U.S. Supreme Court Bankruptcy Roundup
Supreme Court Unanimously Strikes Down 2017 U.S. Trustee Fee Hike as Unconstitutional
On June 6, 2022, the U.S. Supreme Court issued a much-awaited decision, Siegel v. Fitzgerald, No. 21-441, __. U.S. __, 2022 WL 1914098 (U.S. June 6, 2022), holding unconstitutional certain aspects of Congress's 2017 amendment to 28 U.S.C. § 1930(a)(6) (the "2017 Amendment"). The 2017 Amendment dramatically increased the quarterly fees charged by the United States Trustee ("UST") in chapter 11 cases.
The roots of this dispute go back to the creation of the UST program in the U.S. Department of Justice in the mid-1980s. For political reasons, when Congress created the UST, it established the program in only 88 of the 94 judicial districts across the country ("UST districts"). In the six judicial districts in North Carolina and Alabama ("BA districts"), however, Congress continued to allow bankruptcy cases to be administered by Bankruptcy Administrators ("BAs"), which are a department of the Judicial Branch and overseen by the Judicial Conference.
In 2017, Congress sought to address funding problems with the UST program by enacting the 2017 Amendment, which raised the quarterly fees payable by large chapter 11 debtors in UST districts from a maximum of $30,000 per quarter per debtor to a maximum of $250,000 per quarter per debtor—an increase of more than 700%. In UST districts, the 2017 Amendment's fees took effect in both new and pending chapter 11 cases on January 1, 2018. However, in the six BA districts, the fees did not take effect until the Judicial Conference adopted them in September 2018. And even then, the Judicial Conference decided to apply the fees only prospectively for new chapter 11 cases filed after October 1, 2018. As a result, debtors whose cases were filed in a UST district prior to October 1, 2018, were required to pay significantly higher quarterly fees than they would have if their cases were pending in a BA district.
Several debtors in various UST districts who were required to pay the higher fees challenged the 2017 Amendment. Among their arguments was that by making debtors in UST districts pay significantly higher fees than similarly situated debtors in BA districts, the 2017 Amendment violated the Constitution's requirement that bankruptcy laws be geographically uniform throughout the country. The Fourth, Fifth, and Eleventh Circuits rejected the debtors' uniformity arguments, but the Second and Tenth Circuits agreed with the debtors and ordered a refund of fees. The Supreme Court granted certiorari in Siegel to resolve the circuit split.
In a 9–0 decision written by Justice Sotomayor, the Supreme Court determined that the 2017 Amendment violates Congress's constitutional authority under the "Bankruptcy Clause … to establish 'uniform Laws on the subject of Bankruptcies throughout the United States.' U. S. Const., Art. I, § 8, cl. 4" because while "[t]he Bankruptcy Clause affords Congress flexibility to 'fashion legislation to resolve geographically isolated problems,' … the Clause does not permit Congress to treat identical debtors differently based on an artificial funding distinction that Congress itself created." Siegel, 2022 WL 1914098 at *3, *8 (citation omitted).
In reaching this decision, the Court rejected the argument advanced by the UST that the fee increase was not a "law on the subject of Bankruptcies," and instead held (in agreement with all courts to have considered the question) that the 2017 Amendment affects the "'substance of debtor-creditor relations'" because "[i]ncreasing mandatory fees paid out of the debtor's estate decreases the funds available for payment to creditors." Id. at *6.
The decision also repudiated the UST's argument, embraced by some courts below, that the geographical disparity was justified by the need to address a shortfall in UST funding that did not exist in BA districts. The Court noted that this difference "existed only because Congress itself had arbitrarily separated the districts into two different systems with different cost funding mechanisms, requiring Trustee Program districts to fund the Program through user fees while enabling Administrator Program districts to draw on taxpayer funds by way of the Judiciary's general budget." Id. at *8. The Court likewise rejected the UST's attempt to shift blame from Congress to the Judicial Conference for the unequal fee structure, noting that "prior to the 2021 amendment, the fee statute did not require the Judicial Conference to impose an equivalent increase. It is that congressional decision that led to the disparities at issue here." Id. at n. 2.
