As a continuation of the ongoing disputes that began with a challenged "structured dismissal" in the Jevic Holdings Corp. bankruptcy case, the U.S. Bankruptcy Court for the District of Delaware recently rendered a decision addressing the rights and obligations of a trustee who has been appointed after a debtor’s Chapter 11 case converts to one under Chapter 7 of the Bankruptcy Code. In this latest decision, Official Committee of Unsecured Creditors v. CIT Group/Business Credit (In re Jevic Holdings) No. 08-11066, 08-51903 2021 Bankr. LEXIS 1203 (Bankr D. Del. May 5, 2021), the court held that a Chapter 7 trustee was bound by the pre-conversion actions of the debtors, and that the trustee would not be permitted to step into the shoes of the then-dissolved official committee of unsecured creditors to pursue certain causes of action.

Factual Background

As we reported in an earlier column, Jevic Transportation, a New Jersey trucking company, was acquired by Sun Capital Partners through a leveraged buyout in 2006. Sun Capital financed the buyout with funds advanced by a group of lenders led by CIT. By May 2008, Jevic’s financial situation had worsened significantly, and Jevic’s board ultimately authorized a bankruptcy filing by Jevic and its affiliated companies. At that point, the company halted almost all operations and, on May 19, 2008, it notified its employees of their imminent termination. The next day, Jevic and its affiliates filed a petition for relief under Chapter 11 of the U.S. Bankruptcy Code. At the time of filing, Jevic owed $53 million to senior secured creditors Sun Capital and CIT, and over $20 million to general unsecured creditors and taxing authorities.

Shortly after this filing, the bankruptcy court gave its approval of the debtors’ post-petition financing agreement under which CIT served as the agent for itself and other lenders. Pursuant to the terms of the post-petition financing order, the debtors waived their right to challenge the lenders’ liens and claims or to assert any claims against the lender, subject to the rights of other parties-in-interest to assert timely claims within a 75-day challenge period. The financing order also included express language that its terms were "binding upon the debtors and any successor thereto (including without limitation any Chapter 7 or Chapter 11 trustee appointed or elected for any of the debtors) in all circumstances."

On Dec. 31, 2008, the official committee of unsecured creditors commenced an adversary proceeding against CIT and other lenders asserting claims relating to: the pre-bankruptcy leveraged buyout in which CIT had played an integral role; the subsequent failed refinancing; and the nature, extent and validity of the prepetition indebtedness incurred, and liens granted, by the debtors in favor of CIT and the other lenders. As the case and related claims progressed, the debtors, the creditors’ committee, CIT and other lenders ultimately came to a proposed settlement of the case in the framework of a "structured dismissal" under which certain distributions would be made pursuant to a prescribed scheme. Certain of the debtors’ former employees objected to the structured dismissal, as they held claims that would otherwise have been given a priority of payment under the Bankruptcy Code. Following years of appeals, the U.S. Supreme Court ultimately reversed the approval of the settlement that contained the illegitimate distribution scheme, holding that the dismissal could not (without the prior consent of affected parties) deviate from the basic priority rules that apply under the Bankruptcy Code.

Following this reversal, the proceedings found their way back to the bankruptcy court. The former employees thereafter filed a motion to convert the debtors’ Chapter 11 case to a case under Chapter 7 of the Bankruptcy Code. The employees’ motion was granted, the debtors’ case was converted, the official unsecured creditors’ committee was dissolved, and a Chapter 7 trustee was appointed.

After his appointment, the trustee filed a motion pursuant to which he sought the court’s authorization to substitute for the then-dissolved creditors’ committee in order to pursue claims against CIT and other of the debtors’ pre-petition lenders, which claims had been brought by the creditor’s committee in a pre-conversion adversary proceeding.

The Bankruptcy Court’s Decision

In advancing his request to step into the shoes of the creditors’ committee, the trustee asserted that he was the true "party-in-interest" in these claims, and that his interests in recovering assets for the debtors’ estates were aligned with those of the creditors’ committee. In their defense, however, CIT and the lenders asserted that the trustee received his legal authority as a successor to the debtors—not the committee: as a consequence, CIT argued that the trustee could not undo the debtors’ prior waiver of claims, which waiver had been explicitly incorporated into the court’s pre-petition financing order.

