North Carolina Lawyers Weekly
A little-known quirk of bankruptcy law in North Carolina is garnering national attention as courts across the country debate whether the different treatment afforded debtors in the state’s bankruptcy courts violates the U.S. Constitution.
The issue was placed front and center in an April 29 opinion from the 4th U.S. Circuit Court of Appeals, where a divided panel weighed in on the constitutionality of a 2017 amendment to the U.S. Bankruptcy Code setting quarterly fees for debtors.
The case—just one of many filed across the country—laid bare the two distinct programs that operate the bankruptcy courts: the U.S. Trustee program, which 88 of the 94 judicial districts in the country participate in. The remainder of the districts—three in Alabama and three in North Carolina—operate under the Bankruptcy Administrator program, which is overseen by the Judicial Conference.
The two programs are funded via different sources—the Administrator program receives funding from the Judiciary’s general budget, while Trustee districts are funded by fees from Chapter 11 debtors—and a decline in bankruptcy filings has led to a funding shortage in the Trustee program.
In response, Congress enacted the 2017 amendment. It altered the quarterly fees formula and increased the fees due in large Chapter 11 bankruptcy cases for fiscal years 2018-2022 in Trustee districts. The fee increase was conditional and applied only to certain debtors, but it was a substantial change for those hit with the increase.
Initially, debtors in Administrator districts weren’t subjected to the increased quarterly fees. The Judicial Conference then adopted an amended fee schedule that took effect for petitions filed on or after Oct. 1, 2018.
Debtors in North Carolina and Alabama thus not only avoided the increased fees for a period of several months as compared to the Trustee districts, but the fees applied only to cases filed after Oct. 1, 2018, while Trustee debtors whose cases remain pending, regardless of when they were filed, must pay the increased fees.
The 4th Circuit case involved the Chapter 11 bankruptcy proceedings of Circuit City, which filed its Chapter 11 bankruptcy petition in 2008 in Virginia, a Trustee district. The company’s plan was confirmed in 2010, but its proceedings remained pending on January 2018, after the 2017 amendment took effect.
Although the Circuit City trustee initially paid the increased quarterly fees, he stopped after a bankruptcy court in Texas ruled that the 2017 amendment was unconstitutional because it created nonuniform bankruptcy laws—the constitution grants Congress the power to enact “uniform Laws on the subject of Bankruptcies throughout the United States”—and was unconstitutionally retroactive.
Over the objections of the U.S. trustee, the Virginia bankruptcy court agreed with Circuit City. The U.S. trustee appealed, and the 4th Circuit reversed.
“Although the Amendment may render it more expensive for some debtors in Virginia—as opposed to North Carolina or Alabama—to go through Chapter 11 bankruptcy proceedings, the 2017 Amendment does not draw an arbitrary distinction based on the residence of the debtors or creditors,” Judge Robert B. King wrote for the majority. “Instead, the distinction is simply a byproduct of Virginia’s use of the Trustee program.”
A ‘reasonable’ solution
The 4th Circuit leaned heavily for support on Matter of Buffets, L.L.C., where the 5th Circuit reversed the Texas bankruptcy court decision holding that the amendment was unconstitutional that spurred Circuit City to file suit.
As the 5th Circuit pointed out, “the Bankruptcy Clause forbids only ‘arbitrary’ geographic differences,” King noted.
“Congress was confronted here with a U.S. Trustee problem,” King wrote. “The 2017 Amendment drew a program-specific distinction that only indirectly has a geographic impact. … By increasing quarterly fees for large Chapter 11 bankruptcies in Trustee districts, Congress solved the shortfall in the program’s funding. The Administrator districts, which are funded by the judiciary’s general budget, did not face a similar financial issue. Because only those debtors in Trustee districts use the U.S. Trustees, Congress reasonably solved the shortfall problem with fee increases in the underfunded districts.”
Although the 9th Circuit observed in 1995 that the establishment of separate Trustee and Administrator districts was an “irrational and arbitrary” distinction for which Congress provided “no justification,” the 2017 amendment didn’t suffer from a similar shortcoming, the court said.
“Congress has provided a solid fiscal justification for its challenged action: to ensure that the U.S. Trustee program is sufficiently funded by its debtors rather than by the taxpayers,” King wrote. “Because the 2017 Amendment does not contravene the uniformity mandate of either the Uniformity Clause or the Bankruptcy Clause, we are constrained to reverse the bankruptcy court and resolve [the] appeal in favor of the U.S. Trustee.”
Change in the air?
The 4th Circuit reached a similar conclusion with regard to the issue of whether applying the new quarterly fees to pending bankruptcy cases was unconstitutionally retroactive.
“As the text of the 2017 Amendment indicates, Congress intended for the increased quarterly fees to apply to all Chapter 11 cases,” King wrote. The amendment has no retroactive effect because it doesn’t impair rights that a party possessed when it acted, increase a party’s liability for past conduct or impose new duties with respect to transactions already completed.
“The 2017 Amendment plainly applies only to future disbursements, which are triggered by a debtor’s conduct occurring after the law’s effective date,” King explained. “Although the Circuit City Trustee correctly posits that the Amendment increases the quarterly fees that large Chapter 11 debtors will pay, such debtors were reasonably expected to pay fees pursuant to some formula. Accordingly, we are also constrained to reject the Circuit City Trustee’s challenge to the [bankruptcy court’s] retroactivity ruling and resolve [the appeal] in favor of the U.S. Trustee.”
Judge A. Marvin Quattlebaum Jr. filed a dissent. A “faithful application” of the Bankruptcy Clause renders the statutory scheme permitting differently quarterly fees between the Trustee program and the Administrator programs unconstitutional, he wrote.
Some bankruptcy practitioners agree with Quattlebaum, finding the distinction between the two programs to be the heart of the problem—and not just with regard to the quarterly fees issue presented by the 2017 amendment.
In addition to the fiscal benefits provided to Alabama and North Carolina as Administrator districts, bankruptcy judges in these six districts appoint trustees in bankruptcy cases.
Travis Sasser, a bankruptcy attorney at the Sasser Law Firm in Cary, said he would support the expansion of the Trustee program into North Carolina to allow judges to focus on their adjudicative roles.
“That the bankruptcy judge assigned to a case appoints the Chapter 13 trustee raises the question about how impartial the judge can be in a dispute between their appointee and an opposing party,” Sasser said. “A similar question is raised when local rules, forms and procedures benefit the trustee to the detriment of opposing parties such as debtors and creditors.”
Cases remain pending in other courts, including California, challenging the 2017 amendment. Although the 4th and 5th Circuits reached similar conclusions (albeit both with dissenting opinions), a contrary ruling from another federal appellate panel could create a circuit split, setting the issue up for review by the U.S. Supreme Court.
The 37-page decision is In re Circuit City Stores Inc. The full text of the opinion is available online at nclawyersweekly.com.
