Benchnotes January 2025

By Bradley D. Pack, Aaron M. Kaufman and Christina Sanfelippo1

Constitutional Challenge to Chapter 13 Trustee Compensation Scheme Rejected

The salaries of chapter 13 trustees are paid by the trustees’ collection of a percentage fee from every plan payment made by the debtor. In In re Evans, the Ninth Circuit held that a chapter 13 trustee may not retain those payments when the chapter 13 case has been dismissed prior to plan confirmation.2 Following the Evans opinion, Dianne C. Kerns, a chapter 13 panel trustee for the District of Arizona, challenged the constitutionality of the two statutes — 11 U.S.C. § 1326(b)(2) and 28 U.S.C. § 586(e) — that the Ninth Circuit relied on in reaching its holding.

The bankruptcy court did not consider the merits of the trustee’s constitutionality arguments, holding that Evans conclusively resolved the issue. On appeal, the Ninth Circuit Bankruptcy Appellate Panel (BAP) held that because the constitutionality of the statutes was neither argued by the parties nor considered by the court in Evans until a post-decision motion, the bankruptcy court erred in declining to consider the merits. However, the BAP upheld the bankruptcy court’s ruling declining to allow the trustee to retain the percentage fees, because it found nothing unconstitutional about either of the challenged statutes.3

Under 28 U.S.C. § 586(e), the U.S. Attorney General fixes the maximum annual compensation of standing chapter 13 trustees. To fund that salary and the reimbursement of reasonable and necessary expenses, the chapter 13 trustee collects a percentage (up to 10 percent) of each payment made by the debtor under the chapter 13 plan. If the total percentage fees collected by the trustee exceed the maximum annual compensation and reimbursable expenses, the excess is deposited into the U.S. Trustee System Fund. The chapter 13 trustee is paid the percentage fee “[b]efore or at the time of each payment to creditors under the plan.”4

However, if the bankruptcy case is dismissed prior to plan confirmation, the trustee must return all plan payments to the debtor, deducting only unpaid administrative expenses.5 Because the chapter 13 trustee’s compensation is not an administrative expense, the trustee gets no payment at all if the case is dismissed prior to confirmation.

Relying on U.S. Supreme Court precedent holding that it violates due process when judges or similar decision-makers hold an economic stake in the cases they preside over, Kerns argued that “she is a quasi-judicial officer and that it is constitutionally impermissible to give her a direct pecuniary interest in the outcome of a case.” The Ninth Circuit BAP rejected all facets of this argument.

First, the court held that chapter 13 trustees are not “quasi-judicial officers,” because they are not empowered to render binding decisions. While recognizing the important role that chapter 13 trustees play in advising the bankruptcy court and making recommendations pertaining to plan confirmation, their recommendations are not dispositive. It is ultimately the exclusive responsibility of the bankruptcy judge to determine whether to confirm a plan. The BAP also rejected the suggestion that chapter 13 trustees are akin to magistrate judges, who make recommendations to district court judges on certain issues. It held that magistrate judges “are members of the judiciary who preside over disputes between litigants and render judicial decisions that can bind parties with the force of law,” even if some of their tasks involve making recommendations or other decisions that are subject to de novo review. The court also held that just because chapter 13 trustees are entitled to “quasi-judicial immunity,” it does not make them “quasi-judicial officers”; rather, such immunity is afforded to nonjurists who perform roles associated with judicial process.

Second, the BAP held that the compensation scheme does not unconstitutionally compromise the “prosecutorial discretion” of chapter 13 trustees, noting that the Ninth Circuit in Evans had already rejected the “policy argument” that conditioning the collection of percentage fees on plan confirmation “would incentivize trustees to violate their duty to object to plans prior to confirmation, knowing that they only get paid if a plan is confirmed.” The BAP also noted that chapter 13 trustees could not hope to “profit” by declining to object to plans they believe are not confirmable because percentage fees in excess of the maximum compensation set by the Attorney General are not retained by the trustees, but instead are paid over to the government. In addition, Kerns had not demonstrated a risk of loss, because she “produced no evidence that her total percentage fee collections under the Evans interpretation will be less than her maximum compensation plus her approved expenses.”

Third, the due-process rights that Kerns argued were violated by the compensation structure established by 11 U.S.C. § 1326(b)(2) and 28 U.S.C. § 586(e) were not her rights to assert. It is not the decision-makers themselves who are harmed when they have a personal stake in the outcome of a case, but the people whose rights are affected by those decisions.

Finally, the court held that allowing trustees to retain percentage fees when chapter 13 cases are dismissed prior to confirmation would not alleviate the due-process concerns that Kerns asserted anyway. If a plan is not confirmed, the bankruptcy court will ultimately dismiss the case, the debtor will cease making plan payments, and the trustee will stop receiving her percentage fee. Since plan confirmation “keeps the percentage fees flowing for a longer period, plan confirmation will usually, and might always, produce more money for trustees than denial of confirmation.” Thus, trustees would still have a financial incentive to seek confirmation of otherwise objectionable plans.

