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U.S. Supreme Court Bankruptcy Roundup

Supreme Court to Resolve Circuit Split on Constitutionality of U.S. Trustee Fee Hike

This Term, the U.S. Supreme Court accepted certiorari in Siegel v. Fitzgerald (In re Circuit City Stores, Inc.), 996 F.3d 156 (4th Cir. 2021), cert. granted, No. 21-441 (U.S. Jan. 10, 2022), in order to resolve the growing circuit split over the constitutionality of the 2017 amendment to 28 U.S.C. § 1930(a)(6) ("2017 Amendment"), which greatly increased quarterly fees charged by the United States Trustee ("UST") in large chapter 11 cases. The 2017 Amendment, enacted initially as a temporary measure as part of a large appropriations bill to redress projected UST budget shortfalls, replaced the prior scale that capped quarterly fees at $30,000 for disbursements over $30 million with a new scale that assessed a 1% fee on disbursements of $1 million or more up to a cap of $250,000 for quarterly disbursements of at least $25 million. See Additional Supplemental Appropriations for Disaster Relief Requirements Act, 2017, at Division B, Bankruptcy Judgeship Act of 2017, Pub. L. No. 115-72, § 1004, 131 Stat. 1224, 1232 (Oct. 26, 2017).

In the 88 judicial districts ("UST districts") that are part of the UST program (a division of the U.S. Department of Justice, part of the Executive Branch), the UST charged the increased quarterly fees in both new and pending cases effective January 1, 2018. However, in the six North Carolina and Alabama judicial districts ("BA districts") with Bankruptcy Administrators ("BAs") overseeing the administration of bankruptcy cases (managed by the Administrative Office of the United States Courts, and supervised by the Judicial Conference of the United States, part of the Judicial Branch), the Judicial Conference did not adopt the fee increase until September 2018, and then only for new cases filed on or after October 1, 2018.

While the 2017 Amendment has also been challenged on statutory retroactivity, due process, and excessive user fee grounds, the sole issue currently pending before the Supreme Court is whether the disparity in quarterly fees for cases filed before October 1, 2018, based on the judicial district in which a debtor's case was pending, violates Congress's constitutional authority to "establish … uniform Laws on the subject of Bankruptcies throughout the United States." U.S. Const. art. I, § 8, cl. 4 ("Bankruptcy Clause"). To date, five federal circuit courts of appeals have addressed this important constitutional issue with respect to the 2017 Amendment, each on a direct appeal from the bankruptcy court.

The Circuit Split. In both the Fourth and Fifth Circuits, a majority of a three-judge panel upheld the 2017 Amendment on the basis that the fees were uniform within UST districts and within BA districts, while a dissenting judge objected on the basis that the lack of nationwide geographical uniformity violated the Bankruptcy Clause. See Siegel, 996 F.3d 156; Hobbs v. Buffets, L.L.C. (In re Buffets, L.L.C.), 979 F.3d 366 (5th Cir. 2020).

The Second Circuit weighed in next, where a three-judge panel unanimously rejected the rationale adopted by the majority in Siegel and Hobbs, and held that the 2017 Amendment "was unconstitutionally nonuniform on its face" because it mandated a fee increase in UST districts but only permitted a fee increase in BA districts. See In re Clinton Nurseries, Inc., 998 F.3d 56, 70 (2d Cir. 2021), cert. pending sub nom. Harrington v. Clinton Nurseries, Inc., No. 21-1123 (U.S. Feb. 14, 2022). The government sought rehearing en banc of the Second Circuit's Clinton Nurseries decision, which was denied in September 2021.

In October 2021, the majority of a split Tenth Circuit panel joined the Second Circuit in holding that the 2017 Amendment is impermissibly nonuniform because the same fees were not required in BA districts by the terms of the 2017 Amendment. See John Q. Hammons Fall 2006 LLC v. U.S. Trustee (In re John Q. Hammons Fall 2006 LLC), 15 F.4th 1011 (10th Cir. 2021), cert. pending sub nom. Office of the United States Trustee v. John Q. Hammons Fall 2006, LLC, No. 21-1078 (U.S. Feb. 2, 2022). The short dissent in John Q. Hammons took the position that the debtor's challenge to geographically nonuniform fees should be rejected because the debtors challenged only the 2017 Amendment, and not the dual UST/BA system as a whole.

