The United States Trustee Program (the “U.S. Trustee”) is a component of the Department of Justice responsible for overseeing the administration of bankruptcy cases.1 It is tasked with “promoting the integrity and efficiency of the bankruptcy system for the benefit of all stakeholders—debtors, creditors, and the public.”2 Because the U.S. Trustee is funded by fees paid largely by chapter 11 debtors based on disbursements made in their bankruptcy cases, the larger the disbursements, the larger the fees owed to the U.S. Trustee.3 Disputes regarding U.S. Trustee fees are infrequent (or at least infrequently litigated), but such a dispute was recently before the Delaware bankruptcy court. In that case, Judge Christopher S. Sontchi ruled that when a post-confirmation litigation trust makes distributions to creditors, those distributions are not considered debtor disbursements subject to payment of U.S. Trustee fees.4 In his ruling denying the U.S. Trustee’s motion to compel payment of the fees, Judge Sontchi expressed strong views regarding the “absurdity” of the U.S. Trustee’s efforts to try to collect fees in the situation before him.
The issue arose in the bankruptcy proceedings of Paragon Offshore and its affiliated debtors (the “Debtors”), whose chapter 11 plan of reorganization (the “Plan”) was confirmed back in 2017. As is typical of many large cases, the Plan contained a mechanism whereby the Debtors transferred claims against third parties to a litigation trust (the “Trust”). During the quarter when the assets were transferred to the Trust, the Debtors paid the U.S. Trustee fees in the amount of $250,000, the maximum amount required by statute.5 Recently, the Trust settled certain claims that it held for consideration of $90 million. When the Trust sought to disburse those settlement funds to creditors, the U.S. Trustee sought to collect additional fees of $250,000.
Judge Sontchi rejected the U.S. Trustee’s efforts to recover fees from the Trust. The Judge opined that caselaw is clear on the matter—the only distributions subject to fees were those made by or on behalf of a debtor, and the distributions made by the Trust were not being made by or on behalf of the Debtors. The Judge took particular offense with the effect that the payment of fees would have on creditors. In Judge Sontchi’s own words:
“I cannot stress enough how offensive I find the [U.S. Trustee]’s attempt to double, or triple6 collect its ‘tax.’ It would be hypocritical for a person’s whose livelihood depends on the taxation of his fellow citizens to suggest that taxation is, in and of itself, reprehensible. It is, of course, necessary. What is reprehensible is attempting to take money out of the pockets of creditors, which are already receiving a small recovery on their claims, multiple times for the same distribution.”7
Judge Sontchi also expressed his views about the potential rationale behind the U.S. Trustee’s actions:
“Unfortunately, the [U.S. Trustee] has been compelled to act as a tax collector, focused on increasing the coffers of the U.S. Treasury, perhaps, at times, in derogation of its original mission. In this case, it has led the [U.S. Trustee] to seek to impose a $250,000 tax on the creditors for the second time on payment of their claims (and perhaps the third time).”8
Needless to say, Judge Sontchi’s straightforward ruling is a positive one for creditors that are the beneficiaries of a liquidating trust, which has become a common tool in bankruptcy. If you have questions related to this situation, or creditor treatment or litigation trusts in bankruptcy generally, please don’t hesitate to reach out to John Ashmead (212-574-1366), Robert Gayda (212-574-1490), Catherine LoTempio (212-574-1632), Andrew Matott (212-574-1224), or your primary contact at S&K.