Busted Debtors Go to Court Over 700% Hike in U.S. Bankruptcy Fee

(Bloomberg) -- A quirk in federal law made going bankrupt in Alabama and North Carolina cheaper than in any other state, spurring a lawsuit that says the government has been overcharging everywhere else and violating the Constitution.

The U.S. government increased the fees it charges the largest bankrupt companies for Chapter 11 filings by over 700 percent in 2017, but let debtors in those two states keep on paying the older and cheaper fees, according to a Louisiana hospital chain that sued on April 3. The vast discrepancy meant the federal government overcharged companies struggling with insolvency by about $155 million last year, according to the lawyer who filed the suit.

The court case, which seeks to be certified as a class action for an estimated 600 to 1,000 members, demands that the fee increase be declared unconstitutional and that the U.S. give refunds. The fees help fund the U.S. Trustee Program, a unit of the Department of Justice that serves as a watchdog over bankruptcies. A DOJ representative declined to comment on pending litigation.

The complaint has merit, according to Jared Ellias, an associate professor of bankruptcy law at the University of California Hastings, who cites a rationale that goes back to the 18th Century. The law required uniform fees to facilitate interstate commerce, Ellias said in an interview, because discrepancies in the bankruptcy code would make it possible for legislators in an agrarian state, for example, to pass laws that let farmers easily discharge debts they owed to New York bankers.

Constitutional Question

There’s also an unfair impact from applying the new fees to debtors who filed for bankruptcy before the increase was announced, Ellias said. “The effect of what they did is require debtors in Texas, for example, to fund the U.S. Trustee Program more than debtors in North Carolina and Alabama,” Ellias said. “That is probably unconstitutional.”

The disparate fees arose because the U.S. Trustee has jurisdiction in every state except Alabama and North Carolina, which never implemented the U.S. Trustee system and instead use bankruptcy administrators to oversee cases. The organization that supervises the bankruptcy administrators in those two states delayed implementing the fee increase until last October, and even then only applied the increase to new cases, thus creating the unequal fee structure, the lawsuit states.

Falling Fees

Due to a recent decline in bankruptcy filings, the amount of money collected by the Trustee Program fell dramatically, so the quarterly fee increase was necessary to keep the office funded, according to the fiscal year 2019 budget it submitted to Congress.

For some executives trying to save their companies, the spike in fees came at the worst possible time. “I was up to my neck in trying to reorganize a company and all of a sudden we had an extra $216,000 in fees extorted from us by the U.S. government,” said August J. Rantz IV, the president of Acadiana Management Group LLC, the lead plaintiff in the lawsuit. “You shouldn’t be doing one thing in one state and not the same in another.”

Acadania, a group of 12 hospitals that serve critically ill patients, filed for Chapter 11 protection in June 2017 in Louisiana and emerged from bankruptcy a year later, which meant that the health care company paid the higher fees for the first and second quarters of 2018. The suit estimates that was $216,784.69 more than if the case was handled in Alabama or North Carolina.

Sliding Scale

The fees on the previous schedule were on a sliding scale that, for example, charged $325 for disbursements by the debtor up to $14,999, and $30,000 for amounts over $30 million, according to the DOJ website.

Under new schedule, when the disbursements exceed $1 million, the fee is the lower of $250,000 or 1 percent of quarterly disbursements, which effectively amounts to a massive increase. Debtors who fail to pay on time can wind up with their cases dismissed or converted to a liquidation.

Without the fee increase, the U.S. Trustee estimated its annual revenue would be $139 million, according to the fiscal year 2018 budget it submitted to Congress. While the program also collects significant revenue from bankruptcy filing fees, the majority of its income comes from quarterly fees. With the fee increase, estimated revenue rose to $289 million, the 2018 budget stated.

“Why should you have to pay more to avail yourself of a legal remedy just because of where you live and for no other reason?” attorney Bradley Drell of the firm Gold Weems, who filed the suit, said in an interview. “It makes no sense that debtors in Alabama and North Carolina paid these reduced fees while everyone else in the rest of the country paid much larger fees.”

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