Be Careful What You Wish For: Jevic Court Denies Chapter 7 Trustee’s Substitution Request, Potentially Ending Action Versus Prepetition Lenders

Perhaps proving the maxim that people should be careful what they wish for, in a second significant ruling stemming from the Jevic Holding Corp. bankruptcy case, on May 5, 2021, the US Bankruptcy Court for the District of Delaware found that Jevic’s Chapter 7 trustee, appointed following the conversion of the debtors’ cases from Chapter 11 to Chapter 7, did not have standing to continue claims originally brought against the debtors’ prepetition lenders by the Chapter 11 creditors’ committee. Assuming it is upheld on appeal, the decision leaves Jevic’s unsecured creditors without any further remedy against Jevic’s prepetition lenders—in other words, leaving those employees who successfully fought approval of a prior settlement offer by the same lenders all the way to the United States Supreme Court with no recovery from those lenders. Indeed, the decision appears to be a significant victory for secured lenders generally, underscoring the importance of “challenge” provisions typically included in DIP and cash collateral orders.

1. Background

Jevic, a trucking company, initially filed for bankruptcy in 2008. As part of the order approving the debtors’ entry into a postpetition financing arrangement with their prepetition lenders (the “DIP order”), and as is typical in such DIP orders and similar cash collateral orders, the debtors stipulated to the validity of their prepetition indebtedness and also agreed not to assert any claims against their prepetition lenders. These provisions applied to the debtors and their successors in interest, including a future Chapter 7 trustee in the event of conversion. However, as is also typical in DIP and cash collateral orders, the committee and other parties in interest (including the Chapter 7 trustee) were also given an “investigation period” during which they would be permitted to investigate and pursue claims against the prepetition lenders, on behalf of the debtors’ estates, even though the debtors themselves had chosen not to. For the committee, this period ran for 75 days after its appointment. And for all other parties in interest, this period ran for 75 days after the petition date. If claims were not brought by those parties within this investigation period, those parties in interest would also be bound by the debtors’ stipulations.

Following its investigation, the committee instituted an adversary proceeding against the debtors’ prepetition lenders within 75 days of its appointment, asserting avoidable transfer claims in connection with a 2006 leveraged buyout transaction involving the debtors. The committee subsequently agreed to settle those claims. But certain employees with priority claims objected, arguing that the settlement payment did not comply with the Bankruptcy Code’s priority rules. The bankruptcy court, district court and appeals court all rejected the employees’ claims, but, in its 2017 decision,1 the United States Supreme Court ruled in favor of the employees, rejecting the settlement as running afoul of the Bankruptcy Code’s priority scheme.

With the case sent back to the bankruptcy court, the committee and lenders tried again, this time submitting a revised settlement agreement in 2018, which they claimed complied with the Supreme Court’s mandate in its 2017 opinion. The same group of employees who objected to the first settlement again objected to the revised settlement, now also seeking conversion of Jevic’s bankruptcy case to Chapter 7. The bankruptcy court ruled in the employees’ favor in all regards, rejecting the revised settlement offer, converting the case to Chapter 7 (and thereby disbanding the creditors’ committee) and appointing a Chapter 7 trustee.

In April 2019, the Chapter 7 trustee sought to substitute itself as plaintiff in the action originally brought by the creditors’ committee, arguing that it succeeded to the committee’s claims. Jevic’s prepetition lenders objected, arguing that a Chapter 7 trustee succeeds to the interests of the debtor and not to the interests of an official unsecured creditors’ committee.

2. Decision

In its May 5, 2021 decision, the Delaware bankruptcy court rejected the Chapter 7 trustee’s substitution request, holding that a Chapter 7 trustee succeeds solely to rights of the debtor itself and not to related estate fiduciaries, such as a creditors’ committee. The court began its analysis by noting that the federal rule under which the Chapter 7 trustee sought to substitute itself into the action2 “applies only if substantive law allows the action to continue upon dissolution of a party.”3 The court recognized that, under the applicable substantive law in this case—i.e., the Bankruptcy Code—it is “well-established” that a Chapter 7 trustee succeeds to the rights of the debtor and is bound by the debtor’s prior actions. The only rights a Chapter 7 trustee can inherit from a creditors’ committee, then, are those that the debtor itself would have been able to inherit from the creditors’ committee. Put differently, if the debtor itself could have continued the committee’s action, then the Chapter 7 trustee could as well. If the debtor was barred from continuing the committee’s action, then the Chapter 7 trustee would also be barred. Because the Jevic debtors expressly waived their rights to bring any claims against their prepetition lenders, even though the committee retained its own rights to do so (so long as such action was brought within the committee’s investigation period), the bankruptcy court found that the Chapter 7 trustee was bound by the debtors’ waiver.

The court also emphasized that the applicable DIP order itself provided that the debtors’ stipulations and admissions 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.” Allowing the Chapter 7 trustee to nonetheless continue the committee’s action would deny the “legal consequence” to this “very specific language,” and the Chapter 7 trustee’s substitution request therefore had to be denied.

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Beyond providing a somewhat abrupt end to bankruptcy litigation that has gone on for well over a decade (although subject to further appeals), this decision provides important lessons for all participants in a bankruptcy case. First, unsecured creditors will want to be particularly careful before seeking conversion of a case to Chapter 7, in particular to the extent they are using a conversion threat as leverage to obtain more in a litigation brought by an estate fiduciary. The priority employees who fought the settlement in Jevic for years, all the way to the United States Supreme Court, certainly did not expect to see their claims against the lenders so abruptly rendered worthless after years of hard-fought litigation. Second, debtors, lenders and all other parties in interest will want to stay focused on the relatively standard “challenge” and “investigation” provisions included in DIP and cash collateral orders to ensure their rights are properly protected. The provisions at issue in Jevic appear to have worked exactly as intended, binding the debtors and their successors while providing leeway to estate fiduciaries such as the committee to protect other parties in interest. Debtors and other parties in interest looking for different results will need to consider their options early on in a Chapter 11 case in anticipation of different outcomes, including a potential conversion of the case to Chapter 7.