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On Nov. 2, 2015, the Honorable Vincent F. Papalia, sitting in the United States Bankruptcy Court for the District of New Jersey, issued a 58-page opinion in the In re Petersburg Regency bankruptcy matter, 540 B.R. 508 (Bankr. D.N.J. 2015) (the “Opinion”), whereby the court approved a settlement and structured dismissal of the debtor’s bankruptcy case under the principles of In re Jevic Holding Corp., 787 F.3d 173, 175 (3d Cir. 2015), as amended (Aug. 18, 2015). Jevic is currently on appeal before the Supreme Court in Czyzewski v. Jevic Holding Corp., 136 S. Ct. 2541 (2016).

Background

In Petersburg Regency, all that remained of the debtor was a $10.2 million pool of insurance proceeds resulting from a Virginia hotel that was irretrievably damaged by a hurricane in 2003. The main issue before the court during the bankruptcy case was whether to grant the creditors’ motions to approve a settlement among them that provided for the distribution of the debtor’s only significant asset—the insurance proceeds—under a consensual settlement among those creditors and, thereafter, to dismiss the case. The settling creditors, who represented all secured and unsecured non-insider claims against the debtor, reached a settlement among themselves, consented to the proposed distribution and unanimously opposed the debtor’s and the debtor’s principals’ proposal to proceed with a different distribution scheme under a Chapter 11 plan of liquidation.

The settling creditors took the position that the debtor was using the bankruptcy to hold them hostage and to muscle out a distribution to equity holders who were not entitled to a distribution. While a simple dismissal, for example as a bad faith filing, provided one alternative for the creditors, that alternative would return the creditors to lengthy and costly state court litigation. Thus, the creditors quickly realized that a deal, if it could be reached, was the best approach. Surprisingly, 12 classes of creditors with differing levels of priority and different types of claims agreed to the deal, with only the former owners of Petersburg Regency objecting. As owners, they were at the bottom of the waterfall and would receive nothing.

The Decision

In approving the settlement and dismissing the case, Judge Papalia relied almost exclusively on the Third Circuit’s holding in Jevic. In Jevic, the Third Circuit affirmed a settlement, distribution and structured dismissal in a Chapter 11 case in which two undersecured creditors who were owed far in excess of their collateral ($53 million claim but only $1.7 million in assets) agreed with the creditors committee and debtor to provide a relatively small distribution to administrative and general unsecured creditors from the secured creditors’ collateral and to a dismissal of the bankruptcy case. The Third Circuit approved the settlement and dismissal, even though the proposal failed to make any payment to wage claimants with priority under the WARN Act. These “skipped” creditors argued that the distribution would have violated the priority scheme under 11 U.S.C. §1129(a) and (b) had the proposal been part of a plan and that the bankruptcy court did not have authority to order a structured dismissal in those circumstances.

The Jevic court supported its decision by noting “dire circumstances” existed to warrant granting the relief requested by the debtor, committee and secured lenders. The bankruptcy court found no realistic prospect of a meaningful distribution to anyone other than the substantially undersecured creditors in the absence of the settlement because other traditional routes out of Chapter 11 bankruptcy were “impracticable.” Specifically, there existed no prospect of a confirmable Chapter 11 plan of reorganization or liquidation being filed, and conversion to Chapter 7 would have been unavailing because the two undersecured creditors would not agree to allow their collateral to be used to fund a Chapter 7 liquidation. The Third Circuit ultimately agreed with the bankruptcy court that the structured dismissal was “the least bad alternative” because there was “no prospect” of a plan being confirmed and conversion to Chapter 7 would have resulted in the secured creditors taking their collateral “in short order,” and the employee wage claimants receiving nothing in any event.

Comparing Petersburg Regency and Jevic

Judge Papalia found the Petersburg Regency case ripe for a structured dismissal by using the facts in Jevic as a benchmark for his decision. Like Jevic, the secured claims in Petersburg Regency far exceeded the value of the remaining collateral ($20.9 million versus $10.2 million), and there was no possibility for distribution to unsecured creditors without a settlement. Similarly, there was no realistic possibility of a reorganization or of funding a conversion to Chapter 7, which the Settling Creditors unanimously opposed. See Petersburg Regency, 540 B.R. at 532-33.

Notably, Petersburg Regency diverged from Jevic in a few important ways, leading the court to observe that the Petersburg Regency facts provided greater support for a structured dismissal than the Jevic facts. Id. First, all creditors except the debtor’s principals would receive a distribution. Thus, because the debtor’s principals were insiders, with their claims subject to subordination and/or recharacterization as equity, there was no “class-skipping” in Petersburg Regency as compared with Jevic. Id. Rather, the strict priorities of the Bankruptcy Code were being observed. Second, the long and tortured history of the Petersburg Regency case and its predecessor litigation dating back to 2003 provided a strong basis for approving the settlement to prevent more months or years of continuing and expensive litigation. Id. Finally, the Petersburg Regency case presented the unique fact that the debtor actually admitted that no possibility of reorganization existed. Id. at 533.

The ultimate approval of the settlement in Petersburg Regency under the Martin factors (see In re Martin, 91 F.3d 389, 393 (3d Cir. 1996)), led to a distribution to the settling creditors without the settling creditors having to suffer through the process of a complex and costly bankruptcy proceeding, plan of reorganization, or further state court litigation.

Conclusion

If the Supreme Court is to reverse Jevic, the authors hope that it does so on only the narrowest of grounds. As illustrated by Petersburg Regency, Jevic allows parties in interest to collaboratively develop solutions to difficult issues, thus saving significant legal fees and costs. A broad reversal by the Supreme Court of the Jevic decision might mean the end of efficient structured dismissals that do not involve class skipping, such as the one accomplished by the settling creditors in Petersburg Regency.•