Prediction: The Supreme Court will grant certiorari to decide this term whether the 2018 increase in fees paid by chapter 11 debtors to the U.S. Trustee Program violated the Bankruptcy Clause of the U.S. Constitution.
We now have a 2/2 split among the circuits. The Second Circuit and now the Tenth Circuit found violations of the Bankruptcy Clause because the increase did not apply immediately to chapter 11 debtors in two states with bankruptcy administrators rather than U.S. Trustees.
The Fourth and Fifth Circuits saw no constitutional infirmity. Meanwhile, the same question is winding its way to the Sixth Circuit and to the Federal Circuit. The outcome in the Supreme Court at a minimum will affect chapter 11 debtors nationwide whose cases were pending between January 2018 and October 2018, when the rate increased in bankruptcy administrator districts.
The Alleged Defect and the Circuit Split
Here’s the alleged constitutional defect: The fee increase became effective in January 2018 in 48 states with U.S. Trustees. It applied to pending cases, even those with confirmed chapter 11 plans. In the two states with bankruptcy administrators, the Judicial Conference didn’t make the increase effective until nine months later, and even then, the increase in those two states did not apply to pending cases.
The Second and Tenth Circuits found violations of the uniformity aspect of the Bankruptcy Clause. See Clinton Nurseries Inc. v. Harrington (In re Clinton Nurseries Inc.), 998 F.3d 56 (2d Cir. May 24, 2021), and John Q. Hammons Fall 2006 LLC v. U.S. Trustee (In re John Q. Hammons Fall 2006 LLC), 20-3203 (10th Cir. Oct. 5, 2021). To read ABI’s report on Clinton Nurseries, click here. We discuss Hammons Fall below.
The Fourth and Fifth Circuits found no constitutional infirmity. See Siegel v. Fitzgerald (In re Circuit City Stores Inc.), 996 F.3d 156 (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.
Significantly, the Fourth and Fifth Circuit panels were not unanimous. Dissenters in both circuits saw constitutional violations. So far, only the Second Circuit has been unanimous. The Tenth Circuit also had a dissenter, albeit on a narrow ground. Persistent disagreement among circuit judges is good reason for Supreme Court review.
The issue is already before the Supreme Court. Raising the circuit split, the debtor from the Fourth Circuit filed a petition for certiorari on September 20. See Siegel v. Fitzgerald, 21-441 (Sup. Ct.). Barring delays, the justices will hold a conference to decide on granting or denying certiorari around the new year, allowing time for argument in 2022 and a decision before the end of the term that began this month.
Two other cases are headed for the circuits raising the same question. The Court of Federal Claims adopted the analysis of the Fifth Circuit and dismissed a class action that could have meant refunds for chapter 11 debtors nationwide whose cases were pending before the increase in bankruptcy administrator districts. See Acadiana Management Group LLC v. U.S., 19-496, 151 Fed. Cl. 121 (Ct. Cl. Nov. 30, 2020). The case is on appeal to the Federal Circuit. The last brief was filed in mid-September. For ABI’s report on Acadiana, click here.
In July, a bankruptcy court in Ohio upheld the increased fees. See Pidcock v. U.S. (In re ASPC Corp.), 19-2120, 2021 BL 262969, 2021 Bankr. Lexis 1857 (Bankr. S.D. Ohio July 13, 2021). An opposed motion for direct appeal to the Sixth Circuit is pending. To read ABI’s report on Pidcock, click here.
The Predicted Outcome
If the Supreme Court grants certiorari, how will the Court rule? Your guess is as good as mine.
There is little in the way of Supreme Court precedent on the Bankruptcy Clause. In 1974, the high court found no defect in a special railroad reorganization law that applied only to railroads in the midwestern and northeastern U.S. Blanchette v. Connecticut General Insurance, 419 U.S. 102 (1974).
The bankrupt railroads all were in regions covered by the special legislation. Reversing the district court, the majority ruled that Congress could take a geographically isolated problem into consideration.
Two circuits interpreted Blanchette one way, and the other two circuits read Blanchette differently. Chances are the Supreme Court will consult tax-uniformity cases in an attempt at divining constitutional principles.
The Effect of Outcomes, One Way or the Other
If the Court finds no constitutional violation, nothing will change in the current system. No one is challenging fees imposed today on newly minted chapter 11 debtors.
Finding a violation of the Constitution likely will mean refunds for debtors covered by the class action in the Court of Claims. There could be other repercussions as well.
If different fee schedules violate the Constitution, is the dual system of U.S. Trustees and bankruptcy administrators itself unconstitutional? Or, is the Small Business Reorganization Act unconstitutional because it permits quick and simple chapter 11 reorganization for companies with less than $7.5 million in debt?
The Tenth Circuit Decision
A bankruptcy court in Kansas denied the chapter 11 debtors’ motion to refund overpayment of fees for the U.S. Trustee system. The bankruptcy court denied the motion but certified a direct appeal to the Tenth Circuit. The appeals court accepted the appeal.
The facts in the Tenth Circuit were not fundamentally different from those in the other circuits. The chapter 11 debtors’ cases were pending when the increase became effective. Before their cases were closed, the debtors paid $2.5 million more than they would have paid under the “old” fee schedule.
The Tenth Circuit rejected the idea that the increase was impermissibly retroactive, because it applied only to fees based on disbursements after the increase became effective.
Like all other courts to consider the question, the Tenth Circuit began the uniformity analysis by saying that the fee statute was a law “on the subject of bankruptcies.” The fees are an exaction that must be paid before creditors receive what’s left.
On uniformity, the majority opinion on October 5 by Circuit Judge Gregory A. Phillips found the increase to be “unconstitutionally nonuniform, because it allows higher quarterly disbursement fees on Chapter 11 debtors in Trustee districts than charged to equivalent debtors in Bankruptcy Administrator districts.” He said that the Tenth Circuit agrees “with the Second Circuit’s well reasoned and unanimous ruling.”
On Blanchette, Judge Phillips observed that the Supreme Court validated a bankruptcy law where all members of the affected class were confined to a geographic area. In contrast, the 2018 increase, he said, applied to all chapter 11 debtors in U.S. Trustee districts, with no showing that similar debtors are absent in bankruptcy administrator districts.
Judge Phillips held that the Bankruptcy Clause “precludes increasing fees based just on the location of the bankruptcy court.” He remanded for the bankruptcy court to determine the amount of a refund to the debtors based on what they would have paid over the same time were the case in a bankruptcy administrator district.
Based on a procedural shortcoming by the debtor, Circuit Judge Robert E. Bacharach dissented in a two-page opinion.
Both the majority and Judge Bacharach said that the debtor had not preserved its argument that the dual system of U.S. Trustees and bankruptcy administrators is unconstitutional in itself. Because the “dual system created different financial needs,” he saw no violation of the Bankruptcy Clause. given that the “dual system[] created different financial needs.”
Prediction: The Supreme Court will grant certiorari to decide this term whether the 2018 increase in fees paid by chapter 11 debtors to the U.S. Trustee Program violated the Bankruptcy Clause of the U.S. Constitution.
We now have a 2/2 split among the circuits. The Second Circuit and now the Tenth Circuit found violations of the Bankruptcy Clause because the increase did not apply immediately to chapter 11 debtors in two states with bankruptcy administrators rather than U.S. Trustees.
The Fourth and Fifth Circuits saw no constitutional infirmity. Meanwhile, the same question is winding its way to the Sixth Circuit and to the Federal Circuit. The outcome in the Supreme Court at a minimum will affect chapter 11 debtors nationwide whose cases were pending between January 2018 and October 2018, when the rate increased in bankruptcy administrator districts.