How the New UST Fee Schedule Is a Ticking Tax-Bomb for Middle Market Debtors
As of Jan. 1, 2018, each jointly administered debtor with quarterly disbursements of at least $1,000,000 must pay a fee of 1% of all disbursements, up to $250,000 per quarter. Although this change in the law was only intended to address shortfalls in UST funding, it has taken a little-noticed component of bankruptcy and magnified it into a ticking tax-bomb for unsuspecting debtors and their lenders.
May 09, 2018 at 02:15 PM
12 minute read
As debtors and their lenders budget for a bankruptcy filing, parties negotiate over the cost of the “carveout” for professional fees, leading to a discussion over nearly every detail of the case: How long will a sale process take? Will the Committee retain a financial advisor? What funding will the lenders provide for administrative expenses after a sale or a default?
This negotiation continues after the filing, as the United States Trustee and Committee (UST) weigh in on the potential costs of the case. Yet despite how much attention the carveout receives, one component is often plugged into the debtor's budget with almost no analysis by any party: the quarterly fees payable to the United States Trustee under 28 U.S.C. §1930.
It makes sense that most practitioners pay little attention to the UST fees in middle market and large market cases — after all, the fee never exceeded $30,000 per quarter, and that was for debtors with at least $30MM in quarterly disbursements. Debtors with fewer quarterly disbursements paid significantly less. Relative to other carveout components, the UST fees simply were not large enough to justify any real action by debtors or their lenders.
The relatively small size of UST fees perhaps explains why “disbursement” — the factor that determines the amount of the fee — remains undefined by statute and poorly defined by case law, and why few questioned whether intercompany transfers, “roll-ups” or daily repayments of revolving loans were disbursements. It was just $30,000.
Until now. As of Jan. 1, 2018, each jointly administered debtor with quarterly disbursements of at least $1,000,000 must pay a fee of 1% of all disbursements, up to $250,000 per quarter. 28 U.S.C. §1930(a)(6)(B) (authorizing a heightened fee schedule when the UST budget is underfunded). Although this change in the law was only intended to address shortfalls in UST funding, it has taken a little-noticed component of bankruptcy and magnified it into a ticking tax-bomb for unsuspecting debtors and their lenders.
More concerning, the weight of this tax falls disproportionately on mid-sized debtors. While tying UST fees to quarterly disbursements seems like an equitable way to apportion the burden of paying for the UST program — courts describe the schedule as a “user tax” that places the burden of funding the UST program on the debtors that require the most oversight, see, Walton v. Jamko, Inc. (In re Jamko, Inc.), 240 F.3d 1312, 1316 (11th Cir. 2001) — the practical effect is to distort the cost of bankruptcy for debtors based on their business model, their size, and their structure, with nearly all disproportionate costs falling on mid-sized debtors and their DIP lenders. This unintentional market distortion, which functionally acts as a mid-market bankruptcy tax hike, happens due to the interaction between: 1) the undefined concept of disbursements; and 2) the way the $250,000 cap operates.
|The Undefined Tax on 'Disbursements'
As noted above, quarterly UST fees are calculated based on a debtor's quarterly disbursements. Yet, despite “disbursement” being the trigger for UST fees for over 22 years, Congress has not defined disbursement. See, In re Hale, 436 B.R. 125, 128 (Bankr. E.D. Cal. 2010). The legislative history provides little insight into how Congress intended the fee structure to work: what scant documentation exists does not mention a definition of disbursement. See, In re Pettibone Corp., 244 B.R. 906, 914-18 (Bankr. N.D. Ill. 2000) (finding that the legislative history shows that the quarterly fee program was intended to ensure the UST program was self-funding).
Most courts, finding little help in the statute or legislative history, have turned to the “plain meaning” to find that a disbursement is any transfer of funds, expanding the definition to include funds paid in cash, paid by a third party for the benefit of the debtor, and even book entries as funds move through a cash management system. See, St. Angelo v. Victoria Farms, Inc., 38 F.3d 1525 (9th Cir. 1994); In re Fabricators Supply Co., 292 B.R. 531 (Bankr. D.N.J. 2003).