In January 2022, an Eleventh Circuit panel found the 2017 Amendment constitutional, based not on the rationale expressed in Buffets and Siegel (uniformity within UST districts and within BA districts), but on its view that the Judicial Conference's decision not to increase the fees in BA districts until the fourth quarter of 2018 (and then only prospectively) did not render the 2017 Amendment violative of the uniformity requirement of the Bankruptcy Clause. See United States Trustee Region 21 v. Bast Amron LLP (In re Mosaic Mgmt. Grp., Inc.), 22 F.4th 1291 (11th Cir. 2022). In a separate concurrence, one judge agreed with the Second and Tenth Circuits that the 2017 Amendment was unconstitutionally nonuniform but found that refunding fees in the UST districts would be "at odds with Congress's intent" and therefore concurred in the result. In re Mosaic, 22 F.4th at 1330.

In addition to these circuit court decisions, appeals raising challenges to the 2017 Amendment on uniformity and other grounds are pending in the Federal Circuit, the Sixth Circuit, and the Ninth Circuit.

Against this backdrop, the sole question presented to the Supreme Court in Siegel is straightforward: "Whether the [2017 Amendment] violates the uniformity requirement of the Bankruptcy Clause by increasing quarterly fees solely in U.S. Trustee districts." Yet to answer this question, courts have had to closely examine both the history of the 2017 Amendment and the history of the UST program itself, because the divergence in fees being paid by debtors in UST districts and BA districts under the 2017 Amendment is traceable to Congress's decision to permit North Carolina and Alabama to remain outside the UST program.

The 2017 Amendment. As noted above, Congress enacted the 2017 Amendment as part of the Bankruptcy Judgeship Act of 2017 to address a shortfall in the UST's budget. Under the 2017 Amendment, the revised fee regime of 28 U.S.C. § 1930(a)(6) was supposed to be both temporary (sunsetting in 2022) and conditional, replacing the prior fee structure only if the balance in the UST System Fund at the beginning of the then-current fiscal year was less than $200 million. The 2017 Amendment was silent on whether it applied to pending cases and made no change to the statutory language governing fees in BA districts set forth in 28 U.S.C. § 1930(a)(7), which from its inception provided: "the Judicial Conference of the United States may require the debtor in a case under chapter 11 of title 11 to pay fees equal to those imposed by paragraph (6) of this subsection." See 28 U.S.C. § 1930(a)(7) (emphasis added).

As noted above, debtors in UST districts with pending cases were assessed the quarterly fees under the new scale effective January 1, 2018, while in BA districts, only debtors filing new chapter 11 cases on or after October 1, 2018, became subject to the 2017 Amendment's increased fees.

Although the 2017 Amendment was enacted as a temporary and conditional measure, when it became clear the UST System Fund surplus was projected to exceed $200 million the following year, annual amendments to 28 U.S.C. § 1930(a)(6) were passed by Congress as part of year-end budget bills to increase the required surplus needed to trigger reversion to the pre-2017 Amendment fee schedule. See Consolidated Appropriations Act, 2020, Pub. L. No. 116-93, § 219 (Dec. 20, 2019) (substituting $300 million for $200 million as the surplus threshold); Consolidated Appropriations Act, 2021, Pub. L. No. 116-260, § 218 (Dec. 27, 2020) (same).

In an overhaul of the 2017 Amendment signed into law in January 2021, Congress included amendments to be in effect through 2026 to both: (i) 28 U.S.C. § 1930(a)(6), which replaced the fee schedule of the 2017 Amendment with a new fee schedule no longer tied to the level of surplus in the UST System Fund; and (ii) 28 U.S.C. § 1930(a)(7), by changing the word "may" to "shall" to mandate that the new fees take effect in BA districts. See Bankruptcy Administration Improvement Act of 2020, S. 4996 (116th Cong.), Pub. L. No. 116-325 (2021) ("2021 Amendment"). Congress expressly dictated that the 2021 Amendment's terms should apply to new and pending cases beginning with the quarter after its enactment, i.e., the second quarter of 2021. Therefore, because the 2021 Amendment replaced the 2017 Amendment and amended the language of 28 U.S.C. § 1930(a)(7) governing fees in BA districts, the Supreme Court's resolution of the issue presented in Siegel will not impact quarterly fees paid by debtors from the second quarter of 2021 forward.