The Court's decision in Siegel brings finality to the question of whether the 2017 Amendment violates the uniformity requirement of the Bankruptcy Clause. However, the Court left open two key questions for future cases.
First, the Court's reasoning strongly suggested, but did not hold, that the dual UST/BA system for administering bankruptcy cases itself may violate the uniformity requirement. Future debtors could seek to challenge the dual system itself, which has been in place since 1986. However, a hurdle for any such challenges will be identifying a concrete way in which case administration by a UST is more or less beneficial than administration by a BA. Second, the Court declined to take up the UST's argument that, even if the law was unconstitutional, the appropriate remedy would not be a refund. Id. at *9. Observing that the court below "has not yet had an opportunity to address these issues or their relevancy to the proper remedy," the Court remanded this issue for further proceedings. Id.
Assuming the Fourth Circuit awards a refund, the practical impact of the decision is likely to be limited. For one, Siegel applies only to chapter 11 debtors in UST districts whose cases were pending before October 1, 2018, and who paid fees on disbursements exceeding $1 million. This is necessarily a limited group of debtors, many of whose chapter 11 cases may already have been closed. Moreover, Siegel permits those debtors to recover only excess fees charged between January 1, 2018 and March 31, 2021, when a new law imposing a uniform fee structure went into effect. Finally, even if a debtor is eligible for a refund, it will need to determine whether the costs of seeking a refund justify the amount of excess fees it would stand to recover. That calculus is unlikely to justify a refund in many cases. Still, for chapter 11 debtors in UST districts whose cases were pending before October 1, 2018, and who paid significant excess fees in a Circuit that permits a refund, Siegel could allow those debtors to recover some of the fees paid to the UST during the nonuniform period.
Two petitions for certiorari filed by the UST squarely raised the "remedy" question in seeking review of the decisions by the Second and Tenth Circuits, which had ordered refunds to debtors for excess fees paid during the period from January 1, 2018, through March 31, 2021, when the non-uniform fee schedule was in effect. See William K. Harrington, United States Trustee, Region 2, Petitioner v. Clinton Nurseries, Inc., No. 21-1123 (U.S. 2021); Office of the United States Trustee v. John Q. Hammons Fall 2006, LLC, No. 21-1078 (U.S. 2021).
On June 13, 2022, the Supreme Court issued a "Summary Disposition" of the John Q. Hammons petition that granted certiorari, vacated, and remanded for further consideration in light of Siegel. The Clinton Nurseries petition is still pending.
An earlier article discussing in more detail the chapter 11 fee structure and circuit court opinions addressing its constitutionality is available here.
Rulings on Certiorari Petitions in Other Bankruptcy Cases
Exceptions to Bankruptcy Discharge. On May, 2, 2022, the U.S. Supreme Court granted a petition for certiorari in Bartenwerfer v. Buckley, No. 21-908 (U.S. May 2, 2022), where it will have an opportunity to resolve a circuit split regarding whether a debt based on fraud committed by, or a false representation made by, the debtor's partner or agent is nondischargeable in the debtor's bankruptcy case. Under section 523(a)(2)(A) of the Bankruptcy Code, a discharge of debts under section 727 and parallel sections of other chapters of the Bankruptcy Code does not apply to "any debt … for money … obtained by … false pretenses, a false representation, or actual fraud."
Although liability for fraud committed by a partner or agent can be imputed to other partners or a principal, the circuits and lower courts have long disagreed as to whether a debtor must have some degree of scienter (i.e., the debtor knew or should have known of its partner's or agent's fraud or false representation) before the debt based on that liability is deemed nondischargeable in the debtor's bankruptcy. See generally Collier on Bankruptcy ¶ 523.08[3] (16th ed. 2022) (discussing cases beginning with the Supreme Court's decision in Strang v. Bradner, 114 U.S. 555 (1885), under the since-repealed Bankruptcy Act of 1867).
