Francis J. Lawall and Marcy J. McLaughlin of Pepper Hamilton. (Photo: Courtesy Photo)

The Office of U.S. Trustee, a division within the Department of Justice, is known among practitioners as the “watchdog” of the bankruptcy process. To fund the U.S. Trustee, Chapter 11 debtors must pay quarterly fees, with the amount due calculated based upon the debtor's disbursements during the preceding quarter. Following a recent substantial increase to the U.S. Trustee fee schedule, the U.S. Bankruptcy Court for the Eastern District of Virginia in In re Circuit City Stores, 2019 Bankr. LEXIS 2121 (Bankr. E.D. Va. July 15, 2019), found the amended fee schedule to be unconstitutional because it was being applied nonuniformly to Chapter 11 debtors around the country.

In October 2017, Congress amended the U.S. Trustee quarterly fee schedule, which is codified in Section 1930(a)(6) of Title 28 of the U.S. Code. Prior to the amendment, 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 amendment, however, 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% of such disbursements or $250,000.” Because the balance of the fund fell below $200 million, the higher U.S. Trustee fees were assessed beginning Jan. 1, 2018.

Not all Chapter 11 debtors, however, were subject to these higher quarterly fees. Six federal judicial districts in Alabama and North Carolina are not part of the U.S. Trustee program, but rather participate in the bankruptcy administrator (BA) program. When Congress increased U.S. Trustee fees in October 2017, quarterly fees for debtors subject to the BA program were not raised.  It was not until Sept. 13, 2018, that the BA program increased quarterly fees to match the amendment's U.S. Trustee quarterly fees, and the BA program only prospectively applied the increased fees for debtors filing Chapter 11 petitions on or after Oct. 1, 2018.

In Circuit City, the debtors' liquidating plan was confirmed on Sept. 14, 2010. The plan formed a liquidating trust to administer and distribute assets and provided that the liquidating trustee would pay U.S. Trustee quarterly fees until the bankruptcy cases were closed or converted. After the amendment was enacted, the liquidating trustee paid the increased quarterly fees to the U.S. Trustee for all of 2018. In March 2019, the liquidating trustee requested the Bankruptcy Court to determine the amount of post-confirmation quarterly fees owed to the U.S. 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 the debtor's petition date, not based on the increased fee schedule.

The liquidating trustee challenged the amendment's constitutionality on two grounds: that the amendment could not be retroactively applied to the liquidating trust because the underlying bankruptcy case was pending before the amendment's enactment; and that the amendment's increased fee schedule was not applied uniformly throughout the country (i.e., Chapter 11 debtors in districts subject to the BA program were not subject to the increased fees for the first three quarters of 2018 and the BA program's increased fees were not applied retroactively).

With respect to its argument that the amendment was unconstitutional because it applied retroactively to cases filed prior to the amendment's enactment, the liquidating trustee argued that the “exponential statutory increase” in U.S. Trustee fees could not have been anticipated when the plan was confirmed eight years earlier and that if the liquidating trustee could have anticipated such an increase of fees, he may have made different decisions in the confirmation process. As it stood now, the plan and all parties' rights were fixed, and the increased fees would harm allowed claimholders as a result of fewer assets being available for distribution.

The Bankruptcy Court determined that Congress did not expressly define the amendment's temporal reach; therefore, it was left to the Bankruptcy Court to decide whether the amendment was impermissibly applied to cases pending on the amendment's effective date. The Bankruptcy Court found its prior decision in In re AH Robins, 219 B.R. 145 (Bankr. E.D. VA. 1998) to be controlling, such that the increased U.S. Trustee fees were similar to taxes or expenses that arose post-confirmation and differed in amount from what was initially anticipated. The Bankruptcy Court held that the increased U.S. Trustee fees did not violate the anti-retroactivity principle because the amendment was substantively prospective.

The liquidating trustee's second argument was that the Amendment was unconstitutional because of its nonuniform application between judicial districts participating in the U.S. Trustee program and those participating in the BA program. This argument stemmed from the fact that for the first three quarters of 2018, debtors in judicial districts in the BA program were not subject to the increased fee schedule; and that debtors whose Chapter 11 cases were filed before Oct. 1, 2018, in judicial districts in the BA program are not subject to the increased fee schedule but similarly situated debtors in all other judicial districts are subject to the increased quarterly fees.

Classifying the quarterly fees as a tax, the Bankruptcy Court determined that the Constitution's Uniformity Clause would be violated because the quarterly fees were not applied in a geographically uniform manner given the differences in how the quarterly fees were assessed for debtors in districts participating in the U.S. Trustee program and those in the BA program. Alternatively, classifying the quarterly fees as a Chapter 11 user fee, the Bankruptcy Court found that the amendment violated the Constitution's bankruptcy clause, which requires that Congress establish uniform bankruptcy laws throughout the country.

Thus, the Bankruptcy Court held that, under the Constitution's uniformity and bankruptcy clauses, the amendment was unconstitutional as the increased quarterly fees were not uniformly applied to all Chapter 11 debtors throughout the country. The Bankruptcy Court further held that the quarterly U.S. Trustee fees due by the liquidating trust since Jan. 1, 2018, must be calculated under the pre-amendment version of the fee schedule. The Bankruptcy Court, however, made no finding as to whether the liquidating trustee could recover its overpayment of U.S. Trustee fees and reserved all parties' rights on that issue.

Now that the increased U.S. Trustee's fees are being applied consistently in all districts throughout the United States, the direct application of the Circuit City decision may be of limited impact. However, what it highlights is just how dramatic the increase in U.S. Trustee fees has been and the potential impact on reorganizations throughout the country. Effectively, in many large cases this arguably amounts to 1% of all disbursements, which could translate in some circumstances to 1% or more of gross revenues.

Francis J. Lawall, a partner in the Philadelphia office of Pepper Hamilton, concentrates his practice on national bankruptcy matters and workouts, including the representation of major energy and health care companies in bankruptcy proceedings and general litigation throughout the United States.

Marcy J. McLaughlin is an associate in the corporate restructuring and bankruptcy practice group of the firm, resident in the Wilmington office.