Structured Dismissals – How They Work Part I: Court Authority for an Alternative Ending

A. Introduction

Over the past decade, debtors have increasingly used the protections of Chapter 11 to sell substantially all of their assets in sales under section 363 of the Bankruptcy Code. As a result, post-sale debtors frequently have next to nothing left to reorganize or liquidate. Historically, post-sale debtors had only three options for wrapping up their bankruptcy cases: (1) confirming a liquidating plan of reorganization; (2) converting to Chapter 7 and liquidating remaining assets; or (3) dismissing the bankruptcy case in strict accordance with section 1112(b) of the Bankruptcy Code.

Those three options are frequently unappealing and economically impractical considering post-sale debtors often have so few remaining assets that they cannot pay their post-petition expenses. For example, the costs and delays of filing, confirming, and administering a liquidating plan of reorganization may easily exceed any net proceeds that would otherwise have been available to distribute to unsecured creditors. Likewise, the costs and delays associated with converting a case to Chapter 7 may result in a significant reduction of assets previously available to distribute to creditors. Finally, a strict dismissal may result in a disorderly distribution of a debtor’s remaining assets as creditors scramble to be first to enforce state law rights and remedies against the debtor.

A fourth and recently developed alternative, the structured dismissal, provides a pragmatic solution to the aforementioned problems. Generally speaking, a structured dismissal involves filing a motion to dismiss a debtor’s bankruptcy case pursuant to sections 1112(b), 305(a), and 105(a) of the Bankruptcy Code with additional “bells and whistles” that may address, among other things, how claims will be allowed or disallowed, how the debtor will pay creditors, releases, waivers of preference actions, and the resolution of jurisdictional issues. Because structured dismissals expeditiously terminate a bankruptcy case and provide guidelines for the administration of remaining estate assets, they are frequently a cost-effective and orderly alternative to plans and conversions. As a result, courts are approving structured dismissals with ever-increasing frequency, even despite opposition from the Office of the United States Trustee.

B. How it Works

In order to obtain approval of a structured motion to dismiss, movants must generally prove that: (1) the court has the power to enter an order approving a structured dismissal; (2) “cause” exists to approve the structured dismissal; and (3) the structured dismissal is in the best interest of the debtor’s creditors. In the alternative, movants may seek approval of structured dismissal motions by showing that the interests of both the debtor and creditors would be best served by dismissing the bankruptcy case. If the movant satisfies those elements and does not receive an objection to the motion, courts are likely to approve the structured dismissal. This post will address courts’ authority to enter orders approving structured dismissals. Later posts will address establishing “cause” for dismissal, and proving that a structured dismissal is in the best interest of creditors and, at times, the debtor.

(1) Court Authority to Enter Orders Approving Structured Dismissals

In most cases, movants cite to section 105(a) of the Bankruptcy Code in order to establish that the court has authority to approve a structured dismissal. Section 105(a) states that “the court may issue any order…or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code].” On its face, section 105(a) appears quite clear; the statute allows the bankruptcy court to enter any order necessary to carry out the provisions of the Bankruptcy Code. That interpretation is consistent with the United States Supreme Court’s reasoning that bankruptcy courts are awarded broad discretion to enter a wide array of orders to effectuate the Bankruptcy Code. Thus, section 105(a) appears to grant bankruptcy courts authority approve structured dismissals, because sections 305 and 1112 of the Bankruptcy Code provide means for dismissing cases.

While broad in scope, section 105(a) does not entitle bankruptcy courts to enter orders that are inconsistent with the Bankruptcy Code. Thus, a debate arises regarding how strictly parties should read the Bankruptcy Code. According to the Office of the United States Trustee, structured dismissals are inconsistent with the Bankruptcy Code because their inclusion of various “bells and whistles” conflict with other Bankruptcy Code provisions. Simply put, if the Bankruptcy Code’s dismissal provisions do not expressly allow bells and whistles, they are strictly prohibited. As a result of its narrow interpretation of the Bankruptcy Code, the Office of the United States Trustee frequently argues that structured dismissals exceed the scope of section 105(a) and, as a result, cannot be approved.

Despite the U.S. Trustee’s arguments, which will be further addressed in later posts, bankruptcy courts appear inclined to enter orders approving structured dismissals under section 105(a) of the Bankruptcy Code, so long as the movant satisfies the other elements provided above. For example, in In re 155 Route 10 Associates, Case No. 12-24414 (Bankr. D. N.J. 2013), the debtors sought court approval for a structured dismissal that contained, among other things, a waiver of certain causes of action, and a release of the debtors and other related parties. [Docket No. 609]. In their motion, the debtors argued that section 105(a) granted the court authority to approve the proposed structured dismissal. Id. The U.S. Trustee objected, and argued that section 105(a) cannot be used to “graft a structured dismissal option onto the Bankruptcy Code” – which provides only for strict dismissals, as opposed to structured dismissals with bells and whistles. [Docket No. 625]. The court disagreed, and entered an order pursuant to section 105(a) approving the structured dismissal. [Docket No. 627]. As illustrated by 155 Route 10 Associates and other cases, courts appear more inclined to approve pragmatic solutions to difficult problems than to oppose structured dismissals on the basis of a strict interpretation of the Bankruptcy Code.