The Dual UST/BA System. The discrepancy in fees paid under the 2017 Amendment by debtors with cases pending in UST districts and in BA districts is rooted in the dual UST/BA system, which itself is a vestige of history and a product of politics. Prior to 1978, bankruptcy judges or "referees" both adjudicated and administered bankruptcy cases. In order to separate the judicial and administrative role, Congress in 1978 created the UST within the Department of Justice as a pilot program in 19 judicial districts to perform the administrative functions previously performed by bankruptcy judges. See Bankruptcy Reform Act of 1978, Pub. L. No. 95–598, § 224, 1978 U.S. Code Cong. & Admin. News (92 Stat.) 2549, 2662–65 (codified at 28 U.S.C. §§ 581 et seq.) (amended 1986).

In 1986, Congress decided to fully implement the UST program. See Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act of 1986, Pub. L. No. 99-554, 100 Stat. 3088, 3090-95 (Oct. 27, 1986) ("1986 Act"). But the 1986 Act implemented the UST program in only 48 states—Alabama and North Carolina were not required to join the UST program immediately. Id. § 302(d)(2)-(3), 100 Stat. at 3119–23. In those two states, the administrative functions of bankruptcy cases were performed by Bankruptcy Administrators, a program operated and overseen by the Judicial Branch. Id. Secondary sources from the time period explained that the different treatment was the product of political pressure from those states due to issues with the pilot program in the Northern District of Alabama. See U.S. Gov't Accountability Office, GAO/GGD-92-133, Bankruptcy Administration: Justification Lacking for Continuing Two Parallel Programs 14 (1992) (noting that bankruptcy judges' and BA program officials' "extreme dissatisfaction" with the UST pilot program led to different treatment).

Still, the 1986 Act required Alabama and North Carolina to implement the UST program by 1992. See 1986 Act, § 302(d)(3), 100 Stat. at 3121–23. Two years before the 1992 deadline, however, Congress enacted the Judicial Improvements Act of 1990, Pub. L. No. 101-650, § 317, 104 Stat. 5089 (Dec. 1, 1990), which extended the deadline by 10 years, to 2002. Contemporaneous commentators explained the decision was again due to political lobbying. Dan J. Schulman, The Constitution, Interest Groups, and the Requirements of Uniformity: The United States Trustee and the Bankruptcy Administrator Programs, 74 Neb. L. Rev. 91, 123 (1995) ("Bankruptcy judges in both states successfully lobbied Congress, most particularly Senators Helms [North Carolina] and Heflin [Alabama], to avoid being placed within the United States Trustee program.").

Originally, the chapter 11 quarterly fee provision was adopted specifically for UST districts as part of the 1986 Act to help fund the UST program. See 28 U.S.C. § 1930(a)(6). Because the UST program was not implemented in Alabama or North Carolina, debtors in those states were not required to pay the quarterly fees imposed by section 1930(a)(6). Instead, the BA program was financed by funds from the Judicial Branch. As a GAO study noted in 1992, fees under this arrangement were thus "not uniform" because "[d]ebtors in the UST and BA districts pay the same fees when filing for bankruptcy, but Chapter 11 debtors in BA districts are not subject to the additional quarterly fee that is levied on Chapter 11 debtors in UST districts." U.S. Gov't Accountability Office, GAO/GGD-92-133, at 11.

This discrepancy in fees payable by chapter 11 debtors gave rise to a constitutional challenge. In 1994, the Ninth Circuit ruled that the dual fee structure violated the Constitution's requirement that bankruptcy laws be geographically uniform. See St. Angelo v. Victoria Farms, Inc., 38 F.3d 1525 (9th Cir. 1994), amended, 46 F.3d 969 (9th Cir. 1995); U.S. Const., art. I, § 8, cl. 4. The Ninth Circuit noted that a bankruptcy law "may have different effects in various states due to dissimilarities in state law as long as the federal law itself treats creditors and debtors alike." St. Angelo, 38 F.3d at 1531. However, the court explained, the dual fee structure did not pass this test because it was "federal law, rather than state law, that causes creditors and debtors to be treated differently in North Carolina and Alabama." Id.

Finding "no indication that the exemption in question was intended to deal with a problem specific to North Carolina and Alabama," and that it could not "discover such a purpose in the structure of the statute or the legislative history of [section 1930(a)(6)]" (id. at 1530), the Ninth Circuit held that "because creditors and debtors in states other than North Carolina and Alabama are governed by a different, more costly system for resolving bankruptcy disputes," the dual fee structure violated the Bankruptcy Clause's uniformity requirement. Id. at 1531–32. Since the dual fee structure was the direct result of Congress's extension until 2002 of the exemption for North Carolina and Alabama to join the UST system, the Ninth Circuit determined that the "constitutional infirmity in question may be remedied simply by striking down section 317(a)" of the Judicial Improvements Act of 1990, which permitted the BA districts to opt out of the UST system. Id. at 1533.

