The Circuit City Landmine (Siegel v. Fitzgerald): Supremes Declare Bankruptcy Fee Hike Under United States Trustee Program Unconstitutional –What Happens Next?

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While it is becoming increasingly rare for the Supreme Court to speak with a singular voice on virtually anything these days, bankruptcy provides a rare exception.

On June 6, 2022, the Supreme Court unanimously held in Siegel v. Fitzgerald, 596 U.S. ___ , 2022 WL 1914098 (Jun. 6, 2022), that Congress’s enactment of a temporary increase in the fee rates applicable to large Chapter 11 cases in 2017 to address a shortfall in the United States Trustee System Fund (Pub. L. 115-72, Div. B, 131 Stat. 1229) (the “2017 Act”), violated the uniformity requirement of the Bankruptcy Clause set forth in Article I, § 7, cl. 4 of the United States Constitution, which empowers Congress to establish “uniform Laws on the subject of Bankruptcies throughout the United States.”   This decision affects United States Trustee quarterly fees paid by Chapter 11 debtors between January 1, 2018 and January 1, 2021, and opens the door to refund actions across the country, potentially resulting in the evaporation of millions of dollars from the coffers of the Office of the United States Trustee (the “U.S. Trustee”).  

The United States Trustee Program

A little background.  In 1978, Congress piloted the United States Trustee Program in 17 of the 94 federal judicial districts.  Siegel, 596 U.S. ___, 2022 WL 1914098, at *3 (citing Bankruptcy Reform Act of 1979, 92 Stat. 2549).  The purpose of the pilot program was to relieve bankruptcy judges from overseeing the growing administrative tasks by delegating such tasks to newly-created United States Trustees administered by the Department of Justice.  Id.  Congress made the U.S. Trustee Program permanent in 1986 by expanding the program to virtually all federal judicial districts.  However, due to resistance from stakeholders in North Carolina and Alabama, Congress permitted six judicial districts in those states to continue judicial appointment of bankruptcy administrators.  Id. (citations omitted).  Ultimately, these districts were preeminently exempted from the Trustee Program unless they elected to participate.  Id.

Creation of the UST Fund

A unique feature of the U.S. Trustee Program is that the UST Fund is entirely funded by user fees, the bulk of which are paid by Chapter 11 debtors, based on quarterly disbursements to creditors from the bankruptcy estate.  Id. at *4 (citing 28 U.S.C. § 1930(a)). 

Due to a shortfall in the UST Fund, “Congress enacted a temporary, but significant, increase in the fee rates applicable to large Chapter 11 cases.” Id. (citing 2017 Act).  The 2017 Act increased quarterly fees for disbursements of $1 million or more during any one quarter from a maximum of $30,000 to $250,000, “regardless of whether the debtor’s case was newly filed or already pending when the increase too effect.” Id. In contrast to the U.S. Trustee Program which applied to all pending and newly filed cases, the “Administrator Program” administered in six districts in North Carolina and Alabama applied the fee increase only to newly filed cases. In 2021, Congress amended Section 1930(a)(7) to require the “imposition of fees in Administrator Program districts that are equal to those imposed in Trustee Program Districts.” Id. at * 5 (citing 28 U.S.C. § 1930(a)(7)).

The Circuit City Chapter 11 and Post-Confirmation U.S. Trustee Fee Increase

The constitutionality of the UST fee hike was called into question after the one-time electronics store behemoth, Circuit City, confirmed its Chapter 11 liquidating plan.  In 2008, Circuit City Stores, Inc. filed Chapter 11 bankruptcy in the Eastern District of Virgina, and confirmed its Chapter 11 liquidating plan in 2010.  Like all liquidating plans, the Circuit City plan required the liquidating trustee to pay U.S. Trustee fees until the bankruptcy cases were closed or converted.  At the time the plan was confirmed, the maximum quarterly fee was $30,000.  Id.  However, after the fee increase took effect under the 2017 Act, the liquidating trust paid nearly $600,000 in increased UST fees than it would have had to pay had the fee increase taken effect prospectively for cases filed after January 1, 2018.  Id. at *5.

