By Jeffrey C. Toole
Partner, Bernstein-Burkley, P.C.
Under Section 362(a)(3) of the Bankruptcy Code, the filing of a bankruptcy petition automatically operates as a “stay” applicable to all entities of “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” In bankruptcy, for the most part, “property of the estate” consists of “all legal and equitable interests of the debtor in property as of the commencement of the case.” Section 542(a) provides that, with a handful of exceptions, any entity in possession of such property of the estate “shall deliver to the [bankruptcy] trustee, and account for, that property.” Federal appellate courts have disagreed for years about whether a creditor that repossesses or seizes a debtor’s property before bankruptcy and then retains that property during the bankruptcy (instead of delivering it to the trustee or returning it to the debtor), “exercise[s] control over property of the estate” in violation of Section 362(a)(3). On January 14, 2021, in a case entitled Chicago v. Fulton, the U.S. Supreme Court answered that question in an 8-0 decision. The answer is “no.”
The consequences for willfully violating the automatic stay can be severe. Section 362(k) provides that any individual debtor injured by a willful violation of the stay ”shall recover actual damages, including costs and attorneys’ fees, and in appropriate circumstances, may recover punitive damages.” In Fulton, the City of Chicago impounded several debtors’ vehicles for unpaid fines and parking tickets. Each of the debtors filed a Chapter 13 bankruptcy case and demanded the return of his or her vehicle. The City refused, and in each case, the bankruptcy court held that the City violated the stay. On appeal, the Seventh Circuit affirmed those judgments in a consolidated opinion. It concluded that, by retaining possession of the vehicles after the debtors filed bankruptcy, the City had “exercised control” over property of their estates in contravention of Section 362(a)(3).
The Supreme Court vacated that decision. It concluded that merely retaining possession of estate property during bankruptcy does not violate Section 362(a)(3). The Court wrote that, taken together, the most natural reading of the statute’s words – the “stay” of “any act” to “exercise control” – is that Section 362(a)(3) “prohibits affirmative acts that would disturb the status quo of estate property as of the time when the bankruptcy petition was filed.” Therefore, something more than passively retaining possession is required to violate the statute (such as, for example, selling the repossessed or seized property during the bankruptcy, without prior bankruptcy court approval).
The Court also observed that any ambiguity in Section 362(a)(3) is resolved by Section 542(a), which expressly requires “turnover” of estate property to the trustee. Interpreting Section 362(a)(3) to cover mere retention of estate property would render Section 542(a) superfluous, because it would make Section 362(a)(3) a blanket “turnover” provision that displaces most or all of Section 542(a). The better interpretation, the Court concluded, is that Section 362(a)(3) prohibits collection efforts outside of the bankruptcy case that would change the status quo, while Section 542(a) operates within the bankruptcy case “to draw far-flung estate property back into the hands of the debtor or trustee.” Also, the Court observed that interpreting Section 362(a)(3) as a “turnover” provision would render its and Section 542(a)’s commands contradictory. Specifically, Section 542(a) contains exceptions that Section 362(a)(3) lacks, and nothing in the statute suggests that Congress intended Section 362(a)(3) to command immediate turnover of estate property.
In a concurring opinion, Justice Sotomayor agreed with the result but wrote separately to emphasize what the Court did not decide: namely, whether or when Section 362(a)’s other provisions may require a creditor to return a debtor’s property. Some of those other provisions stay: for example, any act to collect, assess, or recover a pre-bankruptcy claim against a debtor, or any act to create, perfect, or enforce any lien against estate property. Those provisions therefore might provide debtors with an alternative means to compel immediate turnover, without having to sue creditors under Section 542(a) to do so. Justice Sotomayor also lamented that a lawsuit for turnover under Section 542(a) can take several months to complete. Because vehicles are often essential for a Chapter 13 debtor to get to work and earn income to repay his or her creditors (including the creditor with a lien on the vehicle), Justice Sotomayor suggested that the Bankruptcy Rules or Code should be amended to expedite the timeline to return debtors’ vehicles.
Although seized vehicles were an issue in Fulton, the Court’s analysis and decision arguably apply much more broadly – to any creditor with a lien on any property that it repossesses or seizes before a debtor’s bankruptcy. If a creditor passively retains possession of estate property during a bankruptcy, a debtor may still try to invoke other provisions in Section 362(a) to sanction the creditor for willfully violating the stay. Consequently, a creditor that merely retains possession of estate property may still be at some risk. But Fulton eliminates the risk that passive retention violates Section 362(a)(3). In view of the uncertainty relating to whether or when Section 362(a)’s other provisions might require turnover, Fulton may give a creditor (with a lien on property it repossesses pre-bankruptcy) additional leverage to insist upon suitable protections in exchange for returning the estate property to the debtor or trustee. Such protections might include periodic payments to compensate the creditor for any future depreciation in the property’s value during the bankruptcy, maintenance of adequate insurance coverage, or other relief, to increase the likelihood that the creditor will be repaid for its collateral’s value.
The decision is City of Chicago v. Fulton, No. 19-357 (U.S. Supreme Court, Jan. 14, 2021).