Supreme Court Decision Provides Good News for Creditors

The United States Supreme Court unanimously reversed the Seventh Circuit and resolved a split among the circuits in a ruling issued on January 14, 2021, concluding “that mere retention of property does not violate the [automatic stay in] § 362(a)(3).” City of Chicago v. Fulton, 19-357 (Sup. Ct., Jan. 14, 2021). Consequently, a creditor that has properly repossessed or otherwise obtained possession of a debtor’s property prior to the debtor’s bankruptcy filing will not violate the automatic stay afforded to the debtor under the bankruptcy laws. Following the Court’s decision, a debtor may have other avenues to seek recovery of possession, but a claim based on Section 362(a)(3) of the Bankruptcy Code will no longer be viable.

Prior to the Supreme Court’s decision in City of Chicago, there had been a split among the circuit courts regarding whether or not a creditor’s retention of a debtor’s property violates the automatic stay. Notably for Missouri creditors, the Eighth Circuit, along with the Second, Seventh, Ninth, and Eleventh Circuits have held that creditors have an affirmative duty to surrender repossessed property after the subject debtor files bankruptcy. Several other circuits, on the other hand, have held that a creditor’s retention of property merely maintains the status quo and is a passive act that does not in itself violate the automatic stay.

In the City of Chicago case, various chapter 13 debtors owed up to $20,000 in unpaid parking fines. Before they filed bankruptcy, the city of Chicago had impounded their cars. After filing their chapter 13 petitions, the debtors demanded the return of their cars. Chicago refused until the debtors paid the fines. The bankruptcy court ordered that the cars be returned to the debtors, and the Seventh Circuit affirmed, finding “that the City violated the automatic stay . . . by retaining possession . . . after [the debtors] declared bankruptcy.” According to the Seventh Circuit, Chicago “was not passively abiding by the bankruptcy rules but actively resisting Section 542(a) to exercise control over the debtors’ vehicles.” In re Fulton, 926 F.3d 916 (7th Cir. June 19, 2019).

In reversing the Seventh Circuit, the Supreme Court determined that the critical provision was the “prohibition [in Section 362(a)(3)] against exercising control over estate property.” The Court concluded that the most natural reading of the words “stay,” “act” and “exercise control” prohibit affirmative acts that would disturb the status quo at the time of the bankruptcy filing. Passive acts, therefore, such as retaining what the creditor had already repossessed prior to bankruptcy, do not violate the stay. The Court further reasoned that concluding otherwise would render much of Section 542 of the Bankruptcy Code superfluous. Section 542 requires a party in possession of a debtor’s property to turn over that property to the debtor or trustee, subject to various exceptions. Turnover proceedings against a noncomplying creditor must be commenced by an adversary complaint, which can be a lengthy process and much slower than a proceeding under the automatic stay.

Justice Sotomayor concurred in the result because it satisfied the “the letter of the Code,” but she complained that Chicago’s policy does not comport with what she called the “spirit” of the Code. She suggested that Congress should pass an amendment to expedite debtors’ requests for turnover under §542(a), especially where debtors’ vehicles are concerned.

Because the issue was not before it in this case, the Supreme Court did not address whether subsections 362(a)(4) and (6) are available to debtors in pursuing turnover for violation of the automatic stay. Those subsections prohibit acts to enforce a lien or recover a prepetition claim against a debtor, whereas subsection (3) at issue in the case prohibits acts to obtain possession or exercise control over property of the estate. 

The Supreme Court’s decision is welcome news for creditors that have taken authorized action to obtain possession of their collateral prior to a debtor’s bankruptcy filing. Although turnover may be subject to other remedies (like Section 542), recognizing that maintaining the status quo by holding the property does not violate the automatic stay is consistent with the purpose and intent of the automatic stay, and it relieves creditors from the burden of having to take affirmative action at their own cost merely because a debtor files a bankruptcy petition. Missouri lenders will welcome this change in how the law has been applied to them for years.

If you have questions about the implications of this ruling, contact John Hall or another Lewis Rice bankruptcy attorney.

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