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self-study / Bankruptcy

Mere retention of property doesn’t violate a bankruptcy automatic stay

David S. Kupetz

Shareholder, SulmeyerKupetz PC

333 S Grand Avenue, Suite 3400
Los Angeles , CA 90071-1406

Fax: (213) 629-4520

Email: dkupetz@sulmeyerlaw.com

UC Hastings College of the Law

David is an expert in bankruptcy, business reorganization, restructuring, assignments for the benefit of creditors, and other insolvency solutions.

In an opinion issued last week, the U.S. Supreme Court in Chicago v. Fulton, 2021 DJDAR 503 (Jan. 14, 2021), addressed the narrow issue of whether the city of Chicago's policy of refusing to return impounded vehicles to individuals who filed for bankruptcy after their vehicle was seized violated Section 362(a)(3) of the Bankruptcy Code. 11 U.S.C. Section 362(a)(3). Section 362(a)(3) prohibits "any act ... to exercise control over property" of the bankruptcy estate. Notably, Section 362(a)(3) is only one component of broader automatic stay protections. Based on a narrow interpretation of the statute's language, the court held that Section 362(a)(3) does not cover the mere retention of property, but the court declined to determine whether the city may have violated other provisions of the automatic stay.

Upon the commencement of a bankruptcy case, an estate is created that generally comprises "all legal and equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. Section 541(a)(1). Additionally, at the inception of a bankruptcy case, an automatic stay goes into effect. 11 U.S.C. Section 362. It is self-executing and no court order is required. The effect of the automatic stay is to prohibit and invalidate certain post-bankruptcy actions taken against the debtor, property of the debtor, or property of the bankruptcy estate. The purpose of the stay is to give the debtor a breathing spell from creditor action; to achieve an equality of distribution of property of the estate among claimants; and to promote an orderly administration of the bankruptcy case. The automatic stay prevents pre-bankruptcy litigation and other collection efforts from continuing against the debtor or property of the bankruptcy estate.

In the case before the court, the city impounded vehicles for failure of individuals to pay motor vehicle infraction fines. The individuals subsequently filed Chapter 13 bankruptcy petitions and requested that the city return their vehicles. The city refused. In each case, a bankruptcy court ruled that the refusal violated the automatic stay. In a consolidated opinion, the 7th U.S. Circuit Court of Appeals affirmed the rulings. In re Fulton, 926 F.3d 916 (7th Cir. 2019). The 7th Circuit held that "by retaining possession of the debtors' vehicles after they declared bankruptcy," the city had acted "to exercise control over" the debtors' property in violation of Section 362(a)(3). The Supreme Court granted certiorari "to resolve a split in the Courts of Appeals over whether an entity that retains possession of the property of a bankruptcy estate violates §362(a)(3)."

The Supreme Court examined the language of Section 362(a)(3), applying what it called a "natural reading" of the words "stay," "act" and "exercise control" to conclude that "§362(a)(3) halts any affirma

tive act that would alter the status quo as of the time of the filing of a bankruptcy petition," but does not apply to mere passive retention of property. The court acknowledged that its interpretation of the language of Section 362(a)(3) does not "definitively rule out the alternative interpretation adopted by the court below and advocated by respondents." Nonetheless, the court clung to its conclusion, stating "the language of §362(a)(3) implies that something more than merely retaining power is required to violate the disputed provision."

The court primarily rested its resolution of any ambiguity in Section 362(a)(3) on the existence of Section 542 of the Bankruptcy Code. 11 U.S.C. Section 542. Section 542(a), in pertinent part, provides: "[A]n entity, other than a custodian, in possession, custody, or control, during the case, of property that the trustee may use, sell, or lease under section 363 of this title, or that the debtor may exempt under section 522 of this title, 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." The court supported its reasoning by asserting that reading Section 362(a)(3) to include "mere retention of property ... would create at least two serious problems. First, it would render the central command [turnover] of §542 largely superfluous." Second, the court stated it would create a conflict between Sections 362(a)(3) and 542 since Section 542 does not require turnover of property that is "of inconsequential value or benefit to the estate" and Section 362(a)(3) contains no such exclusion.

The court emphasized that it was only ruling "that mere retention of estate property after the filing of a bankruptcy petition does not violate §362(a)(3) of the Bankruptcy Code." The court further stated that is was not deciding how the turnover requirement of Section 542 works. Nor was it addressing the meaning of other subsections of Section 362. The court acknowledged that the bankruptcy court had determined that the city, by retaining a debtor's vehicle and demanding payment post-bankruptcy, had also violated Sections 362(a)(4) (precluding any act to create, perfect, or enforce any lien against property of the estate) and (a)(6) (prohibiting any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case).

In a concurring opinion, Justice Sonia Sotomayor announced that she agreed with the court "that, as used in §362(a)(3), the phrase 'exercise control over' does not cover a creditor's passive retention of property lawfully seized prebankruptcy. Hence, when a creditor has taken possession of a debtor's property, §362(a)(3) does not require the creditor to return the property upon the filing of a bankruptcy petition." However, Justice Sotomayor wrote separately to highlight "that the Court has not decided whether and when §362(a)'s other provisions may require a creditor to return a debtor's property." Further, she emphasized that the court did not address "how bankruptcy courts should go about enforcing creditors' separate obligation to 'deliver' estate property to the trustee or debtor under §542(a)." The concurring opinion states that the city may have violated one or both of these other provisions. Presumably, issues that may be addressed on remand.

Taking a step a step back to look at the broader picture, Justice Sotomayor declared that "[r]egardless of whether the City's policy of refusing to return impounded vehicles satisfies the letter of the Code, it hardly comports with its spirit." She explained that the principal purpose of bankruptcy for an individual debtor is to obtain a "fresh start." The concurring opinion details an example where by denying one of the debtors access to his vehicle he needed to commute to work, "the City jeopardized ... [his] ability to make payments to all his creditors, the City included. Surely, ... [his] vehicle would have been more valuable in the hands of its owner than parked in the City's impound lot."

Finally, Justice Sotomayor discusses that relief may be available under Section 542(a) for debtors to compel turnover of impounded vehicles (or other property). However, turnover proceedings under Section 542(a) can be slow since they must be brought as "adversary proceedings," which are "essentially full civil lawsuits carried out under the umbrella of [a] bankruptcy case."

The concurring opinion recognizes that courts may address these situations by granting expedited and/or temporary relief. Ultimately, she suggests solutions by rule drafters and policy makers, not bankruptcy judges, stating that "[i]t is up to the Advisory Committee on Rules of Bankruptcy Procedure to consider amendments to the Rules that ensure prompt resolution of debtors' requests for turnover under §542(a), especially where debtors' vehicles are concerned. Congress, too, could offer a statutory fix, either by ensuring that expedited review is available for §542(a) proceedings seeking turnover of a vehicle or by enacting entirely new statutory mechanisms that require creditors to return cars to debtors in a timely manner." 

#870

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