U.S. Trustee & Bankruptcy Administrator Programs: Is This Constitutional? (St. Angelo v. Victoria / In re Buffets)

Bankruptcy courts in 48 of our 50 United States are administered by the U.S. Trustee program; while bankruptcy courts in the remaining 2 states (Alabama and North Carolina) are under the Bankruptcy Administrator program. This has been true since the 1980s.

The primary differences in the two programs are:

The U.S. Trustee program is under the Department of Justice and is funded by quarterly fees paid by Chapter 11 debtors; while
The Bankruptcy Administrator program is under the Judicial Conference and is funded by the general budget of the federal judiciary.

The Obvious Question

How can this 48 / 2 split be acceptable under the uniformity requirement of of the U.S. Constitution?

Here’s what the Constitution says:

“The Congress shall have Power … To establish . . . uniform Laws on the subject of Bankruptcies throughout the United States.”

So . . . what is “uniform” about the 48 / 2 split?

Declared Unconstitutional in 1995: Ninth Circuit (St. Angelo v. Victoria)

The opinion is St. Angelo v. Victoria Farms, Inc., 38 F.3d 1525, 1533 (9th Cir. 1994), with minor amendments at 46 F.3d 969 (9th Cir. 1995).

Victoria Farms argues that the U.S. Trustee program and the fee system which supports it are unconstitutional as not “uniform”: the U.S. Trustee program has not been implemented in Alabama and North Carolina.

–Some History

In 1978, Congress piloted the U.S. Trustee program in 18 judicial districts to:

alleviate administrative burdens faced by bankruptcy judges; and
eliminate appearances of favoritism arising from close relationships and “cronyism” between judges and trustees.

The success of the pilot program resulted in Congress establishing a permanent national program in 1986. Congress phased the program in over two years—for every state except Alabama and North Carolina. Here’s what happened:

Alabama and North Carolina could vote on implementing the U.S. Trustee program by October 1, 1992; but
In 1990, Congress extended that implementation deadline for Alabama and North Carolina by a decade—to October 1, 2002 (Congress gave no explanation).

A 1992 GAO report explains, (i) the “impetus” for the Administrator program in Alabama and North Carolina was “their extreme dissatisfaction with the operation of the pilot program in the Northern District of Alabama,” (ii) absolutely no explanation can be found for Congress’s ten-year extension in 1990, and (iii) the Administrator program should not have “the appearance of permanence.”

–Unconstitutionality Ruling

The Ninth Circuit held that the statute allowing a separate status for Alabama and North Carolina is unconstitutional. Here is its reasoning.

The Uniformity Clause requires that bankruptcy laws enacted by Congress be geographically uniform.

While a bankruptcy law may have differing effects in differing states, based on dissimilarities in state law, it is a federal law that creates the special treatment for Alabama and North Carolina.

Congress may enact non-uniform laws to deal with geographically isolated problems, as long as the law operates uniformly. Examples upheld by the Supreme Court include:

A bankruptcy statute allowing railroad reorganization in one region is ok because no railroad reorganization was pending outside that region—i.e., the law “operates uniformly upon all bankrupt railroads”;
Regional laws are ok, as long as the laws apply uniformly to defined classes of debtors; and
A tax on ships in all ports is ok, under a different uniformity standard, even if other modes of conveyance are not taxed.

Under any standard of review, however, Congress’s discrimination in favor of Alabama and North Carolina, without any justification, is irrational and arbitrary.

Congress’s Response

In response, Congress empowers the Judicial Conference to set fees in Administrator districts “equal to those imposed” in U.S. Trustee districts, which fees offset judicial branch appropriations.

Then, a North Carolina congressman tucks a permanent exemption from the U.S. Trustee program, for Alabama and North Carolina, into an unrelated bill during the November 2000 lame duck session.

Subsequent Developments

All seems well with the two systems until the mid-2010s, when a decline in bankruptcy filings means the U.S. Trustee program is no longer self-sustaining. So, Congress increases the quarterly fees in Chapter 11 cases in 2017. The increase is:

Temporary—only applying during the fiscal years from 2018 through 2022;
Conditional—only kicks in if the Trustee System Fund’s balance is less than $200 million “as of September 30 of the most recent full fiscal year”;
For large cases—only applies to debtors with disbursements of $1 million or more in a single quarter; and
Substantial—a Chapter 11 debtor, who would previously pay a quarterly fee of $30,000, will now pay a quarterly fee of $250,000.

The 2017 increase applies immediately to all cases in the U.S. Trustee program, including those cases already on file. But the Administrator program waits until September 2018 to adopt the increased fees and applies them only to cases filed after October 1, 2018.

