Defusing the UST Tax Bomb

Given the magnitude of these fees, minimizing “disbursements” is essential (of note, the UST fee more than doubles when a debtor exceeds $999,999 in disbursements, essentially taxing that marginal dollar at over 5,000%). Unfortunately, the statute creating the fees, 28 U.S.C. §1930, does not define the term “disbursement.” Instead, courts have expanded the definition of disbursement to mean any kind of asset transfer made by a debtor or on a debtor's behalf. As detailed in our earlier article, this can include intercompany transfers and applications of cash receipts to revolving loans, even when those funds are immediately available to be reborrowed.

Many mid-sized debtors utilize a multi-entity operating structure and use revolving loans to manage liquidity needs. A tax on the mere transfers of assets presents a real challenge to troubled companies with high velocity cash flows. Counting repayments of DIP financings as disbursements essentially taxes each dollar twice: first, when the funds are initially borrowed to pay debtor expenses, and again when cash receipts come in to repay the loan. And since a revolving DIP lender's “roll-up” of its prepetition debt is also deemed a disbursement, a third level of taxation is added to the same capital.

One way to avoid tax-triggering disbursements is to reduce the use of revolvers. Debtors may be able to save significantly by using term loans and pushing back against roll-ups. In turn, revolving lenders need to be thoughtful in how they structure DIP lending proposals in order to compete with term loans (which don't require applications against the loan as funds come into the estate, thus lowering the number of disbursements).

For example, in In re AcuSport Corp., Case No. 18-52736, Bankr. S.D. Ohio, the lenders agreed to cash collateral usage that was backstopped by a loan commitment if the debtor ran into liquidity issues (and had a fee similar to what would have been charged in a conventional roll-up). In exchange, the debtor agreed to deposit all cash receipts into a controlled account and the financing order granted all of the lenders' prepetition debt the same treatment as post-petition debt for purposes of plan confirmation (providing the lenders all of the cramdown protections they would have enjoyed had they rolled up their debt).

If lenders want to pursue roll-ups, ensuring the “takeout” or “full roll-up” (where a lender converts all outstanding prepetition debt into post-petition debt after the final hearing on the DIP financing) isn't counted as a disbursement can offer significant savings for debtors. Parties should clarify in the financing order that the “full roll-up” is affected by “deeming” the prepetition debt replaced by the post-petition loan documents (or, at the risk of drawing a UST objection, explicitly stating that the roll-up is not a disbursement under 28 U.S.C. §1930).

Even more exotic options exist: revolving lenders could create a “synthetic” borrowing base, whereby cash isn't immediately applied to reduce the loan balance but, so long as that cash is in a controlled account, is added back into availability. The lenders would compare the outstanding revolving loans against a typical borrowing base while also giving the debtors credit for cash on hand (but subject to the lenders' control). Although this creates additional interest expense for debtors (because they would be losing the benefit of interim repayments of the outstanding loan balance), it could offer a net advantage over the UST fees.

If multiple debtor entities plan to file, it may be worthwhile to structure any financing documents so that each debtor entity is a borrower and can have funds directly disbursed to it; that way, the debtors can minimize intercompany transfers that might be taxed as disbursements (in both directions). Alternatively, debtors could try to minimize the number of entities making disbursements (for example, having all operations run through a central debtor), though there is case law that suggests payments on behalf of a third party are counted a disbursements by the benefiting party, including situations where debtors take advantage of a centralized cash management system. Genesis Health Ventures, Inc. v. Stapleton, 402 F.3d 416 (3d Cir. 2005).

In short, with advance planning, lenders and debtors can work to reduce the new UST fees.

Timing the Market: Leveraging the Quarterly Cap

Although lenders and debtors can try to minimize disbursements in order to maximize recoveries for general unsecured creditors (as opposed to the UST), at some point, debtors will need to pay their bills and “incur” disbursements. However, because of the way the UST fee taxes disbursements, debtors can manipulate the timing of payments to minimize their fees.

Remember that there is a $250,000 cap on fees per calendar quarter. To the extent a debtor expects to have more than $25,000,000 in disbursements in any given quarter (for example, if there is a planned §363 sale that will pay secured creditors over $25 million with the proceeds scheduled for July 25), the debtor can see a significant savings by timing other major payments to fall within the same calendar quarter.

So, for example, if critical vendors need to be paid a large, recurring monthly payment, it may make sense to see if those creditors would be amenable to delaying receipt of June payments to fall within July. The net effect of that short delay would be that the payments to critical vendors would not be taxed at all, since the proceeds of the §363 sale would effectively max-out the debtor's quarterly cap.

Returning to the problem of revolving loan applications, timing payments can also play a role here. In many cases, the UST reviews the monthly operating reports of each debtor and may determine the fee attributable to the revolver by calculating the “net reduction” of the loan balance that month. Any net decrease in the balance is taxed as a disbursement (since the debtor has paid down the loan).

However, if the debtor shows a net increase in revolving loan balances, the UST may not charge the debtor for any disbursements related to the revolving loan, even if there have been intervening repayments and loan advances throughout the month. Timing payments and repayments of the revolving loan to minimize the amount of month-to-month balance changes (until the debtor is in a quarter where the UST fee will otherwise be at the maximum level anyway) can offer significant savings. The need for these accounting gymnastics are a direct result of a system that attempts to tax loans even though a cash rich (but balance sheet insolvent) debtor should only be taxed on the permanent reduction of its debts.

