Fifth Circuit Upholds Constitutionality of Increase in U.S. Trustee Fees

Siding with the majority of lower courts around the country, the Fifth Circuit upheld the constitutionality of the 2017 increase in fees paid by chapter 11 debtors to the U.S. Trustee Program.

Circuit Judge Edith Brown Clement dissented. Notably, she believes that the “permanent division of the country into [U.S. Trustee] districts and [bankruptcy administrator] districts violates the Bankruptcy Clause.” Rather than overturn the dual U.S. Trustee/bankruptcy administrator system, she would have limited the remedy by allowing the debtor to pay the fees in effect before the increase came into effect.

The dissent raises the question of whether someone will cite the dissent and mount a headlong challenge to the constitutionality of the dual systems.

The U.S. Trustee Fee Increase

To ensure that taxpayers do not finance the U.S. Trustee Program, Congress revised the U.S. Trustee fees as part of the Bankruptcy Judgeship Act of 2017. Codified at 27 U.S.C. § 1930(a)(6)(B), the fee increases whenever the balance in the U.S. Trustee System Fund falls below $200 million at the end of any fiscal year through 2022.

Since the fund balance was below the threshold, the fee increased as of Oct. 27, 2017, when the amendment became effective. With the increase, “the quarterly fee payable for a quarter in which disbursements equal or exceed $1,000,000 shall be the lesser of 1 percent of such disbursements or $250,000.”

If the debtor disburses $1 million a quarter, the increased quarterly fee is $10,000, or $40,000 a year. Under the prior fee schedule, the quarterly fee would have been $4,785 if disbursements were $999,999 in the quarter, or $6,500 if the quarterly disbursements were $1 million but less than $2 million.

If quarterly disbursements are $25 million or more, the fee is now $250,000 a quarter. At $25 million under the old schedule, the fee would have been $20,000 a quarter. For a company with $25 million in quarterly disbursements, the fee rose by 1,250%

The word “disbursements” is not defined in the statute.

The increase hits middle-market companies, because the fees for large companies in chapter 11 are capped at $250,000 a quarter. The increase is tough on companies with low margins but high sales volumes.

In February 2019, Bankruptcy Judge Ronald B. King of San Antonio ruled that the increase in fees does not apply to pending cases because the amended statute, 27 U.S.C. § 1930(a)(6)(B), is not retroactive. He went on to hold that the statute violates the Bankruptcy, Uniformity, and Due Process Clauses of the Constitution. In re Buffets LLC, 597 B.R. 588 (Bankr. W.D. Tex. 2019). To read ABI’s discussion of Buffets, click here.

The Fifth Circuit accepted a direct appeal from the decision by Judge King.

The Majority Reverse Judge King

Writing for himself and Circuit Judge Carl E. Stewart, Circuit Judge Gregg Costa noted that a majority of bankruptcy courts have found the increase to be constitutional. He agreed with the majority and found the increase to be applicable to the debtor whose chapter 11 plan had been confirmed before the increase came into effect.

The gravamen of the debtor’s argument was based on the six districts in Alabama and North Carolina that Congress allowed to continue using bankruptcy administrators in lieu of the U.S. Trustee program. In those districts, the fees are set by the Judicial Conference of the U.S.

The Judicial Conference raised the fees for the bankruptcy administrators, but the increase was only applicable to cases filed on or after October 1, 2018. In the case on appeal to the Fifth Circuit, the debtor confirmed its plan in 2017. The U.S. Trustee took the position that the increase applied to the debtor because its case was still pending when the increase came into effect.

Bankruptcy Judge King sided with the debtor, but the majority on the circuit panel didn’t.

Judge Costa first ruled that all of the debtor’s expenditures were classified as “disbursements,” including routine operating expenses.

Next, Judge Costa decided that the increase applied even though the debtor’s case was pending when the increase came into effect. He ruled that the “applicability of the new fee thus turns on when debtors make disbursements, not when their cases are filed or confirmed.” Based on “statutory history,” he said that “new disbursements, not new cases, trigger the higher fees.”

Similarly, Judge Costa concluded that the increase was not impermissibly retroactive because it neither attached new consequences to completed events nor affected vested rights. He held that the “mere upsetting of their expectations as to amounts owed based on future distributions does not make for a retroactive application.”

Judge Costa said that a debtor with a confirmed plan is no different from a homeowner who faces increased real estate taxes after purchasing a home.

Next, Judge Costa addressed what he called the “main event”: Did the increase contravene the uniformity aspects of the Bankruptcy Clause because it was not applicable in districts with bankruptcy administrators?

Judge Costa found “no uniformity problem” because the Supreme Court found a uniformity violation just once, when a bankruptcy law was made applicable to only one railroad. He said the Supreme Court does not “bar every law that allows for a different outcome depending on where a bankruptcy is filed,” such as exemptions that are not uniform among the states.

Finally, Judge Costa rejected the debtor’s due process challenge because the “fee increase easily survives rational basis review” and similarly “defeats the takings claim.”

The Dissent

Judge Clement was persuaded by St. Angelo v. Victoria Farms Inc., 38 F.3d 1525 (9th Cir. 1994), amended by 46 F.3d 969 (9th Cir. 1995), where the Ninth Circuit found a constitutional defect when an earlier iteration of Section 1930 resulted in different fees between U.S. Trustee and bankruptcy administrator districts. The Ninth Circuit remedied the defect by “equalizing fees.”

Significantly, Judge Clement interpreted St. Angelo as finding a constitutional violation in “the arbitrary use of two dissimilar systems.” She characterized the “underlying constitutional infirmity” as a “dis-uniform law on the subject of bankruptcies.”

Now that Congress has again treated debtors differently, Judge Clement said that “the problem is once again causing harm.”

In terms of remedy, Judge Clement sided with the Ninth Circuit by saying that the court has “no power to force Alabama and North Carolina into the UST program.” So, Judge Clement said she would “ameliorate the harm of unconstitutional treatment” by having the debtor pay fees under the old schedule.

Judge Clement ended her dissent by saying that Congress had created the dual systems for “no better reason than political influence.” She noted how bankruptcy administrators were authorized by a “permanent exemption from the UST Program [tucked] into an unrelated bill during the November 2000 lame duck session” of Congress.

In language that could be quoted in future litigation, Judge Clement said she “would hold that the permanent division of the country into UST districts and BA districts violates the Bankruptcy Clause.”

While dissenting from the majority’s analysis of uniformity, Judge Clement concurred with the majority regarding retroactivity and takings.

Scholarly Observations

The majority opinion cited the leading scholarly commentary on the Uniformity Clause, written by Prof. Stephen J. Lubben, the Harvey Washington Wiley Chair in Corporate Governance & Business Ethics at the          Seton Hall University School of Law. Stephen J. Lubben, A New Understanding of the Bankruptcy Clause, 64 Case W. Res. L. Rev. 319 (2013).

In a message to ABI, Prof. Lubben observed that “the debtor could have only brought up a potentially viable ‘uniformity’ argument if it had argued that the U.S. Trustee system itself violated the Bankruptcy Clause. Once you concede the validity of the system, it makes perfect sense for Congress to have a two-speed fee system that addresses the fact that there are not U.S. Trustees across the nation.”

Prof. Lubben added that “both opinions offer a kind of roadmap for setting up a real challenge to the U.S. Trustee system.”