The Hidden Chapter of the Financial Aid Handbook:Tuition Payments Subject to Fraudulent Transfer Liability

by Jason Angelo

By Jason D. Angelo

The cost of a college and professional education has, as most attorneys know all too well, skyrocketed over the course of the past few decades. Some students graduate with tens or even hundreds of thousands of dollars in student loan debt. Bankruptcy practitioners know the high hurdle of obtaining a discharge of student loan debt in a personal bankruptcy. But what happens when a student’s parents pay for their son’s or daughter’s tuition and then end up filing a chapter 7 or chapter 13 petition?

There is an emerging trend in bankruptcy cases across the country in which some trustees are attempting to recover pre-petition tuition payments made to educational institutions by debtors (parents) on behalf of their children (students). The Wall Street Journal reports that trustees have recovered over $276,000.00 from at least 25 educational institutions since 2014.1 The rationale is that the student, not the parents, received the reasonably equivalent value of the tuition payments – that is, the child, not the parents, received the actual benefit of the tuition payments, and so those payments are recoverable as fraudulent transfers. Some trustees have even attempted to recover payments made for private elementary and high school education, although with far less success.2

While educational institutions begin to battle these claims, many have opted to settle with trustees rather than see an adversary proceeding through to the end. Some students, however, have been hit with dire consequences: institutions, such as the University of Southern California – currently battling a lawsuit to recover nearly $200,000.00 in tuition payments – have threatened to withhold transcripts, refuse certification of a degree, recover the funds from the students themselves and bar them from registering for classes.3 Institutions also argue that allowing trustees to claw back such funds is inconsistent with the principles of federal financial aid and that, because the student will still owe the tuition to the institution (and the parents will still be on the hook for any loan they co-signed or guaranteed given the difficulty of discharging such loans), this is simply a windfall of funds to creditors – funds that they have no right to receive.

While some courts have agreed with the trustees’ position that the parents did not receive reasonably equivalent value, others have rejected the attempt to recover tuition, relying on a “moral obligation” of parents to pay for higher education. There is little consensus among bankruptcy courts on this issue. This post surveys some recent bankruptcy court decisions on this controversial tactic.

No Reasonably Equivalent Value Received?

The Michigan case of In re Leonard4 is significant because the Bankruptcy Court determined that the debtors did not receive reasonably equivalent value for the tuition payments made on behalf of their son. The Chapter 7 trustee sought to avoid and recover, as fraudulent transfers, four payments totaling $21,527.00 that the debtors made to Marquette University to pay for their 18–year old son’s tuition. The payments were made by checks from debtors’ joint checking account. However, the funds transferred were from a $35,000.00 private student loan from J.P. Morgan-Chase taken out by the student and his father. While the trustee argued that the transfers should be avoided, the University responded that the funds were never debtors’ property and instead had been held in trust for the education of their son. Relying on a theory that an express oral trust was created regarding the use of the loan proceeds, the University contended that debtors held legal, but not equitable, title in the funds, barring them from ever becoming property of the estate.

The Court determined that, because the check for the loan proceeds from J.P. Morgan-Chase was actually made payable to both the student and the father, no express oral trust could be created as to half of the funds. Further, the deposit of the funds into debtors’ joint checking account created a rebuttable presumption under state law that the money was debtors’ property, and cast further doubt upon the claim that an express trust was created given the commingling of the funds. The Court rejected the notion that a constructive trust had been created and hence was not property of the estate. Ultimately, the matter came down to who received reasonably equivalent value for the transfers: the debtors’ son, or the debtors who received value in the form of intangible benefits, such as: (1) the son’s education “bestowed peace of mind” on the debtors in that their son “will be afforded opportunities” in life that would not have come but for the education; and (2) debtors “anticipate that they will not remain financially responsible” for their son. The Court rejected Marquette’s argument and found that the debtors received no economic value in exchange for the transfers. However, the trustee’s summary judgment motion was ultimately denied because there was a still a genuine issue of material fact regarding the creation of an express oral trust and whether the loan proceeds were ever property of the estate.

Recovery of Federal Loan Proceeds

 In a case pending in the District of Connecticut5, the Chapter 7 trustee sought disgorgement of tuition payments from Johnson & Wales University. Slated for trial this year, the trustee seeks to claw back $46,909.00 in payments made from March 2011 to December 2013. According to the University and the amici curiae, the trustee’s argument essentially transforms federal loans into a government subsidy to pay off the debtors’ creditors, leaving educational institutions, which are not able to protect themselves from parents who apply for Federal Loans and later file a bankruptcy petition, incredibly vulnerable.

The key issue here is the source and control of the payments: while the tuition payments were federal dollars, they were never in the debtors’ possession or control. Rather, the government made payments directly to the university for restricted purposes. Thus, according to the University, the funds never were and never could have been property of the estate; the funds were not “fungible cash” that could actually have been utilized by the debtors to pay their creditors. Moreover, as the amici curiae point out, diversion of federal PLUS Loan funds to the debtors’ estate would be deemed “misuse” of the funds, causing the loans to be accelerated and made immediately due. The proper relief, according to the University, is to avoid the debtors’ obligations to repay the loans for which they are solely liable rather than claw back the funds from an educational institution.

In response, the trustee asserts that the debtors are liable as the sole obligor on the master promissory note related to the funds, thereby providing debtors a clear and unequivocal interest in the funds. Where there is a direct transfer to a third party resulting in an increase in a debtor’s liability and no increase in a debtor’s assets, the trustee argues that there has clearly been a transfer of the debtor’s interest in property. The trustee further claims that, had Congress intended to exempt federal loan proceeds as property of the estate, they would have done so when passing BAPCPA – in which they exempted Education IRAs (529 plans), and that this omission demonstrates an intent that proceeds of federal loans be available for recovery. See 11 U.S.C. § 541(b)(5) and (6). By incurring nearly $50,000 in new debt and receiving no corresponding benefit, the trustee believed the transfers to be fraudulent and thus recoverable. The Bankruptcy Court has not ruled yet on these issues, and the case is scheduled for trial later this year.

A “Moral Obligation” As Reasonably Equivalent value

In two separate cases6 in the Western District of Pennsylvania, the bankruptcy court determined that debtors did in fact receive reasonably equivalent value for tuition payments. Specifically, the courts held that undergraduate expenses fit within the definition of “necessities” under Pennsylvania’s Uniform Fraudulent Transfer Act.

In In re Cohen, the trustee challenged a total of $102,573.00 in tuition payments, including $46,059.97 for their son’s undergraduate education, $7,562 for their daughter’s undergraduate education, and $39,205 for their daughter’s graduate education. The Court refused to accept the trustee’s argument that because Pennsylvania law does not require parents to pay for post-secondary education, it is not a necessity and is therefore avoidable. The Court held that post-secondary educational expenses are reasonable and necessary for the maintenance of the debtor’s family for purposes of the fraudulent transfer statutes only. However, the ruling was limited to undergraduate expenses only, with the Court expressly noting that “children in graduate school are well into adulthood.” Similarly, in In re Oberdick, the trustee challenged $82,536.22 used to pay for the college education of debtors’ children at the University of Chicago and Robert Morris University. Citing to Cohen, the Court relied on debtors’ testimony that “they viewed college tuition and related educational expenses for the children as a family obligation” to deny the trustee’s claim.

Willing to Settle

Unlike Johnson and Wales, Marquette and the University of Chicago, other institutions have elected to settle these fraudulent transfer actions rather than incur the costs of litigation. The University of Hartford, Quinnipiac University7, the University of Bridgeport, Pace University, Post University, the University of Arizona and the University of Michigan8 each paid more to the trustee to avoid the risks of litigation.  According to the trustee’s attorney, many similar adversary proceedings have settled, and there are “about a dozen pending” in the Connecticut bankruptcy courts as of May 2, 2016.9

A Potential Solution?

In response to the willingness of some trustees to go after tuition dollars, Congressman Chris Collins (R-NY) introduced H.R. 2267 – PACT (Protecting All College Tuition) Act of 2015. The legislation would amend Section 548 of the Bankruptcy Code to explicitly provide that “payment of tuition by a parent to an institution of higher education . . . for the education of that parent’s child is not a transfer” that is recoverable as fraudulent. While seemingly supported by legislators on both sides of the aisle, including Rep. Blake Farenthold (R-Tex.) and Sen. Richard Blumenthal (D-Conn.), the legislation has been languishing in the House Judiciary Committee’s Subcommittee on Regulatory Reform, Commercial and Antitrust Law since June 1, 2015.10 In the meantime, as educational institutions continue to settle these fraudulent transfer actions, expect to see more filings from trustees across the country in an attempt to claw back tuition payments for distribution to creditors.          

Jason D. Angelo is an Associate in McElroy, Deutsch, Mulvaney & Carpenter, LLP’s Bankruptcy, Restructuring & Creditors’ Rights Practice Group and is admitted to practice in Delaware and New Jersey.

[1] http://www.ctlawtribune.com/id=1202756519162/Bankruptcy-Attorneys-Sue-Colleges-to-Demand-Return-of-Tuition-Payments?slreturn=20160418124233; http://www.wsj.com/articles/bankruptcy-trustees-claw-back-college-tuition-paid-for-filers-kids-1430869820.

[2]               See, e.g., In re Akanmu, 2013 WL 6283582 (Bankr. E.D.N.Y. Dec. 4, 2013) (Debtors legally obligated under New York Law to provide their minor children with an education, and the fact that they chose to do so by sending their children to private or parochial school, rather than public school, did not render the tuition payments avoidable. Debtors received reasonably equivalent value by satisfying their legal obligation to educate their children and because parents and children are viewed as a single economic unit for purposes of a constructive fraudulent conveyance analysis).

[3]                    http://blogs.wsj.com/bankruptcy/2015/11/17/usc-in-tuition-battle-former-students-will-face-consequences/

[4]               In re Leonard, 2011 WL 1344732 (Bankr. E.D. Mich. Apr. 8, 2011)

[5]               Roumeliotis v. Johnson & Wales Univ., No. 15-03011 (Bankr. D. Conn. Apr. 8, 2015)

[6]                  In re Cohen, 2012 WL 5360956, at *9-10 (Bankr. W.D. Pa. Oct. 31, 2012), aff’d in part, vacated in part, remanded sub nom. Cohen v. Sikirica, 487 B.R. 615 (W.D. Pa. 2013); In re Oberdick, 2013 WL 1289152 (Bankr. W.D. Pa. Mar. 27, 2013).

[7]              Roumeliotis v. Univ. of Hartford, No. 15-03006 (Bankr. D. Conn. Mar. 11, 2015); Roumeliotis v. Quinnipiac Univ., No. 15-03017 (Bankr. D. Conn. Apr. 15, 2015).

[8]                       http://www.wsj.com/articles/bankruptcy-trustees-claw-back-college-tuition-paid-for-filers-kids-1430869820.

[9]                       http://www.ctlawtribune.com/id=1202756519162/Bankruptcy-Attorneys-Sue-Colleges-to-Demand-Return-of-Tuition-Payments?slreturn=20160418124233

[10]             http://www.ctlawtribune.com/id=1202756519162/Bankruptcy-Attorneys-Sue-Colleges-to-Demand-Return-of-Tuition-Payments?slreturn=20160418124233; http://blogs.wsj.com/bankruptcy/2015/05/12/bill-proposes-ban-on-tuition-clawbacks-in-bankruptcy/.

CONDOMINIUM ASSOCIATION CLAIMS NOT DISCHARGED BY CONFIRMED PLAN -DELAWARE DISTRICT COURT APPLIES FRENVILLE TEST

by Jason Angelo

In re WCI Communities, Inc., 2015 WL 4477696 (D. Del. July 22, 2015)
In the Third Circuit, the answer to when a claim “arises” for purposes of the discharge depends upon what law applied at the time of the discharge.
The Court in the WCI case looked at three Third Circuit Court of Appeals decisions that addressed when a claim “arises”: In re M. Frenville Co., Inc., 744 F.2d 332 (3d Cir. 1984), which used the widely criticized accrual test based on whether an entity has a right to payment and when such right arose under state law; In re Grossman’s Inc., 607 F.3d 114 (3d Cir. 2010), which overruled the accrual test and used a test based on when the claimant was exposed to the product or conduct that led to the injury and formed the basis for the claim to payment; and Wright v. Owens Corning, 679 F.3d 101 (3d Cir. 2012), which addressed the due process issues raised when a person who did not have a “claim” under the Frenville test applicable at the time of plan confirmation would have had a claim under the subsequent Grossman’s test, thereby retroactively denying due process. The result as set forth in WCI following the opinion in Wright is an approach that permits Frenville to apply in narrow circumstances when to do otherwise would deny due process.

Background
In WCI, following the entry of the confirmation order and the discharge, a condominium association sought inter alia to pursue claims in state court against the reorganized debtor/builder for construction defects and past due amounts owed to the condominium association. As discussed below, the District Court for the District of Delaware, following the Third Circuit Court of Appeals decision in Wright, affirmed the Bankruptcy Court decision that the claims in question did not “arise” until after the discharge and therefore were not barred by it.

WCI Communities, Inc., along with its 126 subsidiaries (the “Debtor”), filed a voluntary Chapter 11 petition on August 4, 2008. Prior to filing its petition, the Debtor constructed homes and operated residential communities throughout the country, including the Lesina at Hammock Bay Condominium in Florida. Debtor filed a Condominium Declaration in 2007, which included Articles of Incorporation and the By-Laws for the community’s Condominium Association (the “Association”), which administers and manages the property. The Articles of Incorporation provided that the Association would be managed by a three-person board of directors appointed by the Debtor until an event known as “Turnover” under Florida law, at which point the control of the Association would be ceded to a five-member board elected by the Condominium owners.

The Bankruptcy Court set the bar date for filing claims against the estate as February 2, 2009, and thereafter approved the restructuring plan in August 2009. The Bankruptcy Court’s confirmation order contained a general discharge of all claims against the Debtor and permanently enjoined any holders of claims from asserting their claims against the Debtor. Following entry of the confirmation order, “Turnover” occurred on December 4, 2009. After the “Turnover,” an independent audit revealed that Debtor owed the Association over $80,000 in payments pursuant to the Condominium Declaration. An inspection by an engineering firm also revealed construction defects at the property with a repair cost of approximately $500,000.

The Association, when it was still under Debtor control prior to the “Turnover,” had timely filed a broad proof of claim that included any claims for “any defect in workmanship” and “assessment funding of association dues for unsold units.” However, post-Turnover, the Association contended that the confirmation order did not discharge its claims and filed a motion for declaratory relief pursuant to 11 U.S.C. §105(a) seeking a determination that the Debtor’s obligations to it were not discharged through the Plan and that Debtor was unjustified in threatening sanctions if the Association commenced a state court action.

Before the Bankruptcy Court ruled on the motion, the Third Circuit issued its opinion in Wright and utilized the standard for determining when a claim arises that was set forth in Frenville rather than the standard articulated in the en banc decision in Grossman’s. Thus, in WCI Judge Kevin Carey of the Bankruptcy Court for the District of Delaware held that Wright compelled the determination that the Third Circuit’s Frenville test applied to the Association’s claims and, under that test, the claims did not “arise” until after the “Turnover” date. Since the “Turnover” date was after the confirmation of the Plan, the Association’s claims were not subject to discharge under the Bankruptcy Code. Judge Gregory Sleet of the District Court upheld the Bankruptcy Court decision.

Analysis
As the District Court noted, when determining when the claims arose, the “dispute hinges upon whether the Association’s asserted statutory claims ‘arose’ prior to the date of the debtor’s plan confirmation.” In re WCI Communities, Inc., 2015 WL 4477696 at *3. The standard in the Third Circuit has been particularly fluid in recent years following the overruling of the widely-criticized Frenville “accrual” test. Under Frenville, a claim did not ripen until a right to payment arises, which in turn was decided by reference to state law. In re M. Frenville, 744 F.2d at 337. The Third Circuit further expounded on this in In re Remington Rand Corp., 836 F.2d 825, 830 (3d Cir. 1988), holding that “the existence of a valid claim depends on: (1) whether the claimant possessed a right to payment; and (2) when that right arose” as determined by reference to relevant non-bankruptcy law.” The Third Circuit’s 2010 Grossman’s decision abrogated the Frenville test. There, the Court held that a “claim” arises when an individual is exposed pre-petition to a product or other conduct giving rise to an injury, which underlies a “right to payment.” In re Grossman’s, 607 F.3d at 125. According to the Grossman’s Court, Frenville’s emphasis on a “right to payment” failed to give sufficient weight to other words in the statutory definition that modified the term “claim,” such as “contingent,” “unmatured,” and “unliquidated.” Id. at 121.

Wright addressed the retroactive effect of the Grossman’s decision, carving out specific exceptions where a claimant’s due process rights would be affected by its application. Specifically, claimants operating under the Frenville test would not have realized that they held “claims” and would not have taken action to protect their interests prior to the bar date and plan confirmation. To ensure that such claimants were afforded due process, instead of allowing claimants operating under the Frenville test to have their claims discharged in an earlier bankruptcy without notice or an opportunity to be heard, the Third Circuit in Wright held that the Frenville test applies to plans proposed and confirmed prior to the Grossman’s decision on June 2, 2010. So those who all of the sudden had “claims” under Grossman’s were exempt from the new test.

Since the WCI Debtor’s plan was confirmed prior to the Grossman’s decision, the Bankruptcy Court applied the Frenville accrual test and determined that the Association’s right to payment did not accrue under Florida law until the “Turnover,” which occurred after confirmation, and thus that the claims did not fall within the scope of the discharge. In upholding the decision, the District Court recognized that Grossman’s is not retroactively applicable in all situations, but only when a claimant’s due process rights would not be violated as per Wright.

The Debtor in WCI argued that the Association had been permitted due process because the Association (prior to the “Turnover”) had actually filed a proof of claim and thus had the opportunity to participate in the bankruptcy proceedings. In Debtor’s view, the filing of a proof of claim alone, even if a claimant did not yet hold a “claim,” would allow such a claim to be discharged upon confirmation of a plan.

The District Court refused to adopt such a bright line rule and countered that the mere filing of a proof of claim does not, in and of itself, mean that a claimant was afforded full due process. The District Court stated that “[w]hether a party receives proper due process depends on the circumstances of a particular case.” In re WCI Communities, Inc., 2015 WL 4477696 at *6 (citing In re Grossman’s, 607 F.3d at 127). Here, the Association could not have asserted the claims against Debtor until “Turnover,” since its cause of action under Florida law did not accrue until the condo owners acquired control of the Association. Further, since it was controlled by a Board hand-picked by the Debtor itself up to that point, the Association was not independent from the Debtor, and under Florida law, its actions were attributable to the Debtor rather than the condo owners until post-“Turnover.”

Key Takeaways
While Grossman’s and Wright have complicated the ever-evolving issue of when a “claim” arises in the Third Circuit, the District of Delaware recognized that due process concerns override the formalistic approach advocated by the Debtor. Additionally, the court made clear that the mere filing of a proof of claim would not per se meet the standard for due process under Third Circuit precedent.

Jason D. Angelo is an Associate in MCELROY, DEUTSCH, MULVANEY & CARPENTER, LLP.’s Bankruptcy Practice Group and is admitted to practice in Delaware and New Jersey.

THIRD CIRCUIT APPROVES STRUCTURED DISMISSAL OF CHAPTER 11 DESPITE NONCOMPLIANCE WITH ABSOLUTE PRIORITY RULE

by Jason Angelo

In re Jevic Holding Corp., 2015 WL 2403443, __ F.3d __ (3d Cir. May 21, 2015)

Section 507’s Absolute Priority Rule always applies – or does it? After last month’s precedential opinion issued by the Third Circuit Court of Appeals, apparently that isn’t always the case. In a matter of first impression within the Third Circuit, the Court determined that the Absolute Priority Rule is not necessarily implicated outside the context of plan confirmations. At the same time, the court became the first circuit court to determine that bankruptcy courts have the discretion to approve structured dismissals in connection with a Rule 9019 settlement, so long as the ultimate result does not evade the safeguards of the plan confirmation or conversion process.

Background

Jevic, a former New Jersey trucking company, was acquired in a 2006 LBO by Sun Capital Partners (“Sun Cap”) and financed by a group of lenders headed by CIT Group. In May 2008, Jevic ceased operations, notified its employees of their imminent termination, and filed a voluntary Chapter 11 petition in the Bankruptcy Court for the District of Delaware.

In the meantime, a group of former Jevic employees (the “WARN claimants”) initiated a class action lawsuit against Jevic and Sun Cap, alleging violations of the federal Worker Adjustment and Retraining Notification (“WARN”) Act and its New Jersey analogue. At the same time, the Official Committee of Unsecured Creditors brought a fraudulent conveyance action against Sun Cap and CIT in connection with the LBO.

The key players soon reached a settlement that provided for a release of claims between and among the Committee, Jevic, CIT, and Sun Cap in exchange for dismissal of the fraudulent conveyance action; for CIT to pay $2 million into an account to pay legal fees and other administrative expenses; for Sun Cap to assign its lien on the bankruptcy estate’s cash to a trust to pay tax, administrative, and general unsecured creditors; and for dismissal of the Chapter 11 case. The WARN claimants, however, were left out of the settlement, as Sun Cap refused to pay them as long as they maintained their WARN action. The WARN claimants and the U.S. Trustee objected to the settlement, arguing that it called for distribution of property of the estate to lower priority creditors under section 507’s distribution scheme; that the Bankruptcy Code does not permit structured dismissals; and that the Committee breached its fiduciary duties to the estate by leaving the WARN claimants out of the settlement.

