The Fee Hike Dilemma: The U.S. Supreme Court Resolves Fee Dispute and Holds Fee Hike Unconstitutional

In Brief

• Parties have long questioned whether the existence of two programs—the Bankruptcy Administrator program and the U.S. Trustee program—to administer bankruptcy cases fails to meet the U.S. Constitutional requirement for uniformity in bankruptcy law.
• In 2017, an increase in quarterly fees by Congress brought this dormant constitutional issue to the forefront because it illustrated the lack of uniformity between these two programs. After the fee hike, debtors in regions administered by the U.S. Trustee program paid significantly more in quarterly fees than debtors in regions administered by the Bankruptcy Administrator program.
• The drastic difference in fees for debtors in the two programs resulted in legal challenges to the constitutional uniformity of the fee hike. This eventually led to a circuit split, with the Fifth and Fourth circuits holding that the fee increase was constitutional and the Second and Third circuits holding that the fee increase was not constitutional.
• Although the U.S. Supreme Court resolved this ensuing circuit split in Siegel v. Fitzgerald, by unanimously holding that the fee hike was unconstitutional, the Court declined to address whether the dual bankruptcy system was constitutional and the appropriate remedy for debtors who paid more fees under the fee increase.

As the recent Congressional tax hike for chapter 11 debtors demonstrates, the existence of two programs to administer bankruptcy cases can result in vehemently different outcomes for similarly situated debtors. In 2017, Congress temporarily increased the quarterly fees large chapter 11 debtors pay during their bankruptcy cases. The change in fees was intended to provide continued funding of the U.S. Trustee program (“UST”). Although a change in fees sounds relatively routine, this Congressional amendment to the bankruptcy code caused an uproar. The controversy was due to the significant variation in fees chapter 11 debtors paid for a few years solely because of geographic differences, rather than a material difference in the bankruptcy filing or debtor’s situation. Debtors in regions administered by the UST program paid significantly higher fees than debtors in regions administered by the Bankruptcy Administrator program (“BAP”). Fees were higher in UST districts because the increase was effective earlier (January 2018). In addition, the fee increase applied prospectively to pending cases. In contrast, debtors in BAP regions paid lower fees because the increase was effective three quarters later (October 2018) and did not apply prospectively to pending cases.

The variation in quarterly fee amounts for similarly situated debtors largely due to geography revived questions regarding the constitutional uniformity of a bifurcated case administration system. The ensuing legal challenges to the fee increase led to contrasting results, in part, because uniformity “has defied principled interpretation since its adoption and continues to be a source of analytical confusion.” Accordingly, the Fourth and Fifth Circuits upheld the fee increase while the Second and Tenth Circuits held that the fee increase was not constitutionally uniform. Signaling the importance of this issue and to resolve the split among circuits, the U.S. Supreme Court (the “Supreme Court”) granted certiorari to the Fourth Circuit case, Siegel v. Fitzgerald (In re Circuit City Stores, Inc.). In considering Siegel, the Court had a rare opportunity to further delineate the meaning of constitutional uniformity in bankruptcy and to address whether the bifurcated case administration system meets that definition.

Despite this rare opportunity, the Supreme Court declined to address whether a bifurcated case administration system is constitutional. Instead, it held that the fee hike was not constitutional and remanded the issue of the appropriate remedy to the Fourth Circuit. Below is a brief history of the events leading to Siegel, a summary of the oral arguments in Siegel, as well as an analysis of the Supreme Court’s decision.

Background

In 1978, to alleviate bankruptcy judges’ administrative burdens and remove the appearance of bias arising from their dual roles as case administrators and jurists—Congress established a pilot UST program. The intent was to “eliminate the appearance of favoritism arising from the close relationship[s] [. . .] between judges and trustees, and to address the problem of ‘cronyism [. . . due to the] appointment of trustees by bankruptcy judges.’” This program became permanent in 1986 in all judicial districts except for Alabama and North Carolina. Many have proffered that this temporary exception to joining the UST program was due to politics. The temporary waiver for Alabama and North Carolina became a permanent exemption from the UST program in 2000.

When Congress created the UST program, it intended for “users of the bankruptcy system” to fund the program “at no cost to the taxpayer.” In contrast, the BAP receives its funding from the general judiciary, which also oversees and operates it. To ensure the UST program would not be funded by taxpayers, Congress promised to “monitor the self-funding mechanism” to ensure debtors would remit sufficient fees to cover costs. Accordingly, 28 U.S.C. § 1930(a)(6) requires chapter 11 debtors to pay quarterly fees based on the size of disbursements debtors make to creditors. Initially, debtors in BAP districts did not have to pay these quarterly fees.

