Fruit Of A Rotten Tree: Bankruptcy Administrator Districts And U.S. Trustee Districts (Siegel v. Fitzgerald)

A healthy tree? (photo by Marilyn Swanson)

Does a rotten tree produce good fruit?

That’s the bankruptcy issue before the U.S. Supreme Court in Siegel v. Fitzgerald, where the Question is this:

“Whether the Bankruptcy Judgeship Act violates the uniformity requirement of the Bankruptcy Clause by increasing quarterly fees solely in U.S. Trustee districts.”

Note:

The Siegel v. Fitzgerald question is NOT the main issue;
The main issue is this: whether the existence of a Bankruptcy Administrator system in two states and a U.S. Trustees system in 48 states violates the Constitution’s uniformity requirement; and
That’s a problem because the stated Question is like focusing on the fruit of a tree while ignoring that the tree’s trunk is rotten to the core.

Fortunately, one of the amici briefs in Siegel v. Fitzgerald focuses on the main issue, arguing that the two disparate systems have always been a constitutional problem—the fee-and-other disparities at issue are merely the fruit of that rotten tree.

What follows are summaries of portions of the argument made in the “Brief of Amici Curiae Acadiana Management Group, LLC.”

Beginnings—To Stop Cronyism

Before creation of the U.S. Trustee system, concern exists over “bankruptcy rings,” where judges appoint cronies as trustees, set their compensation, and then rule on disputes between their cronies and other parties to the bankruptcy.

To address this cronyism concern, Congress shifts the power to appoint trustees and committees from judges to U.S. Trustees. Congress wants to avoid both the appearance and possibility of a conflict of interest: it is for the express purpose of taking the power of appointment away from the courts, and giving it to the U.S. Trustees, that the new system begins.

The new system begins as a pilot program. When it proves successful, Congress makes the U.S. Trustee system permanent and amends the Bankruptcy Code to provide a comprehensive role for U.S. Trustees.

Crony System Holdouts—Alabama and North Carolina

Judges and politicians in Alabama and North Carolina don’t like the new system and want to retain the old crony system for appointing trustees.

So, these two states get Congress to exempt them from this horrible new thing—as an accommodation to judges in those states, who like and want to perpetuate the old crony system.

To keep the old crony system going, Alabama and North Carolina assign bankruptcy oversight to a Bankruptcy Administrator program under auspices and control of the courts. This allows them to keep intact the very type of cronyism that the U.S. Trustee system is designed to replace.

Successful Lobbying

Nobody, other than the judges and politicians in those two states, thought their crony ways were a good idea: a review by the GAO, for example, “could not find any justification for continuing two separate programs.”

Nevertheless, judges in the two states successfully lobby Congress to avoid being placed within the U.S. Trustees system.

The responsible politicians are, primarily, Senators Jesse Helms of North Carolina and Howell Heflin of Alabama. Their first steps are to get extensions of the deadline to become part of the U.S. Trustee system—and then they sneak a permanent exemption into an unrelated bill.

Here’s how they do it:

In 1997, the National Bankruptcy Review Commission (“NBRC”) considers two proposals to incorporate Administrator districts into the Trustee system—one calls for immediate conversion, and the other provides an October 1, 2002, deadline;
The NBRC rejects both proposals; and
A few years later, NBRC eliminates the deadline altogether—this grants the two states “a permanent exemption from the UST program” through “an unrelated law.”

Political Shenanigans

The political shenanigans for all of this include the following:

Judge James Hancock (N.D.Ala.) and Judge Thomas Milton Moore (E.D.N.C.), among others in those states, express dislike for the Trustee system; and
With the aid of Senator Heflin, they are successful in remaining exempt, “at the request of federal courts in Alabama and North Carolina.”

Here are some incestuous details. Jeffrey Hartley:

served as a Commissioner on the NBRC;
also served as Senator Heflin’s Campaign Coordinator in 1990; and
was appointed to the NBRC on Senator Heflin’s recommendation, while serving as law clerk to a bankruptcy judge in Alabama.

