Seventh Circuit Solidifies a Circuit Split on the Automatic Stay

Solidifying a split of circuits, the Seventh Circuit ruled that the City of Chicago must comply with the automatic stay by returning impounded cars immediately after being notified of a chapter 13 filing.

The decision lays the foundation for the Supreme Court to grant certiorari and decide whether violation of the automatic stay requires an affirmative action or whether inaction amounts to control over estate property and thus violates the stay.

The Second, Seventh, Eighth, Ninth and Eleventh Circuits hold that a secured creditor or owner must turn over repossessed property immediately or face a contempt citation. The Tenth and the District of Columbia Circuits have ruled that passively holding an asset of the estate in the face of a demand for turnover does not violate the automatic stay in Section 362(a)(3), which prohibits “any act . . .  to exercise control over property of the estate.”

The same issue was argued on May 23 in the Third Circuit, where the lower courts were siding with the minority. See Denby-Peterson v. NU2U Auto World, 18-3562 (3d Cir.). For ABI’s report on Denby, click here.

The Impounded Cars in Chicago

Four cases went to the circuit together. The facts were functionally identical.

The chapter 13 debtors owed between $4,000 and $20,000 on unpaid parking fines. Before bankruptcy, the city had impounded their cars. Absent bankruptcy, the city will not release impounded cars unless the fines are paid. If the cars are not redeemed by their owners, most of them are scrapped.

In 2016, Chicago passed an ordinance giving the city a possessory lien on impounded cars.

After filing their chapter 13 petitions, the debtors demanded the return of their autos. The city refused to release the cars unless the fines and other charges were paid in full.

The debtors mounted contempt proceedings in which four different bankruptcy judges held that the city was violating the automatic stay by refusing to return the autos. After being held in contempt, the city returned the cars but appealed.

In all four cases, the owners confirmed chapter 13 plans treating the city as holding unsecured claims. The city did not object to confirmation or appeal.

In the four cases, the city never sought adequate protection for its alleged security interests under Section 363(e).

Thompson Controls

Circuit Judge Joel M. Flaum was not writing on a clean slate in his June 19 opinion, given the circuit’s controlling precedent in Thompson v. General Motors Acceptance Corp., 566 F.3d 699 (7th Cir. 2009). Thompson, he said, presented “a very similar factual situation.”

Although Thompson came down only 10 years ago, Judge Flaum nonetheless wrote a comprehensive, 27-page opinion, perhaps sensing that the case will go to the Supreme Court on certiorari.

In Thompson, Judge Flaum said, “we held that a creditor must comply with the automatic stay and return a debtor’s vehicle upon her filing of a bankruptcy petition. We decline the City’s request to overrule Thompson.” He also agreed with the bankruptcy courts “that none of the exceptions to the stay apply.”

Quoting extensively from Thompson, Judge Flaum said that the Seventh Circuit had already “rejected” the city’s contention that “passively holding the asset did not satisfy the Code’s definition of exercising control.” He noted that Congress amended Section 362 in 1984 by adding subsection (a)(3) and making the automatic stay “more inclusive by including conduct of ‘creditors who seized an asset pre-petition,’” citing U.S. v. Whiting Pools Inc., 264 U.S. 198, 203-204) (1983).

Again citing Whiting Pools, Judge Flaum said that Section 362(a)(3) “becomes effective immediately upon the filing of the petition and is not dependent on the debtor first bringing a turnover action.” He added, the “creditor . . . has the burden of requesting protection of its interest in the asset under Section 363(e).”

Judge Flaum found support for his conclusion in Section 542(a). Again quoting Thompson, he said the section “‘indicates that turnover of a seized asset is compulsory.’” Thompson, supra, at 704.

“Applying Thompson,” Judge Flaum held “that the City violated the automatic stay . . . by retaining possession . . . after [the debtors] declared bankruptcy.” The city, he said, “was not passively abiding by the bankruptcy rules but actively resisting Section 542(a) to exercise control over the debtors’ vehicles.”

Telling Chicago how to proceed in the future, Judge Flaum said the city must turn over the car and may seek adequate protection on an expedited basis. The burden of seeking adequate protection, he said, “is not a reason to permit the City to ignore the automatic stay and hold captive property of the estate, in contravention of the Bankruptcy Code.”

In sum, Judge Flaum declined the city’s invitation to overrule Thompson. He said, “Our reasoning in Thompson continues to reflect the majority position and we believe it is the appropriate reading of the bankruptcy statutes.”

Exceptions to the Automatic Stay

Judge Flaum devoted the last third of his opinion to explaining why Chicago was not eligible for any of the exceptions to the automatic stay.

Section 362(b)(3), allowing acts to perfect or continue perfection of liens, does “not permit creditors to retain possession of debtors’ property,” Judge Flaum said. Rather, it allows creditors to file notices to continue or perfect a lien when bankruptcy has intervened. The city, he said, could perfect its possessory lien by a filing with the Secretary of State.

Judge Flaum cited Illinois decisions holding that giving up possession involuntarily does not destroy a possessory lien. The notion that turning over cars would abrogate the possessory lien was one of Chicago’s primary arguments on appeal.

Judge Flaum held that Section 362(b)(4), excepting police or regulatory powers from the automatic stay, did not apply. On balance, he said, the municipal machinery to impound cars “is an exercise of revenue collection more so than police power.”

Is Certiorari Next?

In the term that ends this month, the Supreme Court denied a petition for certiorari raising the same question. See Davis v. Tyson Prepared Foods Inc., 18-941 (Sup. Ct.) (cert. denied May 20, 2019).

Davis, from the Tenth Circuit, was a challenge to the Tenth Circuit’s holding in WD Equipment v. Cowen (In re Cowen), 849 F.3d 943 (10th Cir. Feb. 27, 2017). In Cowen, the Tenth Circuit ruled that passively holding an asset of the estate in the face of a demand for turnover does not violate the automatic stay in Section 362(a)(3) as an act to “exercise control over property of the estate.” To read ABI’s discussion of the denial of certiorari, click here.

In this writer’s opinion, the Chicago parking ticket cases are a better vehicle for certiorari because they raise the issue more cleanly. Davis was a step or two removed from the question of whether overt action is required to violate the automatic stay.

Given the recent change in administration in Chicago, it is not certain that the city will pursue certiorari.

Eric Brunstad told ABI, “The issue is certainly not going away. I predict that eventually the Supreme Court will grant certiorari in a case involving the issue and resolve the conflict among the courts of appeals.” Brunstad represented the debtor who unsuccessfully sought Supreme Court review in Davis.