The liquidating trustee objected to the fee increase under the 2017 Act, asserting that it violated the Bankruptcy Clause of the U.S. Constitution because the fee increase was non-uniform across the Trustee Program districts and the Administrator Program districts.  The Bankruptcy Court sustained the objection, and directed the liquidating trustee to pay the rate in effect prior to the effective date of the 2017 Act, reversing the question of whether the trustee could recover any overpayments made under the 2017 Act.  The Fourth Circuit reversed, concluding that while it agreed that the uniformity requirement of the Bankruptcy Clause applied to the 2017 Act, the Clause only forbid “’arbitrary’ geographic differences.”  Id. (quoting In re Circuit City Stores, 996 F.3d 156, 166 (4th Cir. 2021)). 

Circuit Split Regarding Constitutionality of 2017 Act

A divided panel of the Fourth Circuit concluded that the “fee increase permissibly applied only to Trustee Program districts because the UST Fund, which funded that program alone, was dwindling.” Thus, “Congress’ effort to remedy that problem was not arbitrary.”  Id.  The Fourth Circuit’s decision was consistent with the Fifth and Eleventh Circuits, which found the fee hike did not violate the U.S. Constitution. See, e.g.., United States Tr. Region 21 v. Bast Amron LLP (In re Mosaic Mgmt. Grp.), 22 F.4th 1291, 1327 (11th Cir. 2022); In re Buffets, LLC, 979 F.3d 366 (5th Cir. 2020).  The Fourth Circuit’sdecision further highlighted a circuit split with the Second and Tenth Circuits holding that the 2017 Act violated the Constitutional uniformity requirement.  See, e.g. In re Clinton Nurseries, Inc., 998 F.3d 56 (2d Cir. 2021); In re John Q. Hammons Fall 2006, LLC, 15 F.4th 1011, 1016 (10th Cir. 2021). 

Supreme Court Strikes Down 2017 Act as Violating the Bankruptcy Clause of the U.S. Constitution

The Supreme Court granted certiorari to resolve the circuit split.  See Siegel v. Fitzgerald, No. 21-441 (U.S. 2021).  Justice Sotomayor, writing an opinion for a unanimous Court, held that the different fee systems applicable to the Trustee Program Districts and the Administrative Program Districts, was unconstitutional.  The Court rejected the U.S. Trustee’s arguments that (1) the uniformity requirement of the Bankruptcy Clause did not apply because the statute in question was an “administrative law” rather than a “substantive law”, and (2) even if the Bankruptcy Clause applied, the Bankruptcy Clause only prohibited arbitrary differences and not all dis-uniform bankruptcy laws based on geographical differences.  Specifically, the Court held that the 2017 Act fell within the Bankruptcy Clause’s uniformity requirement. 

The Court analyzed three prior cases interpreting the Bankruptcy Clause to come to this conclusion.  In Hanover Nat. Bank v. Moyses, 186 U.S. 181, 187, 22 S.Ct. 857, 46 L.Ed. 1113 (1902), the Court held that it was not a violation of uniformity to have state exemption laws incorporated into Bankruptcy Code.  Id. at *7.  The Court noted “that the ‘general operation of the law is uniform although it may result in certain particulars differently in different States.’” Id. (quoting Moyses, 186 U.S. 190). In the Regional Real Reorganization Act Cases, 419 U.S. 102 (1974), the Court held that the Regional Rail Reorganization Act of 1973, which only applied to rail carriers operating within a defined region of the country, did not violate uniformity because the Act “”’operate[d] uniformly upon all bankrupt railroads then operating in the United States’ . . . .”  Id. (alteration in original).  The Court noted that the Bankruptcy Clause is inherently flexible, and that “Congress may enact geographically limited bankruptcy laws consistent with the uniformity requirement if it is responding to a geographically limited problem.”  Id.  Finally, the Court relied on Railway Labor Executives’ Assn. v. Gibbons, 455 U.S. 457, 468–469, 102 S.Ct. 1169, 71 L.Ed.2d 335 (1982), which rejected the contention that Congress could “enact nonuniform bankruptcy laws pursuant to the Commerce Clause,” because doing so “would eradicate from the Constitution a limitation on the power of Congress to enact bankruptcy laws.”  In Gibbons, the Court struck down the Rock Island Railroad Transition and Employee Assistance Act which altered the priority scheme in a single railroad’s bankruptcy proceedings.  Id. at *8. The Court held that “’[t]o survive scrutiny under the Bankruptcy Clause, a law must at least apply to a defined class of debtors.’”  Id. (quoting Gibbons, at 473).

After analyzing the foregoing precedent, the Supreme Court concluded that “[n]othing in the language of the Bankruptcy Clause itself . . . suggests a distinction between substantive and administrative laws . . . .”  Indeed, the Supreme Court noted that it had never distinguished between substantive and administrative bankruptcy laws.  Next, the Supreme Court found the 2017 Act violated the uniformity requirement.  The Court noted that the Bankruptcy Clause “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.”  Id. (quoting Regional Rail Reorganization Act Cases, 419 U.S. at 159. Indeed, “Congress may enact geographically limited bankruptcy laws consistent with the uniformity requirement if it is responding to a geographically limited problem.” Id. at *7.  However, there are limits. While “the Bankruptcy Clause offers Congress flexibility, [it] “does not permit the arbitrary, disparate treatment of similarly situated debtors based on geography.” Id. at *8. 

In Siegel, the Court concluded that while “Congress’ stated goal in raising fees in Trustee Program districts was to address this budgetary shortfall . . .[,] [t]hat shortfall . . . existed only because Congress itself had arbitrarily separated the districts into two different systems with different cost funding mechanisms . . . .”  Id. 

Significance of Siegel

Siegel is notable for a variety of reasons. Setting aside the Constitutional implications, this decision will undoubtedly have an impact on the coffers of the Trustee Program.  The 2017 Act was intended to remedy the budget shortfall by making large Chapter 11 debtors fund the Trustee Program.  However, debtors are certain to move to recoup fees paid into the Trustee Program under the 2017 Act now that the Supreme Court has ruled that the Act is unconstitutional.  Indeed, the Court did not decide the appropriate remedy for affected debtors.  In Siegel, the liquidating trustee sought a full refund of fees paid during the nonuniform period while the U.S. Government argued that any remedy should apply prospectively “or should result in a fee increase for debtors who paid less in the Administrator Program districts.”  Id. at *9.  Rather than address the “practicality, feasibility, and equities of each proposal; their costs; and potential waivers by nonobjecting debtors . . .”, the Court remanded the case for further proceedings, noting that the Bankruptcy Court “has not yet had an opportunity to address these issues or their relevancy to the proper remedy.”  Id.  Indeed, the Court did not opine on the vitality or rationale of the holdings in the Second and Tenth Circuits, which ordered refunds for overpayment of excess fees imposed under the 2017 Act.  See In re John Q. Hammons Fall 2006, LLC, 15 F.4th at 1026; In re Clinton Nurseries, Inc., 998 F.3d at 70. Therefore, these decisions are still good law in these circuits.

 In light of the Court’s ruling, it is certain that bankruptcy courts across the country will be asked to determine the appropriate remedy for debtors who have paid unconstitutionally excessive fees under the 2017 Act.  While the potential dollar amounts at issue are large, the decision will likely impact only a small percentage of Chapter 11 cases pending during this narrow window under the 2017 Act.  As a practical matter, many of those cases will likely have been impacted for only one quarter due to sales that may have resulted in distributions of more than $1 million. 

Similarly, the Supreme Court expressly declined to rule on the “potential waivers by nonobjecting debtors.”  Siegel, 596 U.S. ____; 2002 WL 1914098, at *9.  If a debtor paid and did not timely object to the fee increases imposed under the 2017 Act, bankruptcy courts may conclude that such objections have been waived.  Assuming that those waivers are enforceable, the fiscal impact on the Trustee Program may be less catastrophic than one might imagine.  On the other hand, if such waivers are found to be unenforceable, the Trustee Program may have a funding shortfall, and it is unclear whether such a shortfall could impact excess funds that might otherwise flow to Chapter 7 trustees.

On a wider scale, the Siegel decision might be interpreted liberally to cast doubt on the validity of Congress’s implementation of a dual program for administering bankruptcy cases in different parts of the country, which may prompt further litigation. To be clear, the Court took pains to state in no uncertain terms that the decision is intended to be narrow in effect, holding only “that the uniformity requirement of the Bankruptcy Clause prohibits Congress from arbitrarily burdening only one set of debtors with a more onerous funding mechanism than that which applies to debtors in other States.”  Id. As the Court noted, the Court “does not today address the constitutionality of the dual scheme of the bankruptcy system itself, only Congress’ decision to impose different fee arrangements in those two systems. The Court’s holding today also should not be understood to impair Congress’ authority to structure relief differently for different classes of debtors or to respond to geographically isolated problems.”  Id.