Miscellaneous

• Kirkland v. Rund (In re EPD Inv. Co. LLC), — F.4th —, 2024 WL 3909749 (9th Cir. Aug. 23, 2024) (in split decision considering propriety of trial court’s jury instruction regarding “Ponzi-scheme presumption” of fraud, 2-1 majority concluded that trial court’s instruction was proper; trial court instructed jury that fraud could be presumed based on objective factors (i.e., use of new investments to pay old investments, and utter lack of any profit-making business), and that jury was not required to find subjective intent to defraud investors; majority also agreed that lenders can be Ponzi scheme victims, and that such schemes are not limited to equity investments);

• United States v. MacKenzie (In re Leite), — F.4th —, 2024 WL 4020023 (9th Cir. Sept. 3, 2024) (trustee sold property that netted $38,000 to pay valid liens; Internal Revenue Service (IRS) asserted tax lien that included $45,000 in unpaid secured taxes and interest and $24,000 in penalties; trustee avoided $24,000 penalty portion of lien and argued that under 11 U.S.C. § 551, avoided portion of the tax lien ($24,000) should be preserved for benefit of estate; bankruptcy court agreed and allowed trustee to allocate $38,000 in sale proceeds pro rata between secured ($45,000) and unsecured ($24,000) portions, but under this allocation, tax lien was not paid in full; on appeal, court of appeals reversed, concluding that there was no legal basis to prorate sale proceeds between secured and unsecured portion; sale proceeds were insufficient to pay secured tax claim in full, so full $38,000 was to be applied to IRS in partial satisfaction of its $45,000 allowed secured tax claim);

• In re Tonawanda Coke Corp., — B.R. —, 2024 WL 4024385 (Bankr. W.D.N.Y. Aug. 27, 2024) (“Absent a writing expressly agreeing to a release of nondebtors, creditors have not given consent as required by the [U.S.] Supreme Court in Harrington v. Purdue Pharma”; court denied approval of disclosure statement because underlying plan proposed third-party releases with “opt-out” provisions for nonconsenting creditors; applying New York law, court held that such opt-out provisions were insufficient to obtain creditor’s consents to third-party releases; accordingly, court concluded that plan was unconfirmable under Purdue);

• Stecklein & Rapp Chtd. v. Experian Info. Solutions Inc., — F.4th —, 2024 WL 3960231 (8th Cir. Aug. 28, 2024) (in debtor’s Fair Credit Reporting Act (FCRA) lawsuit against credit-reporting agency for incorrectly listing debtor’s reaffirmed car loan as having been discharged in bankruptcy, court of appeals affirmed district court’s order quashing credit-reporting agency’s overly aggressive efforts to take discovery from debtor’s law firm; court of appeals held that district court was well within its discretion to award sanctions against credit-reporting agency based on trial court’s conclusion that reporting agency failed to reduce law firm’s burden and was seeking wide-ranging, mostly irrelevant, information as punitive litigation tactic to discourage law firm from pursuing similar FCRA lawsuits);

• Walker v. CFG Merchant Solutions LLC (In re Chipley’s Family Rest. LLC), – B.R. –, 2024 WL 4111882 (Bankr. M.D. Ga. Sept. 6, 2024) (28 U.S.C. § 1409(b) requires claims under $27,750 that “arise in” or are “related to” bankruptcy case to be filed in district where defendant resides; trustee filed claims for $8,000 each against two defendants, and amount in controversy was well below § 1409(b) threshold but above § 547(c) threshold; case was filed in venue where main case was pending, not where defendants resided; defendants moved to dismiss under Rule 12(b)(3) of Federal Rules of Civil Procedure, arguing that venue was improper; bankruptcy court denied motions, concluding that fraudulent-transfer and preference actions are claims that “arise under” Bankruptcy Code and, thus, are not subject to venue limitation of § 1409(b));

• Wells Fargo Bank NA v. The Hertz Corp. (In re The Hertz Corp.), --- F.4th ---, 2024 WL 4132132 (3d Cir. Sept. 10, 2024) (in split decision regarding “make-whole” premiums that compensate noteholders for profits lost when borrower makes payments ahead of schedule, Third Circuit joined Fifth and Ninth Circuits in concluding that solvent debtors must pay make-whole premiums; while Third Circuit reached same result as Fifth Circuit in Ultra Petroleum Corp. v. Ad Hoc Comm. of Unsecured Creditors of Ultra Res. (In re Ultra Petroleum Corp.), 943 F.3d 758 (5th Cir. 2019), and Ninth Circuit in Ad Hoc Comm. of Holders of Trade Claims v. Pac. Gas & Elec. Co. (In re PG&E Corp.), 46 F.4th 1047 (9th Cir. 2022), it did so for different reasons; here, split panel of U.S. Court of Appeals for Third Circuit held that “make-whole” premiums are “economic equivalent” and “mathematical equivalent” of unmatured interest that is unallowable as part of bankruptcy claim (see 11 U.S.C. § 502(b)(2)); majority then cited Czyzewski v. Jevic Holding Corp., 580 U.S. 451, 464-65, 137 S.Ct. 973, 197 L.Ed.2d 398 (2017), for proposition that absolute-priority rule does not allow plan to impair noteholders by paying junior creditors before paying senior noteholders’ unmatured interest; thus, majority held that because debtors were solvent, absolute-priority rule required full payment of senior creditors’ interest, matured and unmatured, including make-whole premiums, before paying junior claims; dissent pointed out flaw in this logic, which is that creditor is not “impaired” if plan merely provides whatever interest is allowed under Bankruptcy Code; because majority held that make-whole premiums were not allowable under § 502(b)(2), dissent argued that absolute-priority rule did not require payment of make-whole premiums);