The definition of disbursement has become so expansive that debtors who are in the financing business have been assessed fees for making loans to their customers. See, Cash Cow Servs. of Fla. LLC v. U.S. Trustee, 296 F.3d 1261 (11th Cir. 2002). As one court explained, apparently without irony, the idea that UST fees are meant to reflect “'real economic activity' finds no support in the text of the statute nor in any legislative history.” Michel v. HSSI, Inc. (In re HSSI, Inc.), 193 B.R. 851, 855 (N.D. Ill. 1996). As explained below, absent a clarifying definition from Congress, courts should interpret “disbursement” to mean a final cash payment that permanently reduces liabilities on the debtor's balance sheet.
|UST Fees as a Tax on Roll-Ups
To see the disproportionate effect of an expansive definition of disbursement, consider a debtor with high-velocity cash flows and accompanying expenses. It may only need a small amount of incremental liquidity to supplement its cash collateral. In such a case, the incumbent lender may be willing to provide new money, but only if the existing secured debt is “rolled up” into the DIP loan balance. This is most often accomplished as part of the financing order, with the order deeming the prepetition loans repaid and postpetition debt is deemed to exist to replace it. No actual money is transferred from the DIP lenders to the prepetition lenders.
True, the prepetition debt is satisfied and replaced with postpetition debt having administrative priority, but if this type of “repayment” counts as a disbursement for UST fees, then the roll-up will cost the debtor real money while the balance sheet is unchanged. See, Fabricators, 292 B.R. at 531. Considering most prepetition lenders will require at least a partial roll-up as a condition for postpetition financing, the effect of the new fee schedule is to charge mid-market debtors an additional 1% closing fee to refinance their prepetition debt, up to $250,000 per debtor. The legislative history provides no indication that Congress intended to create this additional burden on DIP financing.
This roll-up tax imposes costs on estates and lenders beyond just the surcharge itself. For many roll-ups, part of the economic justification is to avoid the costs of a contested cash collateral hearing. Now debtors must decide whether the cost of a contested hearing would be less expensive than the 1% fee on what could be tens of millions of prepetition debt.
In addition, as with all postpetition financing, debtors must demonstrate that the pricing on a roll-up is more favorable than what is otherwise available. The 1% tax complicates this analysis, since a new lender, with no prepetition debt to roll-up, could offer the exact same pricing as an existing lender for a postpetition loan and still be less expensive overall, since a non-rolling loan would enable the debtor to avoid paying an additional 1% in UST fees. This heightens the burden for debtors and gives other parties additional grounds to object to proposed financing.
To the extent the debtor has $25MM in quarterly disbursements without the roll-up, this 1% tax is essentially waived, since the debtor would already be paying the maximum quarterly fee of $250,000, regardless of how its postpetition financing is structured. In short, this 1% tax falls primarily on mid-sized debtors, and there are no apparent policy reasons for why the fees should disproportionately fall on mid-sized debtors or should apply in a way that discourages roll-ups.
|Treatment of Cash Dominion as Disbursements Is a Boon for Term Lenders
In addition to creating a barrier for roll-ups, the UST fee schedule creates an incentive for DIP lenders to structure their loans as term loans, because the UST may assert that each payment towards a loan is counted as an additional disbursement and incurs a 1% fee. This places revolving lenders, who typically require full cash dominion and daily application of cash receipts against the line of credit, at a significant disadvantage when competing to be the postpetition source of financing. See, In re Wernerstruck, Inc., 130 B.R. 86 (D.S.D. 1991) (finding that applications of cash receipts to a revolving line of credit were disbursements under 28 U.S.C. §1930).
Consider a bankruptcy case that lasts for approximately two calendar quarters, with the debtor paying roughly $3.4MM in operating expenses and administrative expenses each quarter. The debtor is optimistic that it will continue to collect from its customers during the bankruptcy, and, despite an initial liquidity crunch, expects to collect $3.6MM in receipts each quarter (these numbers are roughly the amounts found in in the pleadings for Fabricators, 292 B.R. at 531).
Under these facts, if the debtor received a revolving line of credit, with an initial balance of $1.7MM (roughly the size of the outstanding line of credit in Fabricators) and an interest rate of L+5, assuming a relatively steady repayment of the line of credit, the interest on the facility after six months would be roughly $54,000, plus a typically nominal unused line fee for the unused commitments. However, the overall cost of the revolving facility — due to the daily sweep of cash receipts counting as disbursements and essentially doubling the UST fees — would actually be around $122,000 plus the unused line fee. A term lender that provided a similar extension of credit, but didn't sweep cash or require amortization payments could offer an interest rate 500 basis points in excess of the revolver and still be cheaper from the debtor's perspective.
Again, there appears to be no policy justification for the advantage provided to lenders that do not require cash dominion; in fact, once a debtor is large enough to have $25MM in quarterly disbursements, this “term-loan advantage” disappears. Instead, the revolving-loan penalty appears to be an unintentional quirk of using disbursements to measure the size of a bankruptcy case.
|The UST Fee Structure Discourages Subsidiaries and Varied Corporate Structures
In another anomaly, the fee schedule also penalizes debtors with multiple subsidiaries. Although the total amount of fees is capped at $250,000, that cap only limits the fees of individual debtors. If Debtor A has $20MM in disbursements and Debtor B has $20MM in disbursements, both debtors are required to pay $200,000 in UST fees (as opposed to a single $250,000 fee if the operations of Debtors A and B were consolidated into a single entity). See, Genesis Health Ventures, Inc. v. Stapleton (In re Genesis Health Ventures, Inc.), 402 F.3d 416 (3d Cir. 2005) (affirming decision that allocated expenses, and the related disbursements, across subsidiaries, increasing the UST fees from $691,250 to $4.4MM even though only certain debtors actually made cash disbursement).
Currently, a high-volume, low-margin business with four debtor entities could be required to pay $1MM in quarterly UST fees, greatly hampering its ability to reorganize. See, Carrol, Paul and Roche, Adam, Disparate Effect of Quarterly U.S. Trustee Fees, 30-Jan. Am. Bankr. Inst. J. 36, Jan. 2012 (describing the burden of UST fees on high volume businesses such as grocery stores and gas stations). Again, there appears to be no policy reason behind this disparate effect on high-velocity businesses.
Taken to an extreme, the fee schedule taxes transactions four or five times for a single balance-sheet liability reduction: consider an administrative borrower who draws $100MM per quarter on its DIP revolver. To facilitate the cash needs of its subsidiaries, the parent makes intercompany loans to each of its three subsidiary debtors. Each of those loans is taxed at 1% (as a disbursement by the parent to its subsidiaries). The affiliates then make disbursements to trade vendors (another 1%), and then each of the subsidiaries repays the intercompany debt (taxed at 1% per debtor as a “disbursement” by the subsidiary to the parent), and the administrative borrower then repays the revolving loans (another 1% fee for the application of the funds to the credit line). All the while, the only permanent reductions to the balance sheets are the repayments of trade claims by the subsidiaries, yet the debtors are assessed a $1MM per quarter UST fee.
|How to Fix the Issue
The issue lies in the definition of disbursement: By taking an expansive view of disbursements, courts have disconnected calculation of the UST fee from the actual economic activity of the debtor or the complexity of the bankruptcy case. There is nothing in the “plain meaning” of disbursement that suggests that temporary repayments of revolving loans should be treated the same as payments of accrued payroll or trade claims that permanently satisfy debts in exchange for cash.
Put another way, there is no reason for a mid-sized debtor that cycles through $1MM in inventory every week to be assessed an additional $130,000 in quarterly fees simply because it has a revolving loan instead of a term loan. This is particularly true when that same mid-sized debtor is paying the same amount in quarterly fees as the largest, most complex cases in the country.
The answer is to have UST fees reflect the actual economics of a case by only counting disbursements that permanently reduce a debtor's obligations. To the extent this reduces the fees available to fund the UST program, the answer is not to expand the definition of disbursements, but rather to have Congress adjust the fee schedule (and the $250,000 maximum fee) so that the largest cases pay more and middle-market debtors with high-velocity cash flows are less disproportionately affected.
Unfortunately, those changes likely require Congressional action, so in an upcoming issue we will have a follow-up article summarizing litigation strategies and recommendations on how to structure financing proposals to minimize the impact of the new fee schedule. We anticipate many debtors will be challenging the fees under the new schedule. It is incumbent on debtors and lenders to work to defuse this tax-bomb before it upends the DIP financing market.
*****
Jacob H. Marshall is an associate and Randall Klein is chair of the Bankruptcy and Creditors' Rights practice at Goldberg Kohn Ltd in Chicago. They can be reached at [email protected] and [email protected], respectively.
This content has been archived. It is available through our partners, LexisNexis® and Bloomberg Law.
To view this content, please continue to their sites.
Not a Lexis Subscriber?
Subscribe Now
Not a Bloomberg Law Subscriber?
Subscribe Now
NOT FOR REPRINT
© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.
You Might Like
View AllLegal Departments Gripe About Outside Counsel but Rarely Talk to Them
4 minute readAs Profits Rise, Law Firms Likely to Make More AI Investments in 2025
'Serious Disruptions'?: Federal Courts Brace for Government Shutdown Threat
3 minute read'So Many Firms' Have Yet to Announce Associate Bonuses, Underlining Big Law's Uneven Approach
5 minute readTrending Stories
Who Got The Work
Michael G. Bongiorno, Andrew Scott Dulberg and Elizabeth E. Driscoll from Wilmer Cutler Pickering Hale and Dorr have stepped in to represent Symbotic Inc., an A.I.-enabled technology platform that focuses on increasing supply chain efficiency, and other defendants in a pending shareholder derivative lawsuit. The case, filed Oct. 2 in Massachusetts District Court by the Brown Law Firm on behalf of Stephen Austen, accuses certain officers and directors of misleading investors in regard to Symbotic's potential for margin growth by failing to disclose that the company was not equipped to timely deploy its systems or manage expenses through project delays. The case, assigned to U.S. District Judge Nathaniel M. Gorton, is 1:24-cv-12522, Austen v. Cohen et al.
Who Got The Work
Edmund Polubinski and Marie Killmond of Davis Polk & Wardwell have entered appearances for data platform software development company MongoDB and other defendants in a pending shareholder derivative lawsuit. The action, filed Oct. 7 in New York Southern District Court by the Brown Law Firm, accuses the company's directors and/or officers of falsely expressing confidence in the company’s restructuring of its sales incentive plan and downplaying the severity of decreases in its upfront commitments. The case is 1:24-cv-07594, Roy v. Ittycheria et al.
Who Got The Work
Amy O. Bruchs and Kurt F. Ellison of Michael Best & Friedrich have entered appearances for Epic Systems Corp. in a pending employment discrimination lawsuit. The suit was filed Sept. 7 in Wisconsin Western District Court by Levine Eisberner LLC and Siri & Glimstad on behalf of a project manager who claims that he was wrongfully terminated after applying for a religious exemption to the defendant's COVID-19 vaccine mandate. The case, assigned to U.S. Magistrate Judge Anita Marie Boor, is 3:24-cv-00630, Secker, Nathan v. Epic Systems Corporation.
Who Got The Work
David X. Sullivan, Thomas J. Finn and Gregory A. Hall from McCarter & English have entered appearances for Sunrun Installation Services in a pending civil rights lawsuit. The complaint was filed Sept. 4 in Connecticut District Court by attorney Robert M. Berke on behalf of former employee George Edward Steins, who was arrested and charged with employing an unregistered home improvement salesperson. The complaint alleges that had Sunrun informed the Connecticut Department of Consumer Protection that the plaintiff's employment had ended in 2017 and that he no longer held Sunrun's home improvement contractor license, he would not have been hit with charges, which were dismissed in May 2024. The case, assigned to U.S. District Judge Jeffrey A. Meyer, is 3:24-cv-01423, Steins v. Sunrun, Inc. et al.
Who Got The Work
Greenberg Traurig shareholder Joshua L. Raskin has entered an appearance for boohoo.com UK Ltd. in a pending patent infringement lawsuit. The suit, filed Sept. 3 in Texas Eastern District Court by Rozier Hardt McDonough on behalf of Alto Dynamics, asserts five patents related to an online shopping platform. The case, assigned to U.S. District Judge Rodney Gilstrap, is 2:24-cv-00719, Alto Dynamics, LLC v. boohoo.com UK Limited.
Featured Firms
Law Offices of Gary Martin Hays & Associates, P.C.
(470) 294-1674
Law Offices of Mark E. Salomone
(857) 444-6468
Smith & Hassler
(713) 739-1250