This disparity continued until 1994 when the Ninth Circuit ruled that imposing a “different, more costly system” on debtors everywhere except Alabama and North Carolina violated the Bankruptcy Clause’s uniformity requirement. By way of background, uniformity as a tenet of bankruptcy law originates from Article 1, Section 8 of the U.S. Constitution, otherwise referred to as the Bankruptcy Clause. Under this provision, Congress has the authority to create “uniform Laws on the subject of Bankruptcies.”Although the exact meaning of constitutional uniformity, as noted above, “continues to be a source of analytical confusion,” uniformity should mean that bankruptcy laws treat indistinguishable debtors in a similar if not identical manner.

Rather than eradicate the dual case administrations system in response to the Ninth Circuit’s ruling, Congress enacted 28 U.S.C. § 1930(a)(7), which allowed the Judicial Conference to require BAP debtors “to pay fees equal to those imposed” in UST districts. A year later, the Judicial Conference set fees in BAP districts “in the amounts specified [for UST districts], as those amounts may be amended from time to time.”

The Current Fee Controversy

On October 26, 2017, the issue of constitutional uniformity emerged once again when Congress amended 28 U.S.C. § 1930(a)(6) (the “2017 Amendment” or “Amendment”) in response to declining bankruptcy filings and fee collections. Specifically, Congress temporarily increased fees due to projections that the UST program would have a $92 million shortfall in fiscal year 2017 and a zero balance by fiscal year 2018. To ensure continued funding, the 2017 Amendment increased quarterly fees for debtors with disbursements of $1 million or more in a quarter. The increase is temporary: it only applies from 2018 through 2022. It is also conditional because it goes into effect only if the Trustee System Fund’s balance is less than $200 million as of September of the most recent full fiscal year.

Initially, the temporary fee increase only applied to UST districts. Courts in UST districts applied the new fees to any quarterly disbursements that postdated the effective date of the 2017 Amendment. This meant that a bankruptcy case filed before the 2017 Amendment but still pending after the Amendment would pay the increased fees. The Judicial Conference did not adopt the increased fee schedule for BAP districts until September 2018,and only applied the increase to cases filed on or after October 1, 2018.

The Circuit Split

The Fifth Circuit Holds That UST Fee Increase Is Constitutional.

The first circuit court to address the constitutional uniformity of the fee increase was the Fifth Circuit. The Fifth Circuit has jurisdiction over Louisiana, Mississippi, and Texas district courts—all states in the UST program. In Buffets, the Fifth Circuit ruled against restaurant operators challenging the fee increase on the basis of (1) retroactivity and (2) the constitutional uniformity requirement. The debtors in Buffets operated buffet-style restaurants throughout the U.S. and filed their bankruptcy case before the 2017 Amendment. Despite this, their quarterly fee amount increased from $30,000 to $250,000 because their case was still pending after the Amendment.Although they challenged the increase, arguing that it did not apply because they filed the case before the Amendment, the Fifth Circuit disagreed and held that the fee increase applied to future disbursements.

The Fifth Circuit also held that the 2017 Amendment was constitutionally uniform. Its rationale was that “although the Supreme Court has treated the uniformity requirement as a limit on congressional power, it has also recognized that it ‘is not a straightjacket that forbids Congress to distinguish among classes of debtors [. . .] Nor does it bar every law that allows for a different outcome depending on where a bankruptcy is filed.’” Accordingly, the Fifth Circuit held that the justification for the 2017 Amendment, which was to ensure the UST program remains self-funded, passed constitutional muster. To that end, the court noted that: “the uniformity provision does not deny Congress power to take into account differences that exist between different parts of the country, and to fashion legislation to resolve geographically isolated problems.”

The Fourth Circuit Holds That the Fee Increase Is Constitutional.

The following year, the Fourth Circuit, in Siegel addressed the same issue in a case that would ultimately reach the Supreme Court. The Fourth Circuit encompasses district courts in Maryland, North Carolina, Virginia, and West Virginia—three states in the UST program and one (North Carolina) in the BAP. The debtor in Siegel, Circuit City Stores, Inc., and its affiliates operated a chain of consumer electronic retail stores and challenged the fee increase based on (1) retroactivity and (2) the constitutional uniformity requirement. Similar to the Fifth Circuit, the Fourth Circuit held that Congress intended for the amendment to apply to all disbursements after the Amendment’s effective date. It also held that the increase was constitutionally uniform because unlike the “irrational and arbitrary” distinction which Congress failed to justify in St. Angelo, Congress provided a solid fiscal justification for the 2017 Amendment:ensuring debtors rather than taxpayers fund the UST program. The Fourth Circuit held that Congress could amend the law to apply to UST districts because only debtors in UST districts use the UST program. Congress reasonably solved the shortfall problem with fee increases in the underfunded districts.

