Yesterday, the Supreme Court granted certiorari in City of Chicago v. Fulton, 19-357 (Sup. Ct.), to resolve a circuit split and decide whether inaction can violate the automatic stay under Section 362(a). The case will likely be argued and decided before the high court’s term ends in late June.
An opinion by Bankruptcy Judge Brian F. Kenney of Alexandria, Va., demonstrates how the Supreme Court could dramatically impair the efficacy of bankruptcy by ruling that creditors are not required to unwind actions they have already taken when notified of bankruptcy.
The Prebankruptcy Garnishment
Former matrimonial counsel had a judgment against the debtor for more than $10,000. The law firm had obtained a garnishment order under which $1,000 was being held by the clerk of the state court after having been deducted from the debtor’s wages. A hearing was scheduled in state court to rule on turning the garnished funds over to the firm as the judgment creditor.
One month before the hearing in state court, the debtor filed a chapter 7 petition, listed the judgment as a debt, gave notice of the filing to the judgment creditor, claimed an exemption in the $1,000, and filed a suggestion of bankruptcy in the state court.
Claiming to have performed legal research, the judgment creditor responded to the debtor by saying he was unaware of any obligation to take affirmative action to terminate the garnishment. The judgment creditor said he would appear in state court on the return date, where he expected the state court judge would rule “as the Court deems appropriate.”
[N.B. The judgment creditor’s research must have been incomplete, because there was a prior ruling by a district court in that district imposing an affirmative duty on a creditor to discontinue an action after the defendant’s bankruptcy filing.]
Prior to the return date in state court, the debtor filed a motion for the creditor to be held in contempt for willful violation of the automatic stay under Section 362(k)(1). Before the hearing on the contempt motion, the clerk of the state court returned the garnished funds to the debtor’s employer. In his December 16 opinion, Judge Kenney said the money would “presumably” be returned to the debtor in her next paycheck.
The Circuit Split
On the question of contempt, Judge Kenney said that “the issue of a refusal to release seized property upon a bankruptcy filing is now the subject of some controversy in the case law,” citing, among others, In re Fulton, 926 F.3d 916 (7th Cir. June 19, 2019), and In Denby-Peterson, 941 F.3d 115 (3d Cir. Oct. 28, 2019).
Judge Kenney explained how the circuits are split when it comes to deciding whether a secured creditor must turn over repossessed property immediately or face a contempt citation. Led by Fulton, the Second, Seventh, Eighth, Ninth and Eleventh Circuits impose an affirmative duty on creditors to turn over repossessed property after a filing. With Denby-Peterson as the most recent authority to the contrary, the Third, Tenth and District of Columbia Circuits have held that the retention of property only maintains the status quo. For those three circuits, a stay violation requires an affirmative action. Simply holding property is not an affirmative act, in their view.
To resolve the circuit split, the Supreme Court granted certiorari to review Fulton. To read ABI’s discussion of the Seventh Circuit decision, click here. For ABI’s report on Denby-Peterson, click here.
Judge Kenney Sides with the Majority
Judge Kenney was persuaded to follow the majority and Fulton. He ruled that the creditor “violated Section 362(a)(3) by continuing to exercise control over the garnished funds post-petition.” He prominently relied on U.S. v. Whiting Pools, Inc., 462 U.S. 198 (1983), where the Supreme Court held that the estate has a “possessory interest in certain property of the debtor that was not held by the debtor at the commencement of reorganization proceedings.” Id. at 207.
Compared to Fulton, Judge Kenney said that the case before him was more easily resolved in favor of the debtor because the law firm did not claim to have either an ownership interest in or lien against the garnished funds in the hands of the clerk of the state court. He understood “the ordinary and plain reading of the phrase ‘to exercise control’ to preclude the creditor’s refusal to release the Debtor’s funds from a pre-petition garnishment.”
Judge Kenney decided that the debtor was entitled to damages because there was a stay violation committed willfully. He declined to impose punitive damages under Section 362(k)(1), since the stay violation was neither egregious nor malevolent.
In terms of damages, the debtor claimed none other than the $2,400 in attorneys’ fees incurred in prosecuting the motion to recover garnished wages. Judge Kenney awarded the $2,400 because the fees were incurred “in enforcing the Debtor’s legal right to the release of her property.” He noted that the contempt motion was not brought merely to “or even primarily” to recover attorneys’ fees.
Inaction as a Stay Violation
Judge Kenney was surely correct in one respect: His case presented more persuasive facts for a stay violation because the creditor claimed neither ownership nor a lien on the garnished funds. However, it is possible that the Supreme Court will rule in Fulton that mere inaction violates neither the automatic stay nor the command to turn over estate property under Section 542(a). The case before Judge Kenney was a classic example of inaction.
If the Supreme Court rules that inaction does not violate the stay, a debtor in a case like Judge Kenney’s could not or would not pursue a turnover of $1,000 in garnished wages when her counsel fees would be $2,400.
In deciding Fulton, one hopes the justices will grasp the implications of their ruling. If a stay violation requires an affirmative action by a creditor, many debtors will be unable to enforce rights given them by the Bankruptcy Code because (1) lawyers will not take cases on a contingency, or (2) the debtors will be unable to pay counsel fees.
The Fulton Certiorari Petition
The creditor in Fulton filed a petition for certiorari in September. The justices considered the petition at a conference on December 16 and issued an order on December 18 granting the petition.
The creditor who lost in Denby-Peterson could also file a petition for certiorari in upcoming weeks. Conceivably, the Court could hear Denby-Peterson alongside Fulton. More likely, however, the Court will defer action on a Denby-Peterson petition until the justices decide Fulton.
Any opinions are those of the writer, not ABI.
Yesterday, the Supreme Court granted certiorari in City of Chicago v. Fulton, 19-357 (Sup. Ct.), to resolve a circuit split and decide whether inaction can violate the automatic stay under Section 362(a). The case will likely be argued and decided before the high court’s term ends in late June.
An opinion by Bankruptcy Judge Brian F. Kenney of Alexandria, Va., demonstrates how the Supreme Court could dramatically impair the efficacy of bankruptcy by ruling that creditors are not required to unwind actions they have already taken when notified of bankruptcy.
The Prebankruptcy Garnishment
Former matrimonial counsel had a judgment against the debtor for more than $10,000. The law firm had obtained a garnishment order under which $1,000 was being held by the clerk of the state court after having been deducted from the debtor’s wages. A hearing was scheduled in state court to rule on turning the garnished funds over to the firm as the judgment creditor.
One month before the hearing in state court, the debtor filed a chapter 7 petition, listed the judgment as a debt, gave notice of the filing to the judgment creditor, claimed an exemption in the $1,000, and filed a suggestion of bankruptcy in the state court.