Declared Constitutional (over dissent) in 2020: Fifth Circuit (In re Buffets)

The opinion is Hobbs v. Buffets, L.L.C. (In re Buffets, L.L.C., dba Old Country Buffet), Case No. 19-50765 (5th Cir., decided November 3, 2020), with a strong dissent.

–Facts

Buffets, L.L.C. and affiliates operate buffet-style restaurants like Old Country Buffet and Ryan’s Family Steakhouse.

In 2016, Buffets files Chapter 11 in the Western District of Texas, which is under the U.S. Trustee program. The bankruptcy court confirms Buffets’ plan in 2017. But the bankruptcy is still pending in 2018 when the new fees go into effect.

In each of the first three quarters of 2018, Buffets reports over $1 million in total disbursements, and the U.S. Trustee assesses increased quarterly fees of $250,000 (instead of $30,000 under the prior law). Buffets refuses to pay, on several grounds.

The Fifth Circuit upholds the validity of the new fees for Buffets.

–Uniformity Rationale

On the Constitution’s uniformity issue, the Fifth Circuit explains as follows.

The Constitution grants Congress the power to establish “uniform Laws on the subject of Bankruptcies throughout the United States.” U.S. Const. art. I, § 8, cl. 4.7.

Unfortunately, the Bankruptcy Clause “might win” a “contest for least-studied part” of Article I’s congressional powers:

Although disputes over debtor-creditor relations were an impetus for the Constitutional Convention, the Bankruptcy Clause received “meager” attention in Philadelphia;
The federal bankruptcy power is directly mentioned in only one of 85 essays that make up The Federalist Papers—by James Madison, who merely notes that “the expediency of it seems not likely to be drawn into question”;
Paradoxically, the uncontroversial nature of the Bankruptcy Clause at its inception has led to uncertainty about its meaning today; and
Uniformity in particular “has defied principled interpretation since its adoption and continues to be a source of analytical confusion.”

We find no uniformity problem. Uniformity:

is not a straightjacket that forbids Congress to distinguish among classes of debtors;
does not bar every law that allows for a different outcome depending on where a bankruptcy is filed;
allows the use of state law to decide which property is exempt from creditors; and
permits a bankruptcy court to lift a foreclosure stay, based on economic conditions “in its locality.”

Only once has the Supreme Court overturned a bankruptcy law for lack of uniformity: the law applied to only one debtor.

The uniformity requirement forbids only “arbitrary regional differences in the provisions of the Bankruptcy Code.” Congress may take into account differences that exist between different parts of the country and fashion legislation to resolve geographically isolated problems.

On the 48 / 2 issue, Congress confronted the problem of underfunding where it found it: in the Trustee districts. It drew a program-specific distinction that only indirectly has a geographic dimension.

While a Chapter 11 debtor in Texas may have to pay more than a debtor in North Carolina, that is not an arbitrary distinction based on the residence of the debtor or creditors: it is because of the Texas debtor’s use of the U.S. Trustee program.

In the recent fee increase, Congress gives a justification: the need to ensure that the Trustee Program remains funded by users of the bankruptcy court rather than taxpayers.

Such a justification passes constitutional muster, the Fifth Circuit declares.

The Fifth Circuit Dissent

The In re Buffets dissent challenges the majority’s “passes constitutional muster” conclusion, based on the Constitution’s uniformity requirement. Here is the dissenting rationale.

The Constitution authorizes Congress to establish “uniform Laws on the subject of Bankruptcies throughout the United States.” U.S. Const. art. I, § 8.

We currently have two systems, one of which is more expensive for debtors than the other, and the sole factor that determines into which system a debtor is placed is the state in which the debtor files for bankruptcy.

The two systems are not a uniform law on the subject of bankruptcies.

The majority explains that the difference between the fees charged to Buffets and the lower fees charged in Alabama and North Carolina is explained by the different programs:

If there is a shortfall in the UST Program fund, the majority reasons, it’s not arbitrary or irrational to increase fees only in UST districts.

However, the majority’s analysis ends too soon. It:

explains that the higher fees for “a debtor in Texas” are “a product of the Texas debtor’s use of the Trustee”; but
fails to address why the Texas debtor is required to use the Trustee in the first place, when Alabama and North Carolina debtors get to use the less-expensive Administrators; and
relies on a flawed tautology—Congress can justify treating bankrupts differently because it has chosen to treat them differently.

Here’s the problem: the sole reason Alabama and North Carolina are treated differently is regional political influence.

The two programs are not a uniform law and violate the U.S. Constitution’s Bankruptcy Clause.

Conclusion

It will be interesting to see how this plays out.

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