Fourth Circuit Judge Arthur Quattlebaum, Jr. issued an opinion concurring in part and dissenting in part. In his opinion, Judge Quattlebaum proffered that the bifurcated administration system is not constitutionally uniform because debtors in UST districts pay materially more in quarterly fees.These fee differences “trickle down” and reduce amounts unsecured creditors receive. As a result, unsecured creditors in UST program districts receive less of the amounts owed to them than similar situated unsecured creditors in Alabama and North Carolina.

The Second and Tenth Circuits Hold Fee Increase Is Not Constitutional.

Months after the Fifth Circuit held that the fee increase was constitutionally uniform, the Second Circuit, in In re Clinton Nurseries, held that the increase violated the Bankruptcy Clause’s uniformity provision. The Second Circuit has jurisdiction over district courts in Connecticut, New York, and Vermont—all part of the UST program. The Second Circuit noted that the Fourth and Fifth Circuits had overlooked a critical factor: uniform application of bankruptcy laws. According to the Second Circuit, the 2017 Amendment applied “to the class of debtors whose disbursements exceed $1 million,” yet there was no suggestion that members of that broad class were absent in the BAP districts. The Second Circuit concluded that although the Supreme Court has held that Congress can take geographical differences into account and fashion legislation to resolve geographically isolated problems, to survive scrutiny under the Bankruptcy Clause, a law must apply uniformly to a defined class of debtors.

Soon thereafter, the Tenth Circuit—which includes UST program districts in Colorado, Kansas, New Mexico, Oklahoma, Utah, and Wyoming—followed suit and adopted an identical conclusion. It held that the Bankruptcy Clause required any law to “apply uniformly to a defined class of debtors.” Since large debtors likely existed in districts overseen by both the UST Program and BAP, the Tenth Circuit concluded the parallel systems did not meet this standard.

The Supreme Court Strikes Down Fee Hike in Siegel.

On June 6, 2022, the Supreme Court issued a unanimous decision in Siegel v. Fitzgerald and resolved the circuit split delineated above. While holding that the fee hike was not constitutional, the Supreme Court explicitly declined to address whether the bifurcated bankruptcy case administration system was constitutional. The Court also declined to address the appropriate remedy, stating that it was a court of review not of “first view.” Accordingly, the Supreme Court remanded the issue of the appropriate remedy to the Fourth Circuit.

The decision not to address the bifurcated bankruptcy case administration system nor remedies was surprising, given that oral arguments in the case in part focused on these two issues. Specifically, the oral arguments that occurred months before, on April 18, 2022, focused on three issues: (1) whether the dual bankruptcy case administration system was constitutionally uniform, (2) if Congress could set varying fees due to this system, and (3) possible remedies if the fee increase was not constitutionally uniform. Of note from the hearing is that the Petitioner (the liquidating trustee for the Circuit City stores) failed to preserve the issue of the constitutionality of the original bifurcation for appeal.

In its opinion, the Court rejected the UST’s arguments that the fee hike was an administrative law rather than a “law ‘on the subject of Bankruptcies’ to which the uniformity requirement applies.” The Court stated, “[n]othing in the language of the Bankruptcy Clause itself . . .suggests a distinction between substantive and administrative laws . . . [n]or has th[e] Court ever distinguished between substantive and administrative bankruptcy laws or suggested that the uniformity requirement would not apply to both.”

According to the Supreme Court, Congress has authority to account for differences that exist between different parts of the county and to fashion legislation to resolve geographically isolated problems.However, Congress does not have free rein to subject similarly situated debtors in different states to different fees because it chooses to pay the costs for some but not others. The Court noted that the problems prompting Congress’ disparate treatment in Siegel stem not from an external and geographically isolated need, but from Congress’ own decision to create a dual bankruptcy system funded through different mechanisms in which only districts in two states could opt into the more favorable fee system for debtors.

Potential Remedies

The issue of the appropriate remedy will be a difficult one for the Fourth Circuit to adjudicate. It may adopt the remedies that the Respondent (the United States Trustee for Region 4) prefers. These would be either a fee increase for debtors in the BAP district who paid less fees or for the Supreme Court’s decision to apply prospectively. Alternatively, it may adopt Petitioner’s remedy—a full refund. As the Supreme Court noted each of these remedies pose a host of legal and administrative concerns, which includes the practicality, feasibility, and equities of each remedy. It will be of great interest to see which remedy the Fourth Circuit chooses (if it does not choose a remedy that neither Respondent nor Petitioner have offered) and whether the chosen remedy will result in another appeal to the Supreme Court.