receive money before the priority
creditors, that money does not
belong to the estate—it belongs to
CapSource.… In other words, the
payout to the general unsecured
creditors is a carve out of the secured
creditor’s lien and not estate property.” 8
World Health, like SPM, did not deal
with the issue of gifting within the
context of a plan and therefore did not
trigger the absolute priority rule. SPM
involved a settlement in a Chapter 7
context, and World Heath’s dispute
arose in the context of a settlement,
not a plan. Both cases also involved a
secured creditor’s perfected security
interest, which the seminal 3rd Circuit
decision in Armstrong held is not subject
to distribution under the Bankruptcy
Code’s priority scheme. 9 Finally, the
two cases involved carve-out situations
in which a party whose secured claim
was collateralized by the assets in the
bankruptcy estate allowed a portion of its
proceeds to be paid to other creditors. 10
With the permissibility and parameters
of gifting firmly settled within the
confines of a plan, debtors and secured
creditors continue to seek creative ways
to circumvent the absolute priority rule
through settlements outside of a plan.
Because Federal Rule of Bankruptcy
Procedure 9019 expressly authorizes
settlements that are “fair and equitable”
and settlements outside of a plan do
not directly implicate the absolute
priority rule, the mechanism of a
structured dismissal was recently road
tested in the 3rd Circuit opinion In re
Jevic Holding Corp. 11 In the landmark
case, the court held that a structured
dismissal is not only a permissible
tool on the bankruptcy workbench,
but in appropriate circumstances,
it is also another type of settlement
that does not need to comply with
the mandates of the priority scheme
established under the Bankruptcy Code.
In Jevic, a settlement was reached
among the debtor, the committee, and
the secured creditors under which
certain creditors would be paid out of a
trust and the case would be dismissed.
Notably, an entire class of creditors with
a priority wage claim did not receive
any distribution under the structured
dismissal, even though they had higher
priority than other creditors receiving
funds under the settlement. The
Bankruptcy and District Courts approved
the settlement, as did the 3rd Circuit.
In affirming the lower court’s
decision, District Judge Thomas
Hardiman, writing for the majority,
cited the following factors in
its determination of whether a
settlement is fair and equitable:
• The probability of success
in the litigation
• The likely difficulties of collection
• The complexity of the litigation
involved and the expense,
inconvenience, and delay
necessarily attending it, and
• The paramount interest
of the creditors12
The court found that in these
circumstances, the case warranted
such a determination. Importantly,
the court did not extend the absolute
priority rule to the approval of these
settlements, but affirmed its application
only in the plan confirmation process. 13
In doing so, the court was careful to
qualify its holding that Bankruptcy
Courts may approve settlements that
deviate from the absolute priority rule
only if they have “specific and credible
grounds to justify [the] deviation.”14
Relying on Jevic and World Health, the
District Court in Delaware also recently
affirmed the Bankruptcy Court’s approval
of a settlement that effected disparate
treatment of a group of noteholders
within a class in In re Energy Future
Holdings, 15 refusing to extend the
absolute priority rule to pre-plan
settlements. 16 Time will tell whether this
issue will also travel to the 3rd Circuit,
but the trend of these cases seems clear:
the protections afforded creditors under
the bankruptcy priority scheme do not
apply to gifts of non-estate property
or settlements outside of a plan, but if
the court finds any sort of bad behavior
on the part of the gifting (or gifted)
parties, the “fair and equitable” standard
continues to give courts discretionary
power to step in and right the wrong.
Is it good policy, then, to continue to
enlarge the exceptions swallowing
the absolute priority rule? Perhaps the
widening judicial willingness to approve
the circumstances of the rule’s nonapplication is ultimately rooted in the
court’s real ability to judge what is “fair”
and most likely achieve the best practical
benefit for the parties involved. J
1 Orwell, George. Animal Farm.
New York : Penguin, 1946.
2 In re DSBD North America, Inc., 634
F.3rd 79, (2nd Cir 2011), citing N. Pac.
Ry. Co. v Boyd , 228 U.S. 482, 507-08,
33 S.Ct. 554, 57 L. Ed. 931 (1913).
3 11 U.S.C. § 1129(b)( 1).
7 344 B.R. 291 (Bankr. D.Del 2006).
8 World Health at 297 (citing In
re SPM Mfg. at 1313).
9 In re Armstrong World Industries,
432 F.3d 507 at 514 (3d Cir.2005).
10 The court in World Health did not consider
this carve-out to be offending to the
absolute priority rule even in the event
it had applied. See In re World Health
Alternatives, Inc., 344 B.R. 291 (Del 2006).
11 F.3d 173 (3rd Cir. 2015).
12 Slip Op. at 14, quoting In re Martin,
91 F.3d 389, 393 (3d Cir. 1996).
14 Id. (citing In re Iridium Operating
LLC, 478 F.3d 452 (2007) at 464.
15 In re Energy Future Holding Corp.,
et al., 2015 WL 729666 (D. Del).
16 A related issue not reached here but with
obvious future implications is the improper
sub rosa plan occurring when parties attempt
to incorporate these settlements into a plan;
as these decisions may create tension under
the DSBD and Armstrong line of cases.
Kelly Beaudin Stapleton is a managing director
with Alvarez & Marsal in New York. The national
practice leader for the Unsecured Creditors’
Committee Practice, she specializes in creditor
representations, fiduciary roles, and fraud
investigations across various industries. Stapleton
began as a prosecutor and later worked for a large
national law firm before being appointed U.S. Trustee
for Region 3, where she oversaw restructurings
that included New Century Financial, Dura,
Owens Corning, and Sharper Image. Stapleton
has advised numerous Chapter 11 proceedings in
the capacity of assisting clients in pre- and post-bankruptcy financial and operational strategies.