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The US Supreme Court on Wednesday said that a judge can’t bypass the priority scheme for which parties get paid first in the structured dismissal of a bankruptcy case, even in rare cases.

The US Bankruptcy Code sets out an order for parties vying for a piece of the debtor’s estate, ranging from high-priority secured creditors to lower-priority unsecured creditors.

Normally, in a Chapter 11 bankruptcy, if a consensual distribution plan is not reached, and the case is not converted into a Chapter 7 liquidation, then it can be dismissed, and the estate reverts to the pre-bankruptcy status quo.

That wasn’t quite how it went in the bankruptcy of trucking company Jevic Transportation. The judge overseeing its bankruptcy dismissed the case in what is known as a “structured dismissal”. Rather than letting the estate revert to the status quo, the court authorised distribution of assets that gave money to high-priority secured creditors and to low-priority general unsecured creditors but then skipped “certain dissenting mid-priority creditors”, according to the ruling.

The Supreme Court, where the appeal ultimately landed, disagreed with that approach. In a 6-2 ruling from Justice Stephen Breyer on Wednesday, the high court answered in the negative the question of “whether a bankruptcy court has the legal power to order this priority-skipping kind of distribution scheme in connection with a Chapter 11 dismissal.”

Justice Breyer wrote:

In our view, a bankruptcy court does not have such a power. A distribution scheme ordered in connection with the dismissal of a Chapter 11 case cannot, without the consent of the affected parties, deviate from the basic priority rules that apply under the primary mechanisms the code establishes for final distribution of estate value in business bankruptcies.

And, he added, even in “rare cases” the priority scheme could not be set aside in a structured dismissal even if there were “sufficient reason” to do so.

Craig Goldblatt, a lawyer at WilmerHale who represented the petitioners, said in a statement:

“We are very pleased with today’s decision, which provides very helpful clarification of a previously unresolved question of bankruptcy law. The decision properly recognizes that while bankruptcy courts have broad discretion to achieve the purposes contemplated by the Bankruptcy Code, that discretion does not authorize actions that are inconsistent with the Code itself. We look forward to the opportunity, on remand, to press for the compensation to which our clients are entitled.”

The ruling is a significant win for the former Jevic employees whose claim prompted the case, and gives clarity to the court’s interpretation of whether the priority scheme can ever be put aside in the structured dismissal of a bankruptcy case, said Patrick Mohan, a distressed debt legal analyst at Reorg Research Inc.

Mr Mohan added:

The ruling stresses that the priority scheme is a fundamental element of the bankruptcy code, and if Congress intended to divert from the priority scheme, it would have expressly done so in the Bankruptcy Code. However, as the ruling points out, there is no indication that Congress intended for structured dismissals to serve as a backdoor to allow non-consensual distributions that violate the priority scheme in Chapter 7 and 11, which are prohibited by the Bankruptcy Code.

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