In 2000, Congress addressed the dual fee system found unconstitutional in St. Angelo. But rather than abolish the BA program, as St. Angelo had contemplated, Congress: (i) amended 28 U.S.C. § 1930 to eliminate the oft-extended requirement that the six judicial districts in North Carolina and Alabama become UST districts; and (ii) simultaneously enacted 28 U.S.C. § 1930(a)(7) to provide that "the Judicial Conference of the United States may require the debtor in a case under chapter 11 of title 11 to pay fees equal to those imposed by paragraph (6) of this subsection." See Federal Courts Improvement Act of 2000, Pub. L. No. 106-518, § 105, 114 Stat. 2410, 2412 (Nov. 13, 2000) ("2000 Amendment").

The enactment of the 2000 Amendment did not automatically implement equal fees in UST districts and BA districts; rather, the dual fee structure persisted until the Judicial Conference in September 2001 approved a recommendation "that quarterly fees for chapter 11 cases in BA districts be imposed," and took action to have the BA districts collect quarterly fees in chapter 11 cases, effective April 1, 2002.

From 2002 until the first quarter of 2018, when the 2017 Amendment raised the cap by up to $220,000 for chapter 11 quarterly fees in UST districts, quarterly fees in the UST districts and the BA districts were uniform, eliminating any party's standing to raise the constitutional infirmity identified by the Ninth Circuit in St. Angelo. But given that the 2017 Amendment resurrected the dual fee structure for chapter 11 debtors with cases pending before October 1, 2018, based solely on whether their case was pending in a UST district or a BA district, the Supreme Court will have to resolve the circuit split over whether this dual fee structure violates the Bankruptcy Clause.

Moreover, since Congress rejected the St. Angelo remedy and instead elected to make the dual UST/BA system permanent, if the Court finds the 2017 Amendment to be unconstitutional, the Court would also have to address whether the proper remedy, as the Second and Tenth Circuits have found, would be to order a refund of any excess fees paid in the UST districts, or whether some other relief is appropriate. Similarly, while only the uniformity issue is currently teed up for review by the Court, unless the Court strikes down the 2017 Amendment for those debtors who paid excess fees, courts will have to continue to review challenges to the increased fees based on statutory retroactivity, due process, and excess user fee grounds. The petitioner's brief in Siegel was submitted on February 24, 2022, so those watching to see how the Court will resolve this rare challenge under the Bankruptcy Clause will not have to wait much longer.

Notable Supreme Court Denials of Petitions for Review

"Control Test" for Imputing Fraudulent Intent in Bankruptcy Avoidance Litigation. In Kirschner v. Fitzsimons, No. 21-1006, 2022 WL 516021 (U.S. Feb. 22, 2022), the Supreme Court denied a petition seeking review of a 2021 ruling by the U.S. Court of Appeals for the Second Circuit that largely upheld lower court dismissals of claims asserted by the chapter 11 liquidation trustee of media giant The Tribune Co. ("Tribune") against various shareholders, officers, directors, employees, and financial advisors for, among other things, avoidance and recovery of fraudulent and preferential transfers, breach of fiduciary duties, and professional malpractice in connection with Tribune's failed 2007 leveraged buyout ("LBO"). See In re Trib. Co. Fraudulent Conv. Litig., 10 F.4th 147 (2d Cir. 2021), cert. denied sub nom. Kirschner v. Fitzsimons, No. 21-1006, 2022 WL 516021 (U.S. Feb. 22, 2022).

In Trib. Co., the Second Circuit affirmed four district court rulings dismissing the liquidating trustee's claims against all of the defendants except two financial advisors alleged to have received fraudulent transfers in the form of fees paid in connection with the LBO. In so ruling, the Second Circuit adopted the "control test," rather than a "scope-of-employment agency" standard or a "proximate cause" standard, for determining whether the fraudulent intent of a company's officers can be imputed to its directors for the purpose of avoidance litigation.

