Article Examines the Future of Unsecured Creditors’ Recovery Efforts

A partner with Squire Patton Boggs, Norman Kinel brings more than 30 years of experience to bear as a bankruptcy attorney involved in some of today’s most complex Chapter 11 cases. Recently, Squire Patton Boggs served as lead counsel for the Official Committee of Unsecured Creditor in the Chapter 11 cases of Constellation Enterprises, LLC, et al. As Normal Kinel outlines in a recent journal article, the ruling in this case, based on an interpretation of a recent Supreme Court decision, may have significant implications for future recovery efforts by unsecured creditors.

In many of today’s large Chapter 11 cases, because the debtors are so over-leveraged, general unsecured creditors do not have a strong chance of a meaningful recovery. To improve the chances of a recovery, it is therefore a common practice for official unsecured creditors’ committees to try and leverage their position by asserting their rights under the U.S. Bankruptcy Code. This often involves raising good faith objections to a number of matters, then seeking to negotiate a settlement of these objections. At times, such a settlement may involve the “gifting” of certain non-estate assets to a trust (either liquidating or litigation) that has been established for general unsecured creditors’ benefit. In essence, this practice may have the effect of skipping certain claimants who have a higher priority than that of general unsecured creditors.

However, as a result of the recent Supreme Court ruling in Czyzewski v. Jevic Holding Corp., bankruptcy courts are now generally deemed not to have the legal power to order a distribution scheme that skips priority claimants and must not deviate from ordinary priority rules without the consent of the affected creditors or unless it is in furtherance of some other permissible bankruptcy code based objective. Consequently, in the Constellation Chapter 11 cases, the Bankruptcy Court did not approve the settlement agreement, reasoning that it was not permissible under Jevic. Although the Committee in Constellation disagreed and appealed the denial of the settlement, while the appeal was still pending, the Constellation Chapter 11 cases were converted to Chapter 7. In an opinion issued by the District Court, the Committee was determined to have been automatically dissolved upon conversion and as a result, the settlement appeal was dismissed.

If in the future courts follow the Bankruptcy Court’s ruling in Constellation, creditors’ committees may find their options and leverage for recoveries to be significantly impaired. For a closer look at the Constellation case and its implications, see Norman Kinel’s article, authored with his partner Nava Hazan, in the November/December 2018 issue of the Journal of Corporate Renewal.