Siegel v. Fitzgerald: the U.S. Supreme Court weighs in on the meaning of the bankruptcy clause

Article I, Section 8 of the United States Constitution authorizes Congress to enact “uniform Laws on the subject of Bankruptcies” throughout the United States (“Bankruptcy Clause”). On June 6, the United States Supreme Court decided Siegel, Trustee of the Circuit City Stores, Inc. Liquidating Trust v. Fitzgerald, Acting United States Trustee for Region 4, 596 US ___ (06/06/2022) (Docket No. 21-441), a decision which may have far-reaching financial implications for the Respondent, the United States Trustee in large Chapter 11 bankruptcy cases.

Background of United States Trustee Program and the Dispute Decided by the U.S. Supreme Court

In 1978, effective Oct. 1, 1979, Congress enacted a new set of laws known as the Bankruptcy Reform Act of 1978 (“Bankruptcy Code”). Congress was empowered to enact the Bankruptcy Code under the Bankruptcy Clause of the U.S. Constitution which is identified above. Previously, bankruptcy laws in the United States had been governed by the Bankruptcy Act of 1898, which had its last significant amendment in 1934. The Bankruptcy Code enacted many very significant changes to the Bankruptcy Practice generally and to Chapter 11 reorganization practice, specifically. One of those changes was the creation of the United States Trustee program, operating under the auspices of the Department of Justice of the United States. The stated purpose of the United States Trustee program was to “…serve as trustee in cases where private trustees were unable or unwilling to serve…” Prior to the creation of the U.S. Trustee Program, bankruptcy judges appointed trustees and the creation of the U.S. Trustee Program helped to achieve one of the paramount purposes of the Bankruptcy Code – which was to separate the Bankruptcy Judge from the “…administrative duties in bankruptcy from the judicial tasks, leaving the bankruptcy judges free to resolve disputes untainted…” by an administrative role. (H.R. Rep. No. 764, 99th Cong., 2d Sess. 17-18 (1986); Opening Brief to the U.S. Supreme Court for the Petitioner Alfred Siegel, pg. 4-5).

In Chapter 11 cases, the U.S. Trustee is active in (a) appearing with respect to first day orders which are emergency hearings regularly conducted In Chapter 11 cases, oftentimes before other creditors or constituencies have a chance to react to these emergency hearings, (b) formation of Official Committee of Unsecured Creditors, (c) active in reviewing Chapter 11 Plans and Disclosure Statements, (d) ensuring that Bankruptcy Schedules, Statement of Financial Affairs, Monthly Operating Reports, Tax Returns, proof of insurance and similar “compliance” or important financial information is filed and properly scrutinized, (e) moving Chapter 11 cases along to the most possible expeditious conclusion, (f) reviewing and commenting upon employment of Professionals and upon the fees and costs which they request from the Court, and (g) investigate fraud or abusive conduct for possible civil or criminal prosecution. (See 28 U.S.C. §586).

Upon the Bankruptcy Code’s enactment, the US Trustee program was initially effective for a period of five years (1979-1984) in a limited number of federal judicial districts, after which it was reviewed to decide if the program should be enacted nation-wide. Following this review, the program was enacted nation-wide (in 88 separate judicial districts), with the exception of the six judicial districts in North Carolina and Alabama – which were permitted to opt out of the United States Trustee program. In these six districts, bankruptcy courts sought and were granted authority to continue the US Trustee program through a system known as the “Administrator Program,” having the same “…core administrative functions…” (Siegel v. Fitzgerald opinion, pg. 3; 596 U.S. ___(2022)). Importantly, the funding for the Administrator Program came from different sources than the U.S. Trustee Program. As the Supreme Court stated, “(T)he Trustee Program and the Administrator Program handle the same core administrative functions, but have different funding sources. Congress requires that the Trustee Program be funded in its entirety by user fees paid to the United States Trustee System Fund (UST Fund), largely paid by debtors who file cases under Chapter 11 of the Bankruptcy Code. 28 U.S.C. §589a(b)(5). Those debtors pay a fee in each quarter of the year that their case remains pending at a rate set by Congress and determined by the amount of disbursements the debtor’s estate made that quarter. (See §1930(a)).