In analyzing the parties’ arguments, the bankruptcy court reiterated the well-established principle that a Chapter 7 trustee succeeds to the rights of the debtor-in-possession and is bound by the prior actions of that debtor, to the extent such actions have been approved by the court. Indeed, this proposition is critical to the efficient administration of bankruptcy cases: as many courts have observed, holding that the prior actions of a debtor are not binding on a subsequently appointed trustee would impair the ability of a debtor to conduct business, as creditors would be discouraged from dealing with such a debtor for fear that a later-appointed trustee would seek to invalidate prior court-approved agreements.

From this starting point, the bankruptcy court proceeded to examine the terms of the pre-petition financing order that CIT and the lenders urged were determinative. The court noted that the pre-petition financing order contained provisions approving the debtors’ acknowledgement of, and agreement to: the validity of the prepetition indebtedness and liens granted in favor of CIT and the other lenders; the debtors’ waiver of all claims they may have held against CIT and the other lenders; and the binding nature of these agreements and waivers on any successor to the debtors, including a Chapter 7 trustee.

Notwithstanding the content of the court’s pre-petition financing order, the trustee asserted that his ability to step into the shoes of the now-disbanded creditors’ committee and pursue the adversary proceeding against CIT and the other lenders arose from other language in the court’s pre-petition financing order: that language, according to the trustee, granted "interested parties" a 75-day window of time within which they would be entitled to investigate and take action in connection with the lenders’ liens and rights to payment. Emphasizing what he described as the "binding terms" of the pre-petition financing order, the trustee asserted that the debtors’ waivers were subject to the rights of other "parties in interest," including those of a Chapter 7 trustee. As such, the trustee reasoned, since the creditors’ committee had been actively prosecuting these claims against CIT and the other lenders, he was now the appropriate "party in interest" to pursue the claims originally brought by the creditors’ committee for the benefit of the debtors’ estates.

The court disagreed. It noted that the trustee’s arguments disregarded key language of the relevant provisions of the pre-petition financing order. The terms of the "carve-out" on which the trustee relied, according to the court, were very specific as to which party might assert any challenge to the lenders’ rights, as well as when any such challenge might be prosecuted. The court acknowledged that the creditors’ committee could—and did—initiate its challenge within the 75-day window set forth in the pre-petition financing order. The court also noted that, upon conversion of the debtors’ Chapter 11 case to a case under Chapter 7, the creditors’ committee had dissolved.

The terms of the pre-petition financing order, the court determined, clearly identified the creditors’ committee as the party empowered to pursue an action against the lenders. Equally clear from the language of the pre-petition financing order, according to the court, was that the committee’s rights were not transferable to the trustee, who instead was bound by the waiver and release provisions to which the debtors had agreed.

Under an alternative theory, the trustee asserted that his ability to pursue claims held exclusively by the creditors’ committee did not depend on any transfer of rights or claims from the committee: because these claims were actually assets of the debtors’ estates, the claims were transferred to the trustee by operation of Bankruptcy Rule 25(c), which vests assets of the estate in a successor trustee.

The court remained unpersuaded by the trustee’s legal argument. It noted that a committee’s right to assert claims are generally derivative of the debtor’s rights; committees do not independently hold such rights. In this case, the creditors’ committee held the right to pursue the adversary proceeding against CIT and the lender group by virtue of the specific terms of the pre-petition financing order. Accordingly, upon conversion of the Chapter 11 case, the trustee was unable to pursue claims that had been waived by the debtors.

The language of the pre-petition financing order provided a waiver by the debtors of all claims against CIT and the lenders. Additionally, the terms of the pre-petition financing order provided that this waiver was to be binding upon the debtors and any Chapter 7 trustee. To allow otherwise, the court reasoned, would eviscerate the specific language of the pre-petition financing order. The court therefore denied the trustee’s motion to substitute.

Impact

The bankruptcy court’s decision in Jevic offers guidance—and comfort—to lenders and other creditors that may find themselves similarly situated to the CIT group of lenders. Critical to the orderly and successful administration of bankruptcy cases is the ongoing business relationship between debtors and their various creditors. The Jevic holding clarifies that the contractual obligations of a debtor will bind the debtor’s successors-in-interest, and a debtor’s waivers provided to lenders during the course of a bankruptcy case, if properly documented and approved, will survive the conversion of the debtor’s Chapter 11 case.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights.

Drew S. McGehrin, an associate at the firm, practices in the areas of commercial finance, financial restructuring and bankruptcy.

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.