Supreme Court Issues Decision Addressing Retention of Debtor Property

Admin on February 28, 2021 Posted in Bankruptcy Law, Blog

The Supreme Court of the United States recently examined whether a creditor is required to turn over property of a bankruptcy estate to a debtor or trustee under the Bankruptcy Code’s automatic stay provision if the creditor lawfully possessed the property before bankruptcy was initiated and only passively possessed the property afterward. In this case, the United States Supreme Court ultimately ruled in an 8 to 0 decision that the “mere retention” of a debtor’s property does not violate section 362(a)(3) of the Bankruptcy Code. 

The Supreme Court’s ruling in this case, Chicago v. Fulton, resolves a circuit split that questioned whether section 362(a)(3) imposes an affirmative duty on creditors to turn over a debtor’s property on a bankruptcy filing and overrules the precedent that has been established by the Ninth Circuit. This article examines this case and its ramifications.

The Role of Section 362

Section 362 establishes an automatic stay after the filing of a bankruptcy petition. The automatic stay prevents a debtor’s creditors from enforcing a judgment against a debtor or any property of the estate, taking any action to obtain possession of the property of the estate, or taking any action to either create or enforce a lien. 

Section 362, however, provides several provisions that provide limitations to the automatic stays. One of these provisions provides that if a single or joint case is filed by or against a debtor who is an individual in a Chapter 7, 11, or 13 case and if a single or joint case of the debtor was pending within the preceding one-year period but was dismissed, the stay terminates on the 30th day after the filing of the latter case.

The Current Circuit Split

Because the language in Section 362(a)(3) is not clear about whether the retention of estate property represents an act to exercise control over property of the estate, a circuit split arose. Before the Fulton decision, several circuit courts including the Ninth Circuit held that the knowing retention of estate property violates the automatic stay. These courts have found that the purpose of an automatic stay is best served by placing the onus to return estate property on the possessor instead of requiring the debtor to pursue the possessor. 

Several other circuit courts, including the Third Circuit following a 2019 rule, have held that section 362(a)(3) is only violated by an affirmative act to exercise control. These courts have emphasized a plain language reading of section 362(a)(3) and have argued that if Congress had wanted to add an affirmative obligation, it would have included this extra element in the Bankruptcy Code.  

Before the Fulton case reached the Supreme Court, the Seventh Circuit sided with the Ninth Circuit as well as other courts in adopting the “majority rule” that section 362(a)(3) imposes an affirmative duty on creditors to return estate property. Due in part to the circuit split, the Supreme Court granted certiorari in Fulton to resolve the uncertainty of how to interpret the code.

An Overview of Chicago v. Fulton

The Fulton case represents a consolidation of several cases that were each straightforward and considered the same issues. The case involved the city of Chicago impounding each debtor’s vehicle for failure to pay fines associated with traffic infractions. Each debtor in the case sought Chapter 13 bankruptcy relief and requested that the city of Chicago turn over the debtor’s vehicle, but the city refused to do so. In each case, the bankruptcy court then held that the city’s refusal violated Section 362(a)(3). 

The Court of Appeals affirmed all of the bankruptcy court opinions in a consolidated 2019 ruling. The Supreme Court, however, reversed the Seventh Circuit and overruled the precedent that had been established by the Second, Eighth, and Ninth Circuits. 

Authoring the majority opinion, Justice Alito noted that the critical words from section 362(a)(3), “stay, act, exercise,” suggest that section 362(a)(3) stops any affirmative action that would impact the status quote at the time the bankruptcy petition was filed. Justice Alito also suggested that to the extent that any ambiguity in section 362(a)(e) remains, the Court’s interpretation is supported by section 542 which requires a person or entity in possession of the property to deliver to the trustee and account for any property. 

In the perspective of the majority of the court, the rule that mere retention of estate property might violate the automatic stay would render the central element of section 542 mostly “superfluous” and create a conflict between sections 362(a)(3) and 542 regarding any property of inconsequential value. The majority of the court also noted that its ruling only impacted the interpretation of section 362(a)(3) and not other subjections of section 362(a). 

What Fulton Means for Creditors

The Supreme Court’s decision in Fulton should provide some comfort to creditors in California’s Ninth Circuit as well as in other parts of the country who are interested in obtaining control or possession of a debtor’s property before a bankruptcy filing. Following Fulton, simply retaining property without additional circumstances does not constitute a stay violation that can result in punitive damages. 

Fulton, however, does not entirely remove the possibility that a lone action can elevate the retention of property into an act that violates section 362(a)(3), which implies that something more than retaining power is required for a stay violation. 

Creditors should also be aware that other provisions of section 362(a) were not in question in Fulton and can be interpreted by bankruptcy courts to prohibit the “knowing retention” of estate property. The Seventh Circuit in Fulton did not question whether the city of Chicago had violated other elements of section 362 by retaining the respondent’s vehicle and requesting payment. 

Consequently, Fulton should not be interpreted as providing greater leniency for creditors in regards to the retention of the debtor’s property after a bankruptcy filing.

Contact an Experienced Bankruptcy Attorney

If you have questions or concerns about the bankruptcy process, one of the best things that you can do is to obtain the assistance of a knowledgeable bankruptcy lawyer. Contact attorney Melanie Tavare today to schedule a free case evaluation.