Mootness of Appeals. On June 6, 2022, the Court declined to review an Eleventh Circuit decision dismissing appeals of bankruptcy court orders disallowing through estimation a secured claim and confirming a chapter 11 plan under the doctrines of constitutional and equitable mootness. See KK-PB Financial LLC v. 160 Royal Palm LLC, No. 21-1197 (U.S. June 6, 2022).
However, on June 27, 2022, the Court granted a petition to review the Second Circuit's 2021 decision dismissing an appeal brought by Mall of America challenging the bankruptcy court's assignment of Mall of America's lease to an affiliate of Transform Holdco, the purchaser of bankrupt retailer Sears's assets. See MOAC Mall Holdings LLC v. Transform Holdco LLC (In re Sears Holdings Corp.), 2021 WL 5986997 (2d Cir. Dec. 17, 2021), cert. granted, No. 21-1270 (U.S. June 27, 2022). In its decision, the Second Circuit agreed with the district court below, which concluded that Mall of America's appeal was moot under section 363(m) of the Bankruptcy Code because it failed to obtain a stay of the bankruptcy court order approving the assignment.
Both of these cases involve different types of "mootness" that arise frequently in bankruptcy appeals. Mootness is a doctrine that precludes a reviewing court from reaching the underlying merits of a controversy. An appeal can be either constitutionally, equitably, or statutorily moot. The KK-PB Financial case involved constitutional and equitable mootness. Constitutional mootness is derived from Article III of the U.S. Constitution, which limits the jurisdiction of federal courts to actual cases or controversies and, in furtherance of the goal of conserving judicial resources, precludes adjudication of cases that are hypothetical or merely advisory.
The court-fashioned remedy of "equitable mootness" bars adjudication of an appeal when a comprehensive change of circumstances has occurred such that it would be inequitable for a reviewing court to address the merits of the appeal. In bankruptcy cases, appellees often invoke equitable mootness as a basis for precluding appellate review of an order confirming a chapter 11 plan that has been "substantially consummated."
An appeal can also be rendered moot (or otherwise foreclosed) by statute—the issue presented in Sears Holdings. For example, sections 363(m) and 364(e) provide that a bankruptcy court order approving an asset sale to a good-faith purchaser or postpetition financing provided by a good-faith lender, respectively, cannot be reversed or modified on appeal absent a stay of the order pending the appeal. Sears Holdings involves the application of section 363(m) to the lease assignment transaction at issue.
Standard for Imposing Contempt Sanctions. On June 13, 2022, the Court denied a petition for review of a 2021 decision in which a divided panel of the U.S. Court of Appeals for the Second Circuit ruled that the "fair ground of doubt" standard articulated by the Court in Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), for imposing contempt sanctions due to a violation of the bankruptcy discharge injunction, also applied to contempt sanctions imposed for repeated violations of bankruptcy court orders declaring a home mortgage current. See PHH Mortgage Corp. v. Sensenich (In re Gravel), 6 F.4th 503 (2d Cir. 2021), petition for cert. denied, No. 21-1322 (U.S. June 13, 2022).
In a decision discussed elsewhere in this edition of the Business Restructuring Review—Beckhart v. Newrez LLC, 2022 WL 1122534 (4th Cir. Apr. 15, 2022)—the Fourth Circuit ruled that "Taggart also applies when a court is considering whether to hold a creditor in civil contempt for violating a plan of reorganization of debts entered under Chapter 11." More broadly, the Fourth Circuit wrote, "Nothing about the Supreme Court's analysis in Taggart suggests it is limited to violations of Chapter 7 discharge orders … or that the Court's decision turned on considerations unique to the Chapter 7 context."