It is “a North Carolina congressman” who “tucked” the “permanent exemption” into an unrelated bill. Ironically, the Justice Department at the time (i) recognizes the uniformity issue, and (ii) observes that the section of the unrelated bill eliminating the deadline for Alabama and North Carolina “is not referenced in the table of contents.”

Cronyism Continues

In the Administrator districts, to this day, the courts (rather than U.S. Trustees) appoint interim trustees in chapter 7 cases and trustees in chapter 11, 12 and 13 cases and appoints committees in chapter 9 and chapter 11 cases.

Moreover, (i) once a trustee is appointed by a court in Administrator districts, that trustee can be removed only “for cause,” and (ii) bankruptcy judges approve the budgets of their appointee standing chapter 13 trustees.

Further, in Administrator districts:

the system is under the Judiciary—chief judges of the circuit courts of appeals in Alabama and North Carolina appoint the bankruptcy administrators, who then act under supervision of the respective Eleventh and Fourth Circuits; and
general monitoring and comment responsibilities over bankruptcy cases are handled by the Bankruptcy Administrator—who is appointed by a judge.

U.S. Trustees Contrast

By Contrast, the Trustee system exists under the Executive Branch, as a component of the Department of Justice. U.S. Trustees:

handle trustee and committee appointments;
supervise the administration of cases and trustees in cases;
monitor plans and disclosure statements in Chapter 11 cases and file comments thereon;
perform similar tasks in cases under chapters 12 and 13;
monitor creditors’ committees; and
act to prevent undue delay.

Creditor Recovery Differences

Creditor recoveries differ between the two systems:

Of the funds generated from Chapter 7 cases in 1990-1991, unsecured creditors received 21% in Trustee districts, compared to 14% in Administrator districts;
Debtors have been subjected to non-uniform fees between the two systems, which disparity directly affects the funds available for creditors in each system;
Under the quarterly fee scheme, Chapter 11 debtors in Trustee districts have been charged as much as 733% more than their identically situated counterparts in Administrator districts;
Fee increases in Trustee districts, which easily doubled collections, was borne by about 10 percent of chapter 11 cases; and
A GAO Report concludes that U.S. Trustee programs are on average 22% more expensive to operate than comparable Administrator programs.

Illustrating how/why that is:

Chapter 11 debtors in W.D.N.C., who filed before October 1, 2018, had a dramatically reduced quarterly fee schedule than identically situated debtors in Trustee districts; and
One debtor filed Chapter 11 on November 2, 2017, having domiciled in North Carolina months before filing—its Monthly Reports reflect quarterly fees for 2018 and comparable fees for identically situated debtors in Trustee districts as follows:

Admin. Fees / UST Fees in 2018

$ 9,750 / $20,188.99

$13,000 / $68,381.24

$13,000 / $60,163.23

$13,000 / $84,971.74

This Administrator district debtor paid quarterly fees in 2018 totaling $48,750. Had it filed in a Trustee district, its quarterly fees for 2018 would have totaled $233,705.20 instead.

Forum Shopping

The systemic distinctions between the U.S. Trustee and Administrator systems have led to a series of debtor favorable decisions in the Western District of North Carolina, into which debtors now openly maneuver.

The fee disparities noted above provide additional motivation to establish venue in Administrator districts

Accordingly, the systemic non-uniformity has encouraged corporate debtors to engage in the very type of forum shopping that the Constitution’s Bankruptcy Clause was designed to prevent.

Conclusion

How can the fruit of a tree be constitutionally acceptable, when the trunk of that same tree is constitutionally rotten to the core?

Hopefully, the U.S. Supreme Court will go beyond the limited Question presented in Siegel v. Fitzgerald and address the main issue head-on!

Oral arguments occurred in Siegel v. Fitzgerald on Monday (April 18, 2022)–the transcript of such arguments appears here. Based on comments by the Justices, it appears unlikely they find anything constitutionally deficient about the rotten tree.

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