Guest comment by David Hillman, Charles Dale and Libbie Osaben
Despite the US Supreme Court’s rejection of a structured dismissal, there is a growing trend of courts approving them in Chapter 11 cases following a sale of a debtor’s assets under Section 363 of the Bankruptcy Code. A structured dismissal is a cost-effective way to exit Chapter 11. It is also an alternative to confirming a post-sale liquidating plan – expensive and not always viable – or converting the case to Chapter 7, which introduces significant uncertainty. Private credit lenders should consider this approach because structured dismissals slash significant cost from an already expensive Chapter 11 process. This article explains when structured dismissals are ripe for consideration, what are the alternatives, and why they are gaining popularity.
Private credit lenders have a simple investment thesis – get repaid in full at maturity. That plan does not work when there is no realistic prospect of loan repayment. In this scenario, lenders pivot to plan B, which sometimes involves acquiring or selling to a third party the borrower’s business through a Section 363 sale. A lender might feel like an ATM machine, routinely disbursing cash to preserve and protect its investment, including through: rescue loans; new money DIP loans to pay for the costs of the bankruptcy case; and post-closing working capital for the new business in situations where the lender’s credit bid is the successful bid.
The final expense on the lender’s tab is the funding needed for post-closing wind-down expenses for the period after a successful Section 363 sale. Courts generally refuse to be used to sell businesses if the interested parties will not allocate funds to a soft landing, as opposed to a situation where administrative expenses are left unpaid and the debtor’s shell is left in a shambles. Wind-down expenses typically include: costs to sell non-core assets that were excluded in the 363 sale; costs to terminate benefit plans, to prepare tax returns and to dissolve corporate entities; costs to reconcile claims and distribute excess cash; and other miscellaneous costs.
Wind-down negotiations inevitably turn to the means of implementing a wind-down. There are three options: confirmation of a liquidating plan; conversion to Chapter 7; or a structured dismissal of the case. The negotiation occurs among the secured creditors providing funding for the wind-down, the debtor, and a creditors’ committee.
Most debtors strongly prefer confirming a liquidating Chapter 11 plan. This is the conventional exit path from Chapter 11 and achieves finality in an “official” sense with the entry of a plan confirmation order. This path is preferred because it customarily includes broad releases (at least on a consensual basis) and exculpation provisions providing immunity from disgruntled creditors.
However, the plan path is expensive and sometimes uncertain. A plan might not be viable because approval requires, among other things, acceptance by an impaired accepting class of creditors and payment in full of all administrative claims in cash. While the plan path might be the gold standard, there are many cases where that path is not feasible or is simply too expensive relative to other options.
Conversion is another option. Converting the Chapter 11 case to one under Chapter 7 is the least expensive path. The company simply converts the case and the board of directors walks away. A Chapter 7 trustee is appointed and disposition of the business is the trustee’s headache. Despite the cost savings, this option is universally recognised as the least desirable because it creates uncertainty stemming from the Chapter 7 trustee.
They are compensated only when they create a pool of unencumbered assets to be distributed to creditors. This fee structure often creates situations where trustees take overzealous legal positions to extract value from stakeholders. By adding a new player into the mix, the conversion path introduces uncertainty and risk. For this reason, cases are rarely converted to Chapter 7.
Structured dismissal path
The final option is a structured dismissal. A structured dismissal is memorialised in a negotiated order that dismisses the Chapter 11 case. The terms of a dismissal order are case-specific and the product of bespoke negotiations, but often include provisions: recognising the continued effectiveness of the court’s prior orders, particularly the order approving the sale; setting procedures for final payment of fees; authorising the abandonment of non–core retained assets; establishing claims reconciliation procedures; and consensual releases. Structured dismissal orders usually contemplate conditions precedent to effectiveness of the case dismissal.
A structured dismissal is faster and cheaper than the plan path. Yet, there is often resistance to this strategy. Critics make two arguments – one, the code does not specifically contemplate structured dismissals; and, two, the Supreme Court rejected the structured dismissal in the Jevic Holding Corp case. The critics are wrong.
First, the code contemplates dismissal of a Chapter 11 case in Sections 305(a) and 1112(b). Each statute affords the court discretion to determine whether there is cause to dismiss the case and whether the interests of debtor and creditors are best served by dismissal. The argument that a dismissal order must simply dismiss the case ignores the fact that many bankruptcy court orders (such as DIP and sale orders) include conditions that go beyond the general language in the applicable authorising statute. Bankruptcy courts enjoy discretion to craft provisions to an order beyond a simple dismissal. The key is to restrict the order’s extra provisions to matters otherwise authorised under the Bankruptcy Code.
The Supreme Court did not ban all structured dismissals in Jevic. It only addressed a particular feature (a “gifting” distribution that violated the code’s absolute priority rule) of an order. Jevic merely held that structured dismissals cannot be approved if distributions are made to creditors in violation of the code’s priority rules and the affected creditors have not consented.
Jevic is not a death knell for structured dismissals. In fact, the Supreme Court noted that structured dismissals were “increasingly common” and it expressed “no view about the legality of structured dismissals in general”.
According to a survey, since the Jevic decision there have been at least 21 cases involving a structured dismissal. In nearly all those cases, parties objected to the motion to dismiss. These objections focused on the treatment of the objector’s individual claim, not the propriety of the structured dismissal itself. Nonetheless, in 18 of the 21 cases, the bankruptcy court entered the structured dismissal order. That is an impressive record and provides a strong and credible basis to push for structured dismissals in the right circumstances.
The trend in favour of structured dismissals is a positive development for private credit lenders and adds a practical and efficient tool to their restructuring toolbox.
David Hillman and Charles Dale are partners in Proskauer’s private credit restructuring group. Libbie Osaben is an associate at Proskauer