• In re Wagner, --- F.4th ---, 2024 WL 4142990 (11th Cir. Sept. 11, 2024) (in dischargeability action under 11 U.S.C. § 727(a), court of appeals reversed district court’s ruling and reinstated bankruptcy court’s judgment, which had granted debtor’s discharge; district court had reversed bankruptcy court’s ruling, finding sufficient amount of fraudulent intent to deny debtor’s discharge; “The clearly erroneous standard ‘does not entitle a reviewing court to reverse the finding of the trier of fact simply because it is convinced that it would have decided the case differently’” (citing Anderson v. City of Bessemer City, 470 U.S. 564, 573 (1985)); court of appeals noted that bankruptcy court’s ruling was primarily based on its determination of witness credibility; “Deference to the bankruptcy court’s findings in this case was particularly appropriate because proving or refuting fraudulent intent depended on the bankruptcy court’s credibility determination.”);

• Murray v. Dinsmore & Shohl LLP (In re Murray Energy Holdings Co.), — B.R. —, 2024 WL 4024427 (Bankr. S.D. Ohio Aug. 30, 2024) (court gave detailed analysis of difference between “related-to” jurisdiction and “arising-in” or “arising-under” jurisdiction; court reiterated that it will always have arising-in jurisdiction to interpret and enforce its own orders; because plaintiffs’ professional malpractice claims centered around activities taken by estate professionals to negotiate and obtain confirmation of bankruptcy plan, court held that it had arising-in jurisdiction and denied plaintiff’s motions to remand or abstain);

• In re Parrott, --- F.4th ----, 2024 WL 4471092 (11th Cir. Oct. 11, 2024) (Eleventh Circuit reversed district court, holding that bankruptcy court’s order striking debtors’ first and timely filed notice of appeal for signature defect did not deprive district court of jurisdiction over appeal; Eleventh Circuit explained that language of Rule 11 of Federal Rules of Civil Procedure permits signature defects to be corrected promptly; in Becker v. Montgomery, 532 U.S. 757 (2001), Supreme Court held that appellant’s failure to comply with signature rule in filing his initial notice of appeal is curable and, as a result, initial signature omission does not deprive court of jurisdiction; Supreme Court explained that imperfections in noticing appeal should not be fatal where no genuine doubt exists about who is appealing from what judgment to which appellate court; in case at hand, chapter 13 debtors sought to appeal bankruptcy court’s Jan. 29 order dismissing their chapter 13 case by filing pro se notice of appeal on Feb. 5 while their counsel’s motion to withdraw as counsel was pending; while bankruptcy court struck notice of appeal from record because it failed to include debtors’ attorney’s signature, as required by Rule 9011 of Federal Rules of Bankruptcy Procedure, debtors promptly cured signature defect by filing second pro se notice of appeal on Feb. 18 — five days after bankruptcy court granted counsel’s motion to withdraw; since no genuine doubt existed as to who was appealing from what and to whom, Eleventh Circuit concluded that bankruptcy court’s order striking timely filed notice of appeal did not deprive district court of jurisdiction over appeal); and

• Int’l Petroleum Prod. & Additives Co. Inc. v. Black Gold S.A.R.L., 115 F.4th 1202 (9th Cir. 2024) (as matter of first impression, Ninth Circuit held that reversal of bankruptcy court order denying chapter 15 petition for recognition of foreign insolvency proceeding does not retroactively trigger automatic stay to date in which petition was denied; under plain-text reading of § 1520(a), only order “granting” petition for recognition triggers automatic stay; court declined to use its equitable powers as workaround to § 1520 and retroactively apply automatic stay as of date that bankruptcy court denied chapter 15 petition because interested parties failed to move for stay of bankruptcy court’s order pending appeal under Rule 8007 of Federal Rules of Bankruptcy Procedure; Ninth Circuit similarly rejected interested parties’ argument that it was procedurally impossible for them to move for stay pending appeal because they were not parties to debtor’s chapter 15 proceedings, explaining that the interested parties could have filed motion to intervene under Bankruptcy Rule 2018(a); ultimately, Ninth Circuit cautioned that interested party would do well to act diligently to intervene and stay objectionable denial of chapter 15 petition that is pending appeal).

Bradley Pack is a shareholder with Engelman Berger, PC in Phoenix. Aaron Kaufman is a partner with Gray Reed in Dallas. Christina Sanfelippo is an associate with Cozen O’Connor in Chicago.