Splitting with the Fourth and Fifth Circuits, the Second Circuit held that the 2018 increase in fees paid by chapter 11 debtors to the U.S. Trustee Program violates the Bankruptcy Clause of the Constitution because the increase did not apply immediately to debtors in two states with bankruptcy administrators.
Due to the limited nature of the relief sought by the debtor, the Second Circuit stopped short of declaring that a later version of the increase violates the constitution. However, the opinion could be read to mean that the increase was unconstitutional for all debtors whose cases were pending when the increase came into effect.
But there’s more. Some readers may see hints in the May 24 opinion by Circuit Judge William J. Nardini that the dual system of U.S. Trustees and bankruptcy administrators by itself is constitutionally suspect.
By the way, dissenters in both the Fourth and Fifth Circuits believe that the increase was unconstitutional. As it now stands, five circuit judges see the increase as unconstitutional, while four circuit judges see no conflict with the Bankruptcy Clause.
The U.S. Trustee Fee Increase
The U.S. Trustee program has always been self-funding, with the cost paid by fees imposed on chapter 11 debtors based on the amount of their “disbursements.” When the funds began to run dry, Congress raised 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 quarterly fee increased as of January 1, 2018.
The increase did not apply in the two states that employ bankruptcy administrators rather than U.S. Trustees. For those districts, the Judicial Conference increased the fees as of October 2018, nine months after the increase became effective in the other 48 states. More significantly, the increase in Alabama and North Carolina did not apply to pending cases.
The original 2017 version of Section 1930 said that the Judicial Conference “may” raise the fee for bankruptcy administrators. When there was an immediate outcry about an unconstitutional lack of uniformity, Congress passed the Bankruptcy Administration Improvement Act of 2020, Pub. L. No. 116-325, requiring the Judicial Conference to charge the same fees in bankruptcy administrator districts. However, the amendment in 2020 did not make the increase applicable to pending cases in bankruptcy administrator districts.
A debtor in Connecticut was reorganizing in chapter 11 when the increase came into effect in 2018. The debtor sued the U.S. Trustee in bankruptcy court, claiming that the increase violated the uniformity aspects of the Bankruptcy Clause of the Constitution. The debtor contended that it should be paying fees under the “old” schedule because its case was pending when the increase came into effect.
The bankruptcy court granted the U.S. Trustee’s motion to dismiss. The Second Circuit granted a petition for direct appeal.
The Connecticut debtor confirmed its chapter 11 plan and closed the case before the 2020 amendment came into effect.
Two Circuits Find No Constitutional Violation
Both 2/1 decisions, the Fourth and Fifth Circuits found no constitutional violation in the increase. See Siegel v. Fitzgerald (In re Circuit City Stores Inc.), 19-2240, 2021 BL 158721, 2021 U.S. App. Lexis 12845 (4th Cir. April 29, 2021), and Hobbs v. Buffets LLC (In re Buffets LLC), 979 F.3d 366 (5th Cir. Nov. 3, 2020). To read ABI’s discussion of Circuit City and Buffets, click here and here.
The dissenters in both cases found constitutional violations and at least hinted that the dual system of U.S. Trustees and bankruptcy administrators may in itself be unconstitutional.
The next circuit decision will come from the Federal Circuit on an appeal from the Court of Federal Claims, where the judge adopted the analysis of the Fifth Circuit and dismissed a purported class action. See Acadiana Management Group LLC v. U.S., 19-496, 151 Fed. Cl. 121 (Ct. Cl. Nov. 30, 2020). For ABI’s report on Acadiana, click here.
The Geographical Exception Didn’t Work
Judge Nardini explained how the crux of the constitutional issue lay in two facts: The increase did not apply for nine months in bankruptcy administrator districts, and the increase never applied to cases pending in administrator districts when the increase came into effect.
To obviate the idea that uniformity was even required, the U.S. Trustee argued that the fee statute was not “a Law on the subject of Bankruptcies throughout the United States.” U.S. Const. art. I, § 8, cl. 4.
Judge Nardini said the argument “has been repeatedly rejected by other courts.” It “plainly fits” within the Supreme Court’s broad definition of bankruptcy, because any increase affects how much creditors receive, he said.
Judge Nardini turned to the question of whether the statute was unconstitutional on its face by focusing on the “geographic discrepancy.” He noted how the increase was “required” in U.S. Trustee districts but only “permitted” in two states.
Curiously, the U.S. Trustee contended that the failure of the Judicial Conference to invoke the increase immediately in administrator districts was an unauthorized act that should not render the statute non-uniform. Judge Nardini didn’t buy the argument, because the statute used the word “may” and not “shall” when describing the Judicial Conference’s ability to increase the fees in administrator districts.
Next, Judge Nardini rejected the theory espoused by the Fourth and Fifth Circuits that the fee discrepancy was permissible to deal with geographical differences, in the same sense that permitting differing exemptions among the states does not offend the notion of uniformity.
