On Oct. 13, 2020, the U.S. Supreme Court heard oral argument that may alter the way bankruptcy courts interpret possession and control under Bankruptcy Code § 362(a)(3), and the right of turnover under the ambit of § 542(a). In Chicago v. Fulton,[1] the Court is set to determine whether the automatic stay requires a creditor who is passively retaining an asset to have an affirmative obligation under § 362 to return the property to the debtor immediately upon the filing of their bankruptcy.
Overwhelmingly, creditors refuse to give back assets that have been levied or seized upon the debtor’s filing of a bankruptcy petition, be it a repossessed vehicle, bank funds or otherwise. There is a split in the courts on whether this act of retention is sanctionable for the exercise of control over property of the estate. Pursuant to 11 U.S.C. § 362(a)(3), this is considered a stay violation. The majority view has determined that creditors have an affirmative duty to turn over repossessed property after a filing.[2] The Second, Seventh, Eighth, Ninth and Eleventh Circuits follow this line of thinking.[3] The Third, Tenth and District of Columbia Circuits, however, have held that the retention of property does not violate the automatic stay because it is not an “act” to exercise control over estate property. For these circuits, a stay violation requires an affirmative action; that is, a secured creditor is not required to return the asset unless and until the debtor obtains a court turnover order stating otherwise.[4]
In Fulton,[5] the bankruptcy court ordered the city to turn over cars that had been impounded for unpaid parking fines pursuant to a city ordinance, which the city argued created a possessory lien on the vehicle until paid in full.[6] The city of Chicago consolidated Fulton with three other chapter 13 cases dealing with the same topic. The bankruptcy court had held in each instance that the city violated the automatic stay by “exercising control” over estate property, where none of the exceptions to the stay applied. The city had argued that § 362(b)(3) allowed it to take possession of the debtors’ vehicles. The Seventh Circuit Court of Appeals affirmed the bankruptcy court, and the Supreme Court heard this matter.
The issue of physical control is significant under § 362(a)(3), which clearly prohibits “any act to obtain possession of property of the estate ... or to exercise control over property of the estate.”[7] If continued possession of the asset after the bankruptcy is filed constitutes “exercising control,” then the language prohibits the creditor’s retention of the asset as a clear violation of the automatic stay. In practice, the consequence of this interpretation has resulted in consumer cases being filed solely to seek immediate recovery of a repossessed vehicle. Meanwhile, these cases more often than not fail to provide adequate protection to the secured creditor, which must act to protect the value of its interest in the collateral. However, where equity exists, an immediate return of the asset would avoid delays and court costs, and maximize value for the estate.
Notably, § 1303 does not expressly reserve the right of turnover for a debtor. As a consequence, it is questionable whether or not the debtor actually has the right to pursue a turnover motion to recover a repossessed asset. Thus, the question arises: If a creditor maintains control of a collateralized asset, is that creditor required to surrender control and possession of the asset upon the filing of a case, or must a motion for turnover first be filed?
Perhaps it is a violation of the stay. Indeed, to maintain control and possession upon receiving knowledge of the stay seems to be within the ‘automatic’ acts prohibited by the Code. Only the exceptions expressly enumerated under § 362(b) are presumed to be nonviolative. Moreover, where a creditor retains possession of an asset that is necessary for the debtor’s rehabilitation in a chapter 13 case, it may completely usurp any chances of plan confirmation and successful reorganization.
Yet § 362(a)(3) must be examined in conjunction with the relevant turnover section of the Code. Section 542(a) provides the rights of the trustee to seek and recover property of value for the benefit of the estate. Likewise, § 547(a) provides the trustee the right to recover assets and avoid preferential treatments.[8] These sections are part of the trustee’s arsenal to secure potential benefits for the estate. As long as the debtor retains an interest in the asset, it seems logical that the value of the asset should come within the purview of the estate.
Bankruptcy courts and appellate courts that stand in the majority on this issue have found that a creditor must proactively return an asset to the estate. The majority interprets § 542(a) to mean that no motion or adversary proceeding is necessary for recovery of the asset. This interpretation would signify that creditors who fail to exert reasonable effort to return collateral upon receipt of notice of a bankruptcy filing may be held in contempt — or quite possibly even avail themselves of sanctions. Conversely, if § 542(a) is interpreted to place the duty on the debtor or a trustee to file a motion for turnover or adversary proceeding, there would be no sanctions against the creditor unless or until the motion is granted, and after the creditor’s failure to abide by orders of the court. Thus, placing the duty on the trustee to file the motion for turnover is certainly a benefit to the creditor, not to the estate.
Section 542(a) does not establish a process, a duty or a condition that would cause a turnover action to be “self-executing.” A trustee’s avoidance action is permissive by nature — i.e., the trustee “may avoid” — whereas a turnover action asserts a requirement against the creditor — i.e., the creditor “shall turn over.” Perhaps the Supreme Court analysis will revolve around such phrases. A contrary interpretation permits a creditor to remain in control and possession of value belonging to the estate, pending a turnover action. By the time this article is published, the Supreme Court will have already heard oral argument on this matter. Whether the high court will take a debtor-friendly stance in favor of the current majority, or impose additional procedural constraints against the estate in favor of creditors, remains to be seen. In either event, the decision in this case is likely to have an immediate and widespread impact in consumer cases as the country prepares to face the current recession.
[1] In re Fulton, 18-02860, (Bankr. N.D. Ill. 2018); City of Chicago, Illinois v. Fulton, 140 S. Ct. 680 (2019).
[2] In re Rozier, 376 F.3d 1323 (11th Cir. 2004).
[3] In re Weber, 719 F.3d at 81 (2d Cir. 2013); Thompson v. General Motors Acceptance Corp., