January 10, 2019 Articles

Dismissing Environmental Claims in Bankruptcy

Jevic adds one more layer of complexity to the already jumbled intersection of bankruptcy and environmental law.

By Sean Malloy and Rion Vaughan – January 10, 2017

Environmental issues often present some of the most difficult challenges for economically distressed companies and their advisors. The regulatory powers of enforcement agencies are generally immune from the automatic stay, contamination (or even the specter of possible contamination) can devalue facilities, and massive claims including administrative cleanup costs can doom reorganizations. These challenges combine to torture the restructuring professional when he or she tries to develop an answer to the most important strategic question at the outset of every engagement: What is the exit strategy?

The traditional exits from a case under chapter 11 of the Bankruptcy Code are a plan of reorganization, a sale followed by a plan of liquidation, or an effort to sell or reorganize followed by a conversion to chapter 7. Each of these strategies is challenged by any significant environmental problem. A reorganization plan must account for the property of the debtor company and environmental claims must be treated in accordance with the priority scheme of the Bankruptcy Code, making deals with other creditors difficult because of the dilution effect of large environmental claims. Sales preceding liquidation plans are also difficult because buyers frequently will inherit environmental problems that have ongoing effects on real estate. Chapter 7 does provide a solution, but frequently chapter 7 isn’t a viable option; often the key parties to an economic deal don’t want a chapter 7 trustee investigating past actions or incurring priority chapter 7 administrative expenses that dilute recoveries (including potentially large administrative expenses associated with environmental responsibilities). Dismissal of a case is also an option, but it usually doesn’t solve the problems that caused the filing in the first place. That may now change.

On December 7, 2016, the U.S. Supreme Court heard oral argument in one of the most significant bankruptcy-related cases to reach the high court in recent history, In re Jevic Holding Corp., 787 F.3d 173 (3d Cir. 2015), as amended (Aug. 18, 2015). In Jevic, the Third Circuit affirmed the lower courts’ decisions approving a “structured dismissal.” A structured dismissal generally involves a settlement in which the rights of many parties are resolved by an order of the bankruptcy court, releases are given, and the case is then dismissed with some of the trappings that are associated with a chapter 11 plan but without all the rules and protections that a plan ordinarily provides. In Jevic, the secured lender agreed to distribute $1.7 million in encumbered cash (its collateral) to the debtor’s tax, administrative, and general unsecured creditors. Significantly, the structured dismissal did not provide for a distribution to the priority wage claims of certain of the debtor’s terminated employees (drivers of the trucking company with alleged Worker Adjustment and Retraining Notification Act claims), who would have been entitled to a distribution prior to the debtor’s general unsecured creditors under the priority scheme of the Bankruptcy Code. Accordingly, the settlement could not have been implemented through a chapter 11 plan, and the secured creditor in this case refused to agree that the settlement would be followed by a chapter 7 conversion. The drivers appealed the Third Circuit’s approval of the settlement and dismissal, and the Supreme Court granted certiorari.

At issue in the Jevic case is the validity of the concept of structured dismissals. The core question posed to the Supreme Court is whether a settlement under Federal Rule of Bankruptcy Procedure 9019 (which governs settlement and compromises in bankruptcy), followed by a dismissal of the case, can provide an exit from bankruptcy that effectively “skips” over entire classes of claims in favor of creditors who are preferred by the settling parties even though they are not senior to the skipped class(es) under the Bankruptcy Code.

The Third Circuit held that because nothing in the Bankruptcy Code requires settlement agreements to distribute estate assets according to the priority scheme of 11 U.S.C. § 507, such structured dismissals could be approved by bankruptcy courts provided they satisfy the more flexible “fair and equitable” standard of Bankruptcy Rule 9019 and the bankruptcy court finds “specific and credible grounds to justify the deviation.” The circuit court emphasized that its decision depended in large part on the bankruptcy court’s finding that the priority-skipping structured-dismissal settlement represented “the least bad alternative since there was ‘no prospect’ of a plan being confirmed and conversion to Chapter 7 would have resulted in the secured creditors taking all that remained of the estate in ‘short order.’”

A close reading of the Third Circuit opinion shows that the panel had concerns about the potentially sweeping effect that its decision could have, noting that structured dismissals are “likely to be approved only rarely,” and this case was a “close call.” The cautious tone of the decision is justified, as the case could have significant impact on bankruptcy strategies. Much has been written about Jevic and its potential on bankruptcy generally, and a full analysis of the case is beyond the scope of this short article. However, the potential impact on environmental claims and issues cannot be underestimated. For example, imagine a substantial company in liquidation where (like in Jevic) unsecured creditors have a potential cause of action against insiders who are also the undersecured lenders in the case with a lien on all assets. This hypothetical company has significant environmental problems. The insider lenders are willing to pay a dividend to unsecured creditors to avoid litigation, but are unwilling to: (a) allow for a chapter 7 conversion (which could involve additional potential claims against them); (b) fund ongoing environmental remediation responsibilities; or (c) fund the substantial cost of litigation to abandon contaminated real property. The structured dismissal concept under Jevic and similar cases might allow for a settlement that distributes significant funds to general unsecured creditors and dismissal of the case without a distribution to the state or federal environmental authorities due to administrative cleanup costs. Furthermore, the threat of this kind of exit strategy could create leverage for parties negotiating with environmental authorities.

The above example is just one of many scenarios that could affect environmental claims in bankruptcy cases if the Jevic decision is affirmed. Some commentators believe that reversal is a strong possibility. But if the Supreme Court affirms, or if it reverses on procedural grounds or the specific facts of the Jevic case, the possibility of structured dismissals would survive and creative restructuring lawyers would be emboldened, particularly in the popular Delaware jurisdiction within Third Circuit. Accordingly, Jevic adds one more layer of complexity to the already jumbled intersection of bankruptcy and environmental law.

Keywords: litigation, bankruptcy, structured dismissal, restructuring, Chapter 7, Chapter 11, Federal Rule of Bankruptcy Procedure 9019, secured creditor, unsecured creditor, environmental law, contaminated property environmental remediation

Sean Malloy is a member of McDonald Hopkins LLC, in Cleveland, Ohio. Rion Vaughan is an associate with the firm in Chicago, Illinois.

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