In an oral opinion, Chief Judge Brendan L. Shannon approved the settlement and dismissal, concluding that the “dire circumstances” of the case– specifically, the lack of any realistic prospect of a distribution to any unsecured creditors if the settlement was not approved –mandated approval. Moreover, the Bankruptcy Court determined that there was no chance of approval of a Chapter 11 plan, and that conversion to Chapter 7 was impracticable both in terms of cost and the settling parties’ willingness to participate in a settlement in that context. The Bankruptcy Court also concluded that no fiduciary duties had been violated, that the settlements under Rule 9019 need not comply with the Absolute Priority Rule, and that the settlement was fair and equitable under the factors established by In re Martin, 91 F.3d 389 (3d Cir. 1996).

The WARN claimants appealed to the District Court, which rejected their contentions, holding that the Bankruptcy Court had correctly applied the Martin factors and had correctly ruled regarding the fiduciary duties and absolute priority rule issues. The District Court noted that even had the Bankruptcy Court erred, however, the WARN claimants’ appeal was equitably moot because the settlement had been “substantially consummated.” See Jevic Holding Corp., 2014 WL 2688613, at *2 (D.Del. Jan. 24, 2014). The WARN claimants appealed to the Third Circuit, with the U.S. Trustee joining in the appeal as amicus curiae.

Analysis

In a 2-1 panel split, the Third Circuit upheld the District Court’s order and the panel rejected the WARN claimants’ contention that structured dismissals are never permissible and must always comply with Section 507’s priority scheme. See In re Jevic Holding Corp., 2015 WL 2403443 (3d Cir. May 21, 2015).

Noting that the Code does not explicitly permit structured dismissals and that the only statutory ways out of a Chapter 11 case are plan confirmation, conversion to Chapter 7, or reversion to the status quo ante via dismissal “with no strings attached,” the panel stated that “structured dismissals are simply dismissals that are preceded by other orders . . . that remain in effect after dismissal.” Further, the Code, per Section 349, explicitly authorizes Bankruptcy Courts “to alter the effect of dismissal ‘for cause,’” such that “a hard reset” as contemplated by the WARN claimants was unnecessary. At bottom, bankruptcy courts have discretion to approve structured dismissals unless they are effectively sub rosa plans – that is, they are “contrived to evade the procedural protections and safeguards of the plan confirmation or conversion process.”

The Court next discussed whether settlements approved in the context of structured dismissals may ever disregard the Absolute Priority Rule by skipping a class of objecting creditors in favor of less senior creditors. Agreeing with the Second Circuit’s opinion in In re Iridium Operating LLC, 478 F.3d 452 (2d Cir. 2007), the panel noted that in determining whether a proposed settlement is “fair and equitable,” compliance with the Absolute Priority Rule will “usually be dispositive” because the policy behind the rule, “evenhanded and predictable treatment of creditors,” applies with equal force to both settlements and plans. The panel gave bankruptcy courts some leeway, however, to exercise their discretion depending on the facts of each case, by holding that they may approve settlements that do not follow the Absolute Priority Rule “’only if they have specific and credible grounds to justify [the] deviation.’”

The panel went on to conclude that the Bankruptcy Court had “sufficient reason” to approve the settlement and dismissal in this case because it was the “least bad alternative” – that is, there was no prospect of a confirmable plan and conversion would have resulted in the secured creditors taking what was left in the Estate. Outside of the settlement, there was no chance of the unsecured creditors receiving a meaningful distribution. Faced with the Hobson’s choice of accepting a settlement that strayed from the Code’s priority scheme or allowing the WARN claimants’ lawsuit to deplete the Estate, the Bankruptcy Court made a judgment call within its discretion in approving the settlement and dismissal.

Key Takeaways

This decision is significant for a number of reasons, especially considering the relative dearth of case law from courts of all levels across the nation addressing the issues discussed. The Third Circuit is the first circuit court to explicitly acknowledge that structured dismissals are permitted in some cases. Of particular note is the panel’s refusal to adopt a hard and fast rule that such structured dismissals are disallowed per se.

In the rare case where the traditional routes out of a Chapter 11 are closed off and a settlement will best serve the interests of the estate and its creditors as a whole, structured dismissals that deviate from the Absolute Priority Rule are justifiable. The Third Circuit’s decision grants further discretion to bankruptcy courts to approve alternatives to plan confirmation, conversion, or plain dismissal when the unique circumstances of a case justify such a decision.

Jason D. Angelo is an Associate in McElroy, Deutsch, Mulvaney & Carpenter, LLP’s Bankruptcy Practice Group and is admitted to practice in Delaware and New Jersey.