Supreme Court authority regarding the geographical exception to uniformity is found in Blanchette v. Connecticut General Insurance Corp., 419 U.S. 102 (1974), where the high court upheld bankruptcy laws pertaining to railroads in only one region of the U.S. The justices reasoned that a non-uniform law was permissible because, as Judge Nardini said, all railroad bankruptcies were confined to that region, making it “a geographically isolated problem.”
Judge Nardini said that the two other circuits “overlooked a critical distinction.” He cited Ry. Labor Execs.’ Ass’n v. Gibbons, 455 U.S. 457, 473 (1982), where the Supreme Court said that a bankruptcy law “must at least apply uniformly to a defined class of debtors.”
Judge Nardini found a lack of uniformity because two debtors, “identical in all respects save the geographic locations in which they filed for bankruptcy, are charged dramatically different fees.” He also rejected the idea that the funding shortfall in U.S. Trustee districts resulted from a “geographically isolated problem.”
The distinction “appears to exist,” Judge Nardini said, “only because Congress chose — for politically expedient reasons — to create a dual bankruptcy system.” He went on to say that “the [U.S. Trustee] program was intended to be a uniform, nationwide program, but lawmakers in Alabama and North Carolina resisted and, after receiving a number of extensions, ultimately were granted a permanent exemption from the [U.S. Trustee] program in an unrelated law.”
Adopting a geographical exception to uniformity, Judge Nardini said, “would yield the following inexplicable rule: Congress must enact uniform laws on the subject of bankruptcy . . . except when Congress elects to treat debtors non-uniformly.”
Relief Granted by the Appeals Court
Judge Nadini said that the debtor was only challenging Section 1930 as it read before the 2020 amendment. He therefore held that the 2017 statute, before adoption of the 2020 amendment, “was unconstitutional on its face insofar as it charged higher fees to debtors in [U.S. Trustee] Districts.” He ruled that the debtor was entitled to a refund of anything it paid in excess of what it would have paid in a bankruptcy administrator district.
Judge Nardini limited the scope of the holding by saying, “We do not address the constitutionality of the current version, or of any other portion of § 1930, or of any other aspect of the [U.S. Trustee/bankruptcy administrator] District system.”
Observations
“It’s a nice, clearly written opinion,” Prof. Stephen J. Lubben told ABI. He occupies the Harvey Washington Wiley Chair in Corporate Governance & Business Ethics at Seton Hall University School of Law.
Prof. Lubben went on to say that the opinion “does not greatly further our understanding of the Bankruptcy Clause, and it does leave open the question of whether the U.S. Trustee system itself is unconstitutionally nonuniform.”
The dissents in the Fourth and Fifth Circuits could be read to insinuate that the dual system of U.S. Trustees and bankruptcy administrators may be non-uniform and unconstitutional. Judge Nardini seemed skeptical about the underpinnings of the dual system when he referred to the “politically expedient reasons” for rejecting U.S. Trustees in two states.
However, bankruptcy administrators and U.S. Trustees are not judges. They do not make law and do not enforce law on their own. In substance, they are debtors’ government-financed adversaries. Does the Constitution mandate that debtors’ adversaries must be identical throughout the country?
Instead of U.S. Trustees, would it have been unconstitutional had Congress instead permitted local courts to employ attorneys to appear as watchdogs, perhaps combining the roles of case trustee and U.S. Trustee?
If the dual system is unconstitutional, what about trustees in chapters 7, 11, 12 and 13? In some respects, trustees have more important roles and more authority than U.S. Trustees. Is our system of trustees unconstitutional because trustees are not employed by the same governmental agency?
Prof. Lubben is the author of the leading scholarly commentary on the Uniformity Clause, A New Understanding of the Bankruptcy Clause, 64 Case W. Res. L. Rev. 319 (2013).
Note: Judge Nardini received his commission in November 2019, immediately after being confirmed by an 86-2 vote in the Senate. He had been executive editor of the Yale Law Journal and clerked for both the Second Circuit and the Supreme Court. He was an assistant U.S. Attorney in Connecticut for 15 years, including service as chief of the criminal division.
Splitting with the Fourth and Fifth Circuits, the Second Circuit held that the 2018 increase in fees paid by chapter 11 debtors to the U.S. Trustee Program violates the Bankruptcy Clause of the Constitution because the increase did not apply immediately to debtors in two states with bankruptcy administrators.
Due to the limited nature of the relief sought by the debtor, the Second Circuit stopped short of declaring that a later version of the increase violates the constitution. However, the opinion could be read to mean that the increase was unconstitutional for all debtors whose cases were pending when the increase came into effect.
But there’s more. Some readers may see hints in the May 24 opinion by Circuit Judge William J. Nardini that the dual system of U.S. Trustees and bankruptcy administrators by itself is constitutionally suspect.
By the way, dissenters in both the Fourth and Fifth Circuits believe that the increase was unconstitutional. As it now stands, five circuit judges see the increase as unconstitutional, while four circuit judges see no conflict with the Bankruptcy Clause.