “potentially serious,” including “changing the bargaining power of different classes of creditors” and “risks of collusion.”  Id. at *30-31.

For these reasons, the Supreme Court reversed the bankruptcy court’s approval of a settlement that, as part of the dismissal of a Chapter 11 case, allowed payment to general unsecured creditors while skipping the higher priority claims of the WARN creditors.

Implications For Employers

Financially distressed employers who are the subject of potential WARN litigation should be aware that, as a result of this decision, they will not be able to pay the claims of general unsecured creditors during bankruptcy absent the consent of WARN creditors.  The case has special implications for employers who own distressed employers, as was the case with Sun in Czyzewski, who want to avoid funding litigation against themselves under a joint employer theory.