The Last Resort of Debtors: Litigation

Since the new fee schedule was put in place, we've seen no cases where the definition of disbursement or the magnitude of UST fees has been litigated at an appellate level. And perhaps there is good reason for that: debtors and lenders (and their legal and financial advisors) are not used to treating the United States Trustee as an adversary party, and existing case law has consistently endorsed a broad definition of “disbursement” under 28 U.S.C. §1930.

However, the existing case law is not particularly persuasive. For example, many cases rely on the legislative intent of the statute as a revenue-generating mechanism to justify a broad definition of the word disbursement. See, In re Pettibone Corp., 244 B.R. 906, 914-18 (Bankr. N.D. Ill. 2000) (finding that the legislative history shows that the UST fee program was intended to ensure the UST program was self-funding).

Yet an examination of the legislative history shows that Congress spent little, if any, time discussing the definition of disbursement, the application of the fees, or how fees would affect debtors. In fact, the only discussion on the scope of the law appears to justify limiting the impact of the fee change on small and mid-sized debtors: the House Report on the 2017 bill that increased the fees suggested that Congress believed the change would only affect “the largest [C]hapter 11 debtors (i.e., excluding small businesses)”. House Rep. No. 115-130 at 8 (2017).

Courts should take note that, instead of affecting only the largest of cases, the new fees are primarily being borne by small and mid-sized businesses, while the largest Chapter 11 debtors are using the $250,000 cap to keep their fees low relative to the size and complexity of their cases. For example, per the monthly operating reports filed in each case, the iHeartMedia, Inc. debtors are likely to pay $520,975 in quarterly fees for the quarter ending June 2018, based on $1.09 billion in disbursements, an effective tax rate of .048%; PenAir will be asked to pay 1% of its $17,607,993 in disbursements during that period. Clearly the current definition of disbursement is not adequate in placing the burden on only the largest of debtors.

Litigants should also point out that, when read together, the existing case law sets forth an absurd result: any transfer of assets away from a debtor would be taxed as a disbursement; even inventory being sold by the debtor in the ordinary course of business. Surely Congress did not intend for regular sales by a debtor to be taxed at 1%, yet that is exactly how the case law reads.

For instance, the Eleventh Circuit has held that a company that makes consumer loans can be taxed on its ongoing retail business: each loan made was a disbursement, notwithstanding the lower court noting that “Congress did not intend the Trustee's fees to be based, in part, on the gross volume of Cash Cow's business just because Cash Cow was in the business of lending money.” Cash Cow Services of Florida LLC v. United States Trustee, 296 F.3d 1261 (11th Cir. 2002). So, under 28 U.S.C. §1930, the fact that a disbursement is part of a sale to a customer does not differentiate that exchange from other disbursements. Worse yet, an intercompany loan from Debtor A to Debtor B could be a “disbursement” from A to B, and another when repaid by B to A, and a third when A uses the funds to repay its DIP loan.

Other courts have held that a “disbursement” is not limited to payment of funds. See, In re WM Six Forks, LLC, 502 B.R. 88 (Bankr. E.D.N.C.). In WM Six Forks, the debtor objected to the UST's attempt to charge a fee based on the amount of a successful credit bid, noting that no funds had ever been “disbursed,” since the existing lender was simply reducing the amount of its claim. The court disagreed, noting that Congress has used the term “moneys disbursed” when it wants to limit the definition of disbursement to payment of funds. Id. at 92 (comparing 28 U.S.C. §1930 with 11 U.S.C. §326(a), which pays Chapter 7 trustees based on “moneys disbursed”). Seemingly relying on the idea that any transfer that satisfied or “went to pay obligations that were the sole legal obligation of the debtor,” the court held that the credit bid — which again, reflected nothing more than a book entry reduction in the lender's claim — should be taxed as a disbursement. Id. (quoting In re Munroe, 2011 WL 1157542 at 1, March 28, 2011 (Bankr. E.D.N.C.)).

Given these two holdings — that ordinary sales to customers can be disbursements and that a disbursement is any asset transfer that settles a debtor's legal obligation — the UST can arguably tax sales of inventory to customers, exchanges which technically reduce or satisfy the legal obligations of the debtor. The existing case law simply has no definition of disbursement that would exclude such sale (or “roll-ups”, debt-for-equity conversions under confirmed plans or refunds issued to a customer). While such an expansive definition has no support in the statute itself or its legislative history, there is nothing that prevent the UST from asserting such an administrative claim.

Courts should be persuaded that the UST fee is supposed to act as a use-tax based on the complexity of a bankruptcy case, and, given that intention, courts should then limit disbursements to permanent balance sheet reductions that involve payment of actual funds. Such a definition would still capture what are generally considered disbursements today while ensuring that middle-market debtors (and their unsecured creditors who fall behind the UST in priority) are not forced to subsidize the UST system for larger debtors that can take advantage of the $250,000 cap. The current case law that argues “'real economic activity' finds no support in the text of the statute nor in any legislative history” simply is not persuasive. See, Michel v. HSSI, Inc.(In re HSSI, Inc.), 193 B.R. 851, 855 (N.D. Ill. 1996).

Conclusion

It should be noted that past UST guidelines have suggested that local UST offices must first confirm with the central UST office in Washington prior to litigating fee disputes (recent copies of the guidelines are not readily available). Perhaps, much of what has been discussed above will be the subject to negotiation and consensual resolution instead of litigation. Still, courts and Congress need to focus on the absurdity of the existing case law and protect small businesses from fees that are at the same time destroying the ability of companies to reorganize and interfering with and discouraging revolving DIP financing.

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Jacob H. Marshall is an attorney in the Bankruptcy and Creditors' Rights practice at Goldberg Kohn Ltd in Chicago. He can be reached at [email protected].