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William James and the Absolute Priority Rule

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There was a fascinating discussion of the "absolute priority rule" in bankruptcy, in Dealbook, on December 6th. Yes, this will bring us to William James but, I warn you, there's some expository material to get through first.

The APR says that in any bankruptcy of a corporate entity, the secured creditors get paid in full before unsecured creditors get a dime, and the unsecured creditors in turn get paid in full before the equity holders get their own first dime.

Under the existing code, there are three ways to bring a chapter 11 case to an end: turn it into a chapter 7 liquidation; confirm a plan; or dismiss it. The first two must comply with the APR. A dismissal doesn't have to comply with APR because, after all, why should it? It's a dismissal!

But "dismissals" are not always mere dismissals, returning everything to the pre-filing status quo. No, certain agreed-upon arrangements have long been acceptable under the name "structured dismissal" and  this has raised the question whether there is a sort of loophole, a priority-skipping structured dismissal.

Stephen J. Lubben, writing in Dealbook and starting from the Supreme Court's pending decision in Jevic Holding, made the following points:

1) a strict constructionist could well argue from the language of the code that  there is no bar to such a structured dismissal, thus it is permitted. In the case at hand, some of the parties want to have the case dismissed pursuant to an agreement that pays out the debtor's cash to some of the creditors, but skipping some, who would be entitled under APR. Which creditors are those and why were the courts below inclined to go along with this? I'll get back to that. The point at the moment is: a strict constructionist could allow it.

2) But no one before the court is now arguing for a strict constructionist reading. The hold of the APR, which has a lot to do with a Justice William O. Douglas opinion from  1939, Case v. Los Angeles Lumber Products, [That's Douglas pictured above] is too strong. The assumption all around is that APR either has to apply or that there has to be a pragmatic policy reason why it doesn't.

3) Those who believe SCOTUS should crack down on priority-skipping structured dismissal argue that this is essential to what one understands by equity and debt in US corporate finance, and that anything short of an absolute rule and a firm judicial hand enforcing same will allow the big players to squeeze out little players.

4) Those who want SCOTUS to retain priority-skipping structured dismissal contend that the APR has never been "absolute," that it isn't even a "rule," and that bankruptcy court judges need the flexibility.

5) Lubben professes to being "conflicted over what the right result is here."

I suspect that the Jamesians who read this blog for those posts that once in awhile justify its name will be happy to take the side of legal flexibility over anything called an "absolute."
Indeed, James wrote: "Common-law judges sometimes talk about the law ... in a way that makes their hearers think they mean [an entity] pre-existing to the decisions, determining unequivocally and requiring them to obey."  But that notion, he continues, collapses under the  "slightest exercise of reflexion."

The lower courts in the Jevic Holding case seem to have taken James' comment to heart -- they did not presume that the APR pre-determined their decision. They approved a structured dismissal even though it  meant stiffing the possessors of a judgment debt, which would normally have priority over some of the debts the structure does pay.  That debt came about due to a class action of 1,800 truck drivers over Jevic's violations of the Worker Adjustment and Retraining Notification Act (WARN).

Why were the WARN judgment creditors sriffed? I'll leave Lubben behind and quote  from ScotusBlog's analysis, which says that the courts below found: "that no good alternative existed. No Chapter 11 plan could be confirmed given the estate’s inability to satisfy outstanding administrative and priority claims (i.e., the estate was 'administratively insolvent'), and, in a Chapter 7 liquidation, no one other than the senior secured creditors would receive anything, because the fraudulent-transfer action would have to be abandoned for lack of resources to prosecute. In short, the courts concluded, the workers were no worse off in the structured dismissal, and other constituents were all measurably better off."

So perhaps we ought to allow courts to create ad hoc exceptions where every alternative is worse? Is that the pragmatic meta-rule? Well, maybe. But at oral argument the Supreme Justices pressed the attorneys involved as to how they would frame such an exception in ways that wouldn't prove very slippery ahead.

And pragmatism should not be confused with ad hocery in general.

I'll be giving the matter some more thought.






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