In contrast, the Administrator Program is funded by the Judiciary’s general budget. While initially Congress did not require Administrator Program district debtors to pay user fees at all, Congress permitted the Judicial Conference of the United States to require Chapter 11 debtors in Administrator Program districts to pay fees equal to those imposed in Trustee Program districts. (See §1930(a)(7)). Pursuant to a 2001 standing order of the Judicial Conference, from 2001 to 2017 all districts nationwide charged similarly situated debtors uniform fees.” Siegel v. Fitzgerald opinion, pg. 3; 596 U.S. (2022).

Under 28 U.S.C. §1930(a)(6), chapter 11 Debtors are required to pay a quarterly fee to the “United States Trustee System Fund” in each chapter 11 case. This fee is due “…for each calendar quarter, or portion thereof, between the date a bankruptcy petition is filed and the date the court enters a final decree closing the case, dismisses the case, or converts the case to another chapter…” under the Bankruptcy Code. (See 28 U.S.C. §1930(a)(6)). These fees are for the purpose of funding the cost of operations of the United States Trustee’s Office, and are due from Chapter 11 Debtors in every district in the United States other than the 6 districts referenced above. Further, in those few districts in the U.S. remaining under the Administrator Program, the payment of the statutory fees (equal to a percentage of the funds received and disbursed in the normal course of operations by the Chapter 11 Debtor), was still a requirement. (See 28 U.S.C. §1930(a)(7)).

Until changes to the Trustee Program in 2017, the amounts charged to Chapter 11 debtors nationwide was equal.

Statutory Change in U.S. Trustee Fees Charged to Chapter 11 Debtors

A change occurred with regard to this system of assessing U.S. Trustee fees in chapter 11 cases when, in 2017 in response to an operating shortfall in the U.S. Trustee program, Congress enacted a temporary five-year increase in the U.S. Trustee fees. (Bankruptcy Judgeship Act of 2017).

This increase went into effect the first quarter of 2018 and would last through 2022 and was applied to all pending Chapter 11 cases and Chapter 11 cases filed after the enactment of the Statute. However, in the six Administrator Program districts, the increase was only effective starting nine months after the 2017 Act’s effective date and was only applied to Chapter 11 cases filed after the effective date of the statute in those Administrator districts.

The Circuit City Bankruptcy Cases and the Current Dispute

Circuit City, a long-time operator of consumer electronics’ stores, filed Chapter 11 cases in 2008 in the Eastern District of Virginia and confirmed its reorganization plan two years later in which it formed a liquidating trust to conclude the company’s liquidation. The Petitioner, Alfred Siegel (“Petitioner”), was appointed as the liquidation trustee under the confirmed Plan.

Among other things, the liquidation trustee was required to pay quarterly U.S. Trustee fees until “…the Chapter 11 Cases are closed or converted and/or the entry of final decrees…” Due to their size and considerable complexity, the Circuit City bankruptcy cases were still pending when the 2017 Act became effective. According to the Petitioner’s Opening brief, “…In the prior seven years, petitioner paid “approximately $833,000 in quarterly fees.” (citation omitted) “In the first three quarters of 2018 alone, [petitioner] paid approximately $632,000” under the 2017 Act. (citation omitted) Without the increased quarterly fees, [petitioner] would have paid $56,400 – a difference of approximately $575,600.” (See Petitioner’s Opening Brief, pg. 11). As pointed out by Petitioner, under the prior computation of fees charged in large Chapter 11 cases, the difference in the funds referenced would have gone instead to creditors of the Debtor or to the Debtor, rather than to the United States Trustee.

