The Supreme Court will hear arguments on Wednesday in a case that could upend the common practice that ranks lenders, employees and other creditors in order of priority as they try to recover their money when a company files for bankruptcy.
The case has attracted wide attention from academics, workers’ groups and state tax authorities. A decision could affect how much power bankruptcy courts have to approve settlements that do not follow the conventional order of creditor priority and potentially block some parties, in this case the company’s former employees, from any financial recovery.
Jevic Transportation Company, a New Jersey trucking company, filed for bankruptcy in 2008, two years after a $77.4 million leveraged buyout by the private equity firm Sun Capital Partners, which former employees say heaped too much debt on its books. The bankruptcy put 1,785 drivers and staff members out of work, but they sued for wages under a federal law and state law that requires employers to give 60 days’ notice before mass layoffs.
The drivers figured the company owed them approximately $8 million in pay because they were not warned that their jobs were ending. At the same time, the drivers and other creditors filed suit against Sun Capital and Jevic’s main lender, the CIT Group, saying their buyout had fraudulently pushed Jevic into bankruptcy.
In practice, employees who lose their jobs are supposed to rank higher in the line of those owed money than some others, so the drivers anticipated recouping their lost wages. But they got a surprise. Sun and CIT settled with the other unsecured creditors in their fraud case. In exchange for a $3.7 million payment to them, including the lawyers on the case, the creditors agreed to abandon their claim. The drivers were not part of that settlement and were left with nothing.
The sudden job loss was a shock, they said. One driver was unable to find replacement insurance to cover his terminal cancer treatments and died three months later. Other drivers scrambled for work. They have continued to struggle as their case winds through the courts, said Melvin Myers, one of the plaintiffs who had to take a job paying half as much and cash in his retirement plan to make ends meet.
“You think things are clear-cut, in your view, and then over eight years it’s disappointment after disappointment. It shakes your faith in the system,” Mr. Myers said.
There are a few cardinal rules about bankruptcy that have been followed for decades. Lenders whose debts are secured by the company’s assets are paid first, for example. Next are the lawyers and professionals who work on the bankruptcy, followed by the so-called junior creditors, starting with employees who worked for the company who are owed wages, followed by employee benefits and unpaid taxes, among other groups. And those who hold the company’s shares, or equity, are generally last. Congress created this pecking order. Senior creditors must be paid in full before any junior creditors — unless all the parties agree otherwise.
The case being argued Wednesday is Czyzewski v. Jevic Holding Corporation. If the Supreme Court sides with Jevic and its owner and chief lender, the decision could upend bankruptcy law by altering the rights and expectations of these various groups. A friend-of-the-court brief signed by 19 law professors in support of the drivers says such a decision could lead to cases where the stronger parties in a bankruptcy gang up to squeeze out whichever creditors they decide to target: workers, say, or the Internal Revenue Service.
On the other hand, if the court were to ban all bankruptcy settlements that do not strictly follow the order of priority, supporters on Jevic’s side say it could wreak havoc with a number of established practices involving payments to creditors, especially in the early part of a bankruptcy. And they say it could hamstring judges in finding the right resolution in an individual case.
The drivers have received a lot of support including from surprising places like the Loan Syndications and Trading Association, which represents banks and other lenders. It argues that if the court rejects priority in settlements, there is a danger that the position of secured creditors who now stand at the front of the line of repayment also could be in jeopardy.
As the solicitor general explains in a brief on behalf of the drivers, the absolute priority rule “is designed to protect intermediate creditors from being squeezed out by a deal between senior and junior creditors.” The law itself does not detail this priority rule, but it has been followed since the 1930s and is seen as a proxy for what is “fair and equitable” in resolving a Chapter 11 bankruptcy.
Jay L. Westbrook, a bankruptcy scholar at the University of Texas at Austin who signed the professors’ friend-of-the-court brief on behalf of the drivers, said Chapter 11 bankruptcy involved a trade-off. On one hand, the company benefits from the enormous power of the law that shields it from creditors, as it plans its future, he said. But in turn it is required to settle with all the creditors — “not just the ones you want to deal with. A settlement in which you can do what you want is called a lawsuit,” he said.
On the other side, Jevic and its private equity owner said the settlement was the fairest result because if the company were liquidated, all of the small creditors would have been left empty-handed because of secured creditor liens on the company’s assets. By paying some of the small creditors a fraction of their claims, rather than zero, they argued, the settlement was in the best interest of most of the creditors. Their argument persuaded not only the bankruptcy judge, but also a divided panel of the United States Court of Appeals for the Third Circuit.
The 2-to-1 Third Circuit panel said that in rare cases an agreement could be acceptable even when the settlement “skips a class of objecting creditors in favor of more junior creditors.” In this case, Judge Thomas Hardiman wrote, the agreement was the “least bad alternative” that existed.
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The bankruptcy judge in Jevic, Brendan Shannon, said he was persuaded to allow a settlement that cut out the drivers not only because he believed the law allowed it, but because of the “dire circumstances” Jevic was in.
To Jack Raisner, a specialist in employment law litigation at Outten & Golden who represents the drivers, that raises the question: “Who put Jevic into those dire circumstances?”
“Sun did,” he says.