Seeking to resolve a 5-3 split among the Courts of Appeals, the Supreme Court will consider whether a creditor which passively retains property of the estate violates the automatic stay. Case No. 19-357, City of Chicago v. Fulton. The Second, Seventh, Eighth, Ninth and Eleventh Circuits have ruled that retaining possession or control of property of the debtor violates the stay. The Third, Tenth and D.C. Circuits have held that passive retention of property is not an "act" to exercise control over property of the estate.
Two Code Sections
The case turns on how to reconcile two provisions of the Bankruptcy Code. 11 U.S.C. Sec. 362(a)(3) prohibits "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." Because the statute is written in the conjunctive, either an act to obtain possession of property of the estate or to exercise control over property of the estate will violate the statute. Because the word "act" modifies both clauses, there is a fair argument that the offended party must point to a post-petition "act" before the stay is violated.
However, 11 U.S.C.Sec.542(a) says that "an entity . . . in possession, custody, or control during the case of property that the trustee may use, sell, or lease ... or that the debtor may exempt ... shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value or benefit to the estate." Thus, an entity having control over property of the estate must turn over that property to the trustee unless the property is of inconsequential value. Because a person in control of property of the estate "shall" turn such property over, there is an argument that failing to do so is an act to exercise control over property of the estate.
Two Approaches
Two cases from 2019 help to explain how the competing theories work in practice.
In re Fulton, 926 F.3d 916 (7th Cir. 2019) is a case where the City of Chicago impounded cars for failure to pay traffic fines. The City refused to return the vehicles claiming that it would lose its possessory lien if it did so. In four separate cases, bankruptcy courts found that the City had violated the automatic stay by exercising control. In two cases, the City returned the vehicles but only after it had been held in contempt and a request for stay pending appeal had been denied. In a third case, the City returned the vehicle prior to being held in contempt. In a fourth case, the debtor's bankruptcy case was dismissed and the City disposed of the vehicle. The Seventh Circuit affirmed the finding that the stay had been violated.
Meanwhile, the Third Circuit found no violation of the stay under similar facts in In re Denby-Peterson, 941 F.3d 115 (3rd Cir. 2019). Joy Denby-Peterson bought a 2008 Chevrolet Corvette. She agreed to make a down payment of $3,000, a "deferred" down payment of $2,491 some three weeks later and 212 weekly payments of $200. When she did not pay the deferred down payment, the creditor repossessed the vehicle. She then filed Chapter 13 and demanded that the car be returned to her. When the creditor failed to return the car, she filed a motion for turnover and for sanctions. The Bankruptcy Court granted turnover but denied sanctions on the basis that the creditor had not committed an "act" to exercise control over the vehicle. The District Court and Third Circuit affirmed the finding that there had been no stay violation. The Courts found that passively retaining collateral was not an "act." They also held that the turnover provision of Sec. 542(a) was not self-executing because a creditor might have a defense to turnover.
Why It Matters
There are legitimate reasons why a creditor would not want to return a car to a debtor. For example, if the debtor did not have insurance and liked to drive at 100 mph in the rain, a creditor might be reticent about returning the vehicle. The lender may have read on the debtor's Facebook page that he planned to permanently move to Mexico the following week. Or the debtor may be a repeat chapter 13 filer with no income and the lender may object to extending the automatic stay (assuming that the debtor timely files the motion).
The lender is not without remedies in these understandable situations. Under 11 U.S.C. Sec. 362(d), the court may terminate, annul, modify or condition the automatic stay on request from a creditor. Thus, if a creditor learns of the bankruptcy on the date of filing and files a motion to annul the stay the next day, the court could retroactively annul the stay so that the stay was deemed never to have gone into effect. The court could also condition the stay on the debtor providing proof of full coverage insurance and agreeing not to leave the country.
The practical consequence of this dispute is establishing which party has the requirement to seek relief first. Under the Seventh Circuit's position, the creditor has the burden to request that the automatic stay be annulled or conditioned in order to avoid violating it. Under the Third Circuit's view, the debtor must seek turnover unless the creditor takes some affirmative action post-petition. For example, if the vehicle was parked in front of the debtor's home and the creditor used a kill switch to disable the car after learning of the bankruptcy, that would be an act to exercise control. Under the Third Circuit's view there must be some act occurring post-petition which alters the status quo ante.
I prefer the majority position. The purpose of the automatic stay with respect to property is to allow the debtor to be able to use the property. Withholding a vehicle means that the debtor cannot use it to take his kids to school or drive to work. While that may not be a problem in a city with robust mass transit, such as New York or Washington, D.C., it is a major burden in a state like Texas where a working vehicle is a necessity. In my view, if the debtor requests the property back and the creditor says no (or fails to respond), that is an act which violates the stay.
On a final note, the Fulton case will be well argued in the Supreme Court. Veteran Supreme Court litigator Craig Goldblatt represents the City while former Bankruptcy Judge Gene Wedoff represents the Debtors.
Thanks to Brit Suttell who sent me the Denby-Peterson case.
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