American Apparel, the struggling clothing manufacturer and retailer, found itself in chapter 11 this past November after failing to implement its turnaround plan amid a challenging retail environment.  Last week, Judge Shannon in the District of Delaware approved a largely consensual sale of American Apparel’s assets to Gildan Activewear.  While the hearing transcript is not yet available, several sources are reporting that, when discussing next steps in the case, Judge Shannon indicated that he is not likely to entertain a structured dismissal.  In fact, one source quoted Judge Shannon as saying he “is not likely going out on that limb now” and that “to the extent [he is] the structured dismissal guy, [he is] on hiatus.”

Judge Shannon’s comments are most certainly a reference to the Jevic Holding Corp. case currently pending before the Supreme Court—a case we have followed over the years.  In Jevic, Judge Shannon approved a structured dismissal wherein unsecured creditors received a distribution from a settlement reached between the official committee of unsecured creditors and secured lenders while wage priority claimants received nothing from the settlement, notwithstanding their senior position under the Bankruptcy Code.  The Third Circuit Court of Appeals affirmed the decision holding that the bankruptcy court has discretion to approve structured dismissals except if there is a showing “that the structured dismissal has been contrived to evade the procedural protections and safeguards of the plan confirmation or conversion process.”

Jevic put front and center two competing concerns in bankruptcy.  On its face, the Jevic structured dismissal appears to conflict with the priority rules set forth in section 507 of the Bankruptcy Code, since junior creditors were paid while certain senior creditors were not.  However, the structured dismissal approved in Jevic also arguably maximized creditor recoveries, albeit in a way that skipped over certain senior creditors.  The estate was administratively insolvent and without the structured dismissal, the case would have been converted to Chapter 7 and distributions would have been significantly reduced.

The Third Circuit’s decision in Jevic is the first of its kind—placing the imprimatur of a circuit court on the construct of structured dismissals.  Structured dismissals have increasingly become an accepted means for a debtor to exit chapter 11 and their use has expanded across the country in recent years.  Structured dismissals are unique in that they can allow a debtor the increased flexibility to strike deals to minimize costs while avoiding liquidation and maximizing creditor dividends where otherwise such dividends may not have been possible.  Under the Bankruptcy Code, there are three expressly sanctioned ways for a debtor to emerge from a chapter 11 bankruptcy: confirmation of a plan, dismissal of a case, or conversion to a chapter 7 liquidation—structured dismissals provide a fourth way out.

As we reported, the Supreme Court is currently considering the Third Circuit’s decision in Jevic and in the meantime, it seems as though Judge Shannon is not going to be as likely to allow structured dismissals.  While Judge Shannon alluded to this on the record in American Apparel, it is very likely that he is not the only judge who feels this way.  His statements only confirm what practitioners should assume right now: until the Supreme Court rules on Jevic it is much less likely that courts will permit structured dismissals.  Restructuring professionals should be aware that in light of the uncertainty in the coming months, courts may be reluctant to approve structured dismissals and they should adjust their chapter 11 exit plans accordingly.