Petitioner brought a proceeding before the Bankruptcy Court against the United States Trustee for the Eastern District of Virginia and argued that the 2017 Act was unconstitutional, on among other grounds, that it violated the Bankruptcy Clause of the U.S. Constitution due to lack of uniformity. The Bankruptcy Court held in favor of Petitioner and ruled that the 2017 Act was unconstitutional because it was “…non-uniform…” within the meaning of the Bankruptcy Clause. The Bankruptcy Court held that from Jan. 1, 2018 forward, that Petitioner should pay U.S. Trustee fees at the rates in existence prior to the 2017 Act. Importantly, in its ruling in favor of Petitioner, the Bankruptcy Court reserved the question of whether any “overpayments” made under the 2017 Act needed to be refunded.

The parties sought a direct appeal of the bankruptcy judge’s decision to the 4th Circuit Court of Appeals, which was granted. A divided panel of the 4th Circuit reversed and held that the disparate treatment between the districts in the United States having the US Trustee program and the six districts in North Carolina and Alabama which did not, was not arbitrary and was permissible because it was the US Trustee fund that was dwindling and the increase provided for in the 2017 Act was focused on remedying that problem. Owing to a split in the Circuits on this issue, the Supreme Court granted certiorari.

United States Supreme Court’s Review and Decision

The United States Supreme Court, in a 9-0 vote held that the 2017 Act was unconstitutional, thereby reversing the 4th Circuit’s decision. Associate Justice Sonia Sotomayor, writing for the Court, observed that if the Circuit City cases were pending in either North Carolina or Alabama, the liquidating trust would have paid $500,000 less in U.S. Trustee fees than were paid because the case was pending in the Eastern District of Virginia. After first determining that the 2017 Act comes within the ambit of the Bankruptcy Clause (primarily by analyzing that the 2017 Act concerns the relations between Debtors and Creditors), the Court turned its attention to whether or not the 2017 Act violated the Bankruptcy Clause. In this regard, the Court looked at three prior opinions it issued addressing the uniformity requirement of the Bankruptcy Clause and concluded that “…the Bankruptcy Clause offers Congress flexibility, but does not permit arbitrary geographically disparate treatment of debtors…” (Siegel v. Fitzgerald opinion, pg. 10). Commenting on the difference in treatment of Debtors under the 2017 Act between those Debtors who file their Chapter 11 cases in the 48 states as compared with those Debtors who file their cases in North Carolina and Alabama. “…the uniformity requirement…does not give Congress 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…” (Siegel v. Fitzgerald opinion, pg. 11). The Court noted that the fact that the U.S. Trustee system that exists in the 48 states is funded by the Chapter 11 fees that are at issue in Siegel, while funding for the Administrator Program in the two states is funded through the Judiciary which created a budget shortfall in the U.S. Trustee System, which the 2017 Act sought to address was a distinction which did not justify the disparate treatment of Debtors.

As set forth in the Court’s opinion, it is important to note that unlike the Regional Rail Reorganization Cases – which gave rise to the Regional Rail Reorganization Act of 1973, where different legislation regarding the reorganization of eight major railroads located in the Northeast and Midwest all entered reorganization proceedings at the same time causing Congress to enact legislation that was geographically specific to each of the regions – Siegel did not present facts that justified the geographical disparities that were present and found to be constitutional in the Rail Reorganization Act Cases, 419 U.S. 102 (1974), at 159, 160.

A Potentially Significant Financial Issue for the United States Trustee

Perhaps the most interesting aspect of the Court’s decision in Siegel is what remedy should be applied if the Petitioner succeeds, as it did, in having the 2017 Act ruled unconstitutional? Petitioner argued that the entire $500,000 “overpayment” he made as required by the 2017 Act should be ordered returned to the liquidating trust. Respondent United States Trustee argued that the relief should only apply prospectively to those fees coming due after the Court’s decision. The Court did not view this question as being before it, and remanded this issue back to the Fourth Circuit Court of Appeals for its consideration. In Petitioner’s brief, they estimated that the difference nationally between what Debtors paid in North Carolina and Alabama versus what was paid in the rest of the country due to the 2017 Act was $100 million. (Petitioner’s Opening Brief, pg. (I)).

The Fourth Circuit Court of Appeals will have a difficult and highly consequential task in front of it when remand of this case reaches them.