Fourth Circuit Rules Higher US Trustee Fees in Chapter 11 Are Constitutional

On April 29, 2021, the United States Court of Appeals for the Fourth Circuit issued its decision in Siegel v. Fitzgerald (In re Circuit City Stores, Inc.), Case No. 19-2240 (4th Cir. Apr. 29, 2021), upholding the constitutionality of a 2017 law that substantially increased the quarterly fees debtors are required to pay to the Office of the United States Trustee (the “US Trustee”) in chapter 11 bankruptcy cases.  This opinion reverses a 2019 decision by the United States Bankruptcy Court for the Eastern District of Virginia that held that the 2017 fee schedule amendment was unconstitutionally non-uniform in its application.  There have been a large number of challenges to the 2017 fee schedule amendment, and the Fourth Circuit’s recent decision joins with a decision issued by the Fifth Circuit in November 2020 also upholding the constitutionality of the amendment.  While several bankruptcy courts have held the 2017 fee schedule amendment is unconstitutional, there is a growing appellate trend upholding the validity of the legislation.

The 2017 Fee Schedule Amendment

As explained in the authors’ prior Law360 articles,¹ on October 26, 2017, Congress amended the US Trustee quarterly fee schedule.  Prior to the amendment, chapter 11 quarterly fees ranged from $6,500 (if debtor disbursements were $1 million or more, but less than $2 million) to $30,000 (if debtor disbursements were more than $30 million).  The 2017 amendment provides that for “fiscal years 2018 through 2022, if the balance in the U.S. Trustee System Fund as of Sept. 30 of the most recent full fiscal year is less than $200 million, the quarterly fee payable for a quarter in which disbursements equal or exceed $1 million shall be the lesser of 1 percent of such disbursements or $250,000.”  Because the balance of the fund fell below $200 million, the US Trustee began assessing the increased quarterly fees on January 1, 2018.

These higher quarterly fees, however, were not immediately applied to all chapter 11 debtors.  Debtors in six districts in Alabama and North Carolina are not part of the US Trustee program, but rather participate in the bankruptcy administrator (“BA”) program.  When Congress increased fees in US Trustee districts, it did not simultaneously raise quarterly fees for debtors subject to the BA program.  Congress did not increase fees in BA districts to match the US Trustee districts until September 13, 2018.

The E.D. Va. Bankruptcy Court Rules the 2017 Fee Schedule Amendment Is Unconstitutional.

Circuit City’s liquidating trust’s disbursements exceeded $1 million for every quarter of 2018. Whereas the trust paid approximately $833,000 in quarterly fees during the entire seven years between plan confirmation and the effective date of the increased US Trustee fees, the trust paid more than $630,000 in such fees in just the first three quarters of 2018.

In March 2019, the liquidating trustee requested that the bankruptcy court determine the amount of post-confirmation quarterly fees owed to the US Trustee.  Specifically, the liquidating trustee argued that the amount of quarterly fees owed should have been calculated based on the statutory fee schedule in effect on Circuit City’s petition date, not based on the higher, amended fee schedule.

The liquidating trustee challenged the constitutionality of the amendment on two primary grounds: (1) the amendment could not be retroactively applied to the liquidating trust because the bankruptcy case was pending before the amendment’s enactment; and (2) the increased fee schedule was not applied uniformly throughout the country because of the delay in implementing the increased fees in BA districts.

The bankruptcy court held that the fee schedule amendment was not impermissibly retroactive, finding that the increased US Trustee fees were analogous to taxes or expenses that arose post-confirmation and differed in amount from what was anticipated.  Based on that rationale, the court held that the increased quarterly fees did not violate the anti-retroactivity principle because the amendment was substantively prospective in that it only required the payment of the increased fees following the enactment of the amendment.

Turning to the trustee’s argument that the fee amendment is unconstitutionally non-uniform, the bankruptcy court began by explaining that the US Trustee fee can be classified as either a tax or a bankruptcy user fee.  The bankruptcy court held that if the fees are classified as a tax, the fees violate the Uniformity Clause of the Constitution, which requires that “all duties, imposts and excises shall be uniform throughout the United States,” because the fees were not applied with geographic uniformity during the first three quarters of 2018 due to the disparity with the BA districts.  The bankruptcy court held that if the fees are instead deemed to be a bankruptcy user fee, the fees violate the Bankruptcy Clause, which provides that Congress shall have the power to “establish … uniform Laws on the subject of Bankruptcies throughout the United States.”  The bankruptcy court held that, because, with respect to cases pending prior to October 26, 2018, chapter 11 debtors “have been and continue to be assessed lower quarterly fees in … [BA districts] than have similarly situated debtors throughout the rest of the country,” the amended fee schedule is unconstitutionally non-uniform.

The US Trustee appealed the bankruptcy court’s decision on uniformity and the liquidating trustee cross-appealed the bankruptcy court’s decision concerning retroactivity. The Fourth Circuit granted the parties’ request for a direct appeal.

The Fourth Circuit Rules the 2017 Fee Schedule Amendment Is Constitutional.

On appeal, the Fourth Circuit affirmed the bankruptcy court’s decision that the 2017 fee schedule amendment is not impermissibly retroactive.  The Fourth Circuit agreed with the bankruptcy court’s reasoning that the amendment was not retroactive because it did not apply to disbursements made by debtors prior to the effective date of the amendment.

The Fourth Circuit, however, reversed the bankruptcy court’s decision concerning uniformity, holding that the amendment does not violate either the Uniformity Clause or Bankruptcy Clause of the Constitution.  With respect to the Uniformity Clause, the Fourth Circuit held that clause applies only to taxes.  The US Trustee fees, however, do not qualify as taxes, rendering the Uniformity Clause inapplicable.  With respect to the Bankruptcy Clause, the Fourth Circuit held that “the Bankruptcy Clause forbids only ‘arbitrary’ geographic differences.  And the Supreme Court has never held that a statute contravened the Bankruptcy Clause because of arbitrary geographic distinctions.”  Furthermore, comparing the legislation to statutes enacted by Congress to help struggling railroads operating only in the Northeast and Midwest in the 1970s, the Court held that the 2017 fee schedule amendment did not run afoul of the Uniformity Clause because:

[T]he 2017 Amendment does not draw an arbitrary distinction based on the residence of the debtors or creditors.  Instead, the distinction is simply a byproduct of Virginia's use of the Trustee program.  By increasing quarterly fees for large Chapter 11 bankruptcies in Trustee districts, Congress solved the shortfall in the program’s funding.  The Administrator districts, which are funded by the judiciary’s general budget, did not face a similar financial issue.  Because only those debtors in Trustee districts use the U.S. Trustees, Congress reasonably solved the shortfall problem with fee increases in the underfunded districts.

Judge Quattlebaum dissented from the majority’s ruling that the 2017 fee schedule amendment is constitutional, finding that the 2017 fee schedule amendment violated the Bankruptcy Clause.  The dissent states, “[s]imply put, the imposition of quarterly fees in the two bankruptcy systems is not uniform.  Many Chapter 11 debtors in Trustee Program districts pay more than similarly situated debtors in Bankruptcy Administrator districts. As a consequence, similarly situated creditors receive less in Trustee Program districts than in Bankruptcy Administrator districts.”  In conclusion, Judge Quattlebaum summarized his dissent by stating that “no matter how you slice it, uniform means not different.  That was true when the Constitution was drafted, and it is still true today.”

Conclusion

The Fourth Circuit’s decision in Circuit City relies upon and agrees with the Fifth Circuit’s decision in Matter of Buffets, L.L.C., 979 F.3d 366 (5th Cir. 2020), which similarly determined that the 2017 fee schedule amendment is constitutional.  While several bankruptcy courts have determined that the fee schedule amendment is unconstitutional, there appears to be a growing trend at the Court of Appeals level in favor of constitutionality.  A similar appeal is currently pending before the Second Circuit, which is likely to be the next appellate court to rule on this issue.²

¹ Chapter 11 Debtors Could Recoup Some US Trustee Fees ; The Divide Between Courts On Ch. 11 Trustee Fees

² See Clinton Nurseries, Inc. v. Harrington (In Re: Clinton Nurseries, Inc.), Case No. 20-1209 (2d Cir.); In Re: MF Global Holdings Ltd., Case No. 20-3863 (2d Cir.).