Good Faith Defense to Fraudulent Transfer Liability in Bankruptcy Avoidance Litigation. In Citibank, N.A. v. Picard, No. 21-1059 (U.S. Feb. 28, 2022), the Supreme Court denied a petition seeking review of a 2021 ruling by the U.S. Court of Appeals for the Second Circuit in In re Bernard L. Madoff Investment Securities LLC, 12 F.4th 171 (2d Cir. 2021). In Madoff, the Second Circuit revived litigation filed by the Securities Investor Protection Act ("SIPA") trustee administering the assets of defunct investment firm Bernard L. Madoff Inv. Sec. LLC ("MIS") seeking to recover hundreds of millions of dollars in allegedly fraudulent transfers made to former MIS customers and certain other defendants as part of the Madoff Ponzi scheme. The court of appeals vacated a 2019 bankruptcy court ruling dismissing the trustee's claims against certain defendants because the trustee failed to allege that the defendants had not received the transferred funds in "good faith." 

The Second Circuit also reversed a 2014 district court decision in holding that: (i) "inquiry notice," rather than "willful blindness," is the proper standard for pleading a lack of good faith in fraudulent transfer actions commenced as part of a stockbroker liquidation case under SIPA; and (ii) the defendants, rather than the SIPA trustee, bear the burden of pleading on the issue of good faith. The ruling, which involved test cases for approximately 90 dismissed actions, breathed new life into avoidance litigation seeking recovery of $3.75 billion from global financial institutions, hedge funds, and other participants in the global financial markets.

Immediate Appeal of Chapter 15 Discovery Orders. In Estate of Omar Fontana v. ACFB Administração Judicial Ltda.-ME, No. 21-828 (U.S. Mar. 7, 2022), the Supreme Court denied a petition seeking review of a 2021 decision by the U.S. Court of Appeals for the Eleventh Circuit regarding the finality of a discovery order in a chapter 15 case. In In re Transbrasil S.A. Linhas Aéreas, 860 Fed. App'x 163 (11th Cir. 2021), the Eleventh Circuit held in a nonprecedential ruling that an order denying a request to quash a subpoena in the chapter 15 case of a Brazilian airline was not final and could not be appealed immediately because the order was "merely a preliminary step" in the context of a broader proceeding. In dicta, however, the Eleventh Circuit appeared to limit its ruling to the facts before it and noted that if the only purpose of the chapter 15 case is to obtain discovery, a discovery order may be final and immediately appealable because the discovery order is effectively the entire proceeding.

The Eleventh Circuit based its ruling on the "framework" established by the Supreme Court for determining the finality of bankruptcy court orders in Ritzen Grp., Inc. v. Jackson Masonry, LLC, 140 S. Ct. 582 (2020). In Ritzen, the Court held that "the adjudication of a motion for relief from the automatic stay forms a discrete procedural unit within the embracive bankruptcy case," which makes an order conclusively resolving such a motion appealable. Id. at 586. Applying that framework to a discovery order, the Eleventh Circuit in Transbrasil concluded that the bankruptcy court's order denying a motion to quash a subpoena in a chapter 15 case was not a final order because, unlike in Ritzen, it was not "discrete" or "separate" from the proceeding for which the discovery was sought. Instead, it was "merely a preliminary step" to obtain information that could be used to support claims against affiliates of the chapter 15 debtor in its Brazilian bankruptcy case and to enforce a Brazilian court order enjoining collection efforts in the United States. 

In so ruling, the Eleventh Circuit disagreed with a ruling by the U.S. Court of Appeals for the Second Circuit in In re Barnet, 737 F.3d 238 (2d Cir. 2013), where the court held that an order denying a motion to stay discovery sought by foreign representatives in a chapter 15 case was immediately appealable because, among other reasons, discovery under chapter 15 is "ancillary to a suit in another tribunal, such that there will never be a final resolution on the merits beyond the discovery itself." Id. at 244.

In Transbrasil, the Eleventh Circuit concluded that Barnet was both noncontrolling and distinguishable. First, it explained, in Barnet, the Second Circuit did not have the benefit of the Ritzen framework for examining the finality of bankruptcy court orders. Second, the court wrote, unlike in the case before it, "there is no indication in Barnet that any proceedings other than discovery were contemplated in that Chapter 15 case." Transbrasil, 860 Fed. App'x at 169.

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Jones Day represents MF Global Holdings Ltd., as plan administrator, in bankruptcy court and Second Circuit proceedings challenging the increased UST quarterly fees, including appearing as amicus curiae in Clinton Nurseries and as amicus curiae in Siegel before the Supreme Court.

Jones Day represents certain of the defendants in the Tribune fraudulent transfer litigation

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