DIP Finance Order Bars Later Clawback Action By Trustee
A recent decision by a Delaware bankruptcy court highlights the important consequences that can flow from a debtor-in-possession (“DIP”) finance stipulation reached early in a case. The decision, in Official Committee of Unsecured Creditors v. The CIT Group /Business Credit, Inc. (In re Jevic Holding Corp.), held that a chapter 7 trustee was barred by the terms of a chapter 11 DIP financing order from pursuing a clawback action against lenders. It provides protection to lenders and guidance to creditors’ committees negotiating DIP finance agreements, and suggests additional considerations for a court in deciding whether to convert a case to chapter 7.
In 2008, Jevic Holding Corp. filed a chapter 11 petition.1 One of the major issues in the case was whether the 2006 leveraged buyout (“LBO”) in which Sun Capital Partners acquired Jevic was a fraudulent conveyance in favor of Sun and the lenders. The DIP financing order contained a waiver by Jevic of its causes of action against the lenders, but preserved the right of the creditors’ committee to assert these claims. Subsequently, the committee filed a complaint.
A settlement was then negotiated among Sun, CIT (the agent bank), Jevic and the committee that provided cash to pay the expenses of the committee’s counsel, a fund to partially pay the claims of unsecured creditors, and releases for Sun and the lenders. The settlement, which did not provide any cash to a group of former Jevic employees who asserted WARN Act priority employment claims, was to be effectuated through a “structured dismissal” in which the bankruptcy court entered an order dismissing the case and approving the elements of the settlement. After years of appeals, in 2017, the U.S. Supreme Court struck down the structured dismissal.
Following the Supreme Court ruling, the case was remanded to the bankruptcy court and the case was converted to chapter 7. As a consequence, the committee was dissolved and a trustee was appointed. The trustee moved to be substituted for the committee as plaintiff, and the defendants objected and moved to dismiss.
The court sided with the defendants. It ruled that a chapter 7 trustee can assert only causes of action that had been held by the debtor and not actions brought by the committee. However, Jevic’s causes of action against the lenders had been waived in the DIP financing agreement. Thus, any cause of action that could be asserted by the trustee had been waived, and the unwaived causes of action asserted by the committee did not pass to the trustee.
The court also dismissed the action as against Sun, even though it was not a pre-petition lender or a DIP lender. As part of a pre-petition post-LBO workout and forbearance agreement Sun had provided financing to Jevic and provided the lenders with a guaranty. The court held that those gave Sun subrogation rights such that Sun should be deemed to be a pre-petition lender under the DIP finance order. It then concluded that, as a pre-petition lender, Sun should benefit from the broad release provisions in the order, which granted releases of not only causes of action regarding the pre-petition loan but also of any other cause of action against the pre-petition lenders.
Jevic is not the first case to hold that a waiver of rights in a DIP finance agreement can bind a subsequent chapter 7 trustee, but it is the first case to apply this principle in this way in the commercially significant Delaware bankruptcy court. The result in this case was a big win for the lenders, and a big loss for unsecured creditors, who may have lost a significant asset because there is no plaintiff with standing to bring the action. The decision turned on the specific release provisions of the DIP finance agreement, but these provisions are quite common. The result is inconsistent with the common expectations of committees in negotiating release provisions. Committees may well push for DIP finance orders in other cases to make clear that the preserved causes of action will pass to a trustee if the case is converted.
It is not uncommon for clawback actions following LBOs to be brought against pre-petition lenders and acquirors. Often those actions can be split, such that, for example, a settlement is reached with the lenders while the action against the acquiror continues. In Jevic, Sun was able to take advantage of releases meant for the lenders. Creditors’ committees would be advised to take heed of this distinction in negotiating DIP finance stipulations.
Another potential consequence of Jevic would be for conversion motions. Under Bankruptcy Code section 1112(b), the court’s determination of a conversion motion should be based on the best interests of creditors and the estate. In hindsight, the unsecured creditors might have been better served had the court not converted the case to chapter 7, so as to preserve the existence of the committee as a vehicle to pursue on behalf of creditors’ claims against the lenders and Sun.
1 Much of the background to this case, including the Supreme Court decision, was discussed in a prior alert.