Setting aside the impact of orders requiring the Trustee Program to potentially disgorge hundreds of millions of dollars in the aggregate, it is not difficult to imagine challenges to the constitutionality of the dual programs themselves. Indeed, prior to the Court’s ruling in Siegel, certain debtors filed a class action complaint requesting such relief in the United States Court of Federal Claims. See Acandiana Mgm’t Group, LLC, et al. v. United States, Case No. 1:10-cv—00496-PEC (Apr. 3, 2019), which case is currently on appeal before the United Stated Court of Appeals for the Federal Circuit, Case No. 21-1941 (Fed. Cir. May 11, 2021).  Oral argument was stayed pending the outcome of the Supreme Court’s ruling in Siegel.

In addition to greenlighting litigation to recoup excessive fees paid under the 2017 Act, the Court’s rationale in Siegel may open up additional constitutional challenges to the dual scheme itself.  For example, while the Office of the United States Trustee has the right to appoint official committees and administrators in Trustee Program Districts, bankruptcy judges have the power to do so in Administrative Program Districts. Are the disparate powers of bankruptcy judges in Trustee Program Districts and Administrative Program Districts simply a question of “administrative law” or do they raise a fundamental question regarding the uniformity of federal “bankruptcy law,” and does this distinction matter given the Supreme Court’s admonition that “[n]othing in the language of the Bankruptcy Clause itself . . . suggests a distinction between substantive and administrative laws”? Might professionals challenge the legitimacy of the Trustee Program itself when confronted with an objection to a fee application?

Similarly, the “Tax and Spending Clause” set forth in Article I, Section 8, Clause 1 of the U.S. Constitution, like the Bankruptcy Clause, requires uniformity.  It is certainly foreseeable that similar challenges could be made to the extent that Congress enacts dual systems that undermine uniformity. 

And what about the effect of legislation like the Puerto Rico Oversight, Management and Economic Stability Act (“PROMESA”), which was enacted in 2016 to make bankruptcy available to Puerto Rico – a U.S. territory – even though Puerto Rico was excluded from the U.S. Bankruptcy Code?  The Supreme Court concluded in a unanimous decision written by Justice Breyer, that the appointment of the members of the Financial Oversight and Management Board, which served as the debtors’ statutory representative under PROMESA, was constitutional because the selection of the board’s members was “not subject to the constraints of the Appointments Clause” set forth in U.S. Const. art. 2, § 2, cl. 2; U.S. Const. art. 4, § 3, cl. 2.  See Financial Oversight & Mgm’t Bd. For Puerto Rico v. Aurelius Invs., LLC, 140 S.Ct. 1649, 1663 (U.S. Jun. 1, 2020).  To be clear, this decision does not address whether such a statutory scheme falls within the ambit of the Bankruptcy Clause’s uniformity requirement, and any future challenges may be moot in any event. As discussed above, the Supreme Court in Gibbons, supra, rejected Congress’ attempt to “enact nonuniform bankruptcy laws pursuant to the Commerce Clause,” because doing so “would eradicate from the Constitution a limitation on the power of Congress to enact bankruptcy laws.” 

The Court’s focus on the arbitrariness of the 2017 Act is potentially instructive as it suggests that nonuniform bankruptcy legislation may be permissible so long as it is not based on the Commerce Clause or other pretext to circumvent the Bankruptcy Clause, and is not otherwise arbitrary. As the Court noted, “our precedent provides that the Bankruptcy Clause offers Congress flexibility, but does not permit the arbitrary, disparate treatment of similarly situated debtors based on geography.” Siegel, 596 U.S. ____; 2022 WL 1914098, at *8.  Of course, the question of what is arbitrary and what is not is left undefined.

In the meantime, in light of Siegel, creative bankruptcy lawyers will undoubtedly look for ways to advocate for their clients both for and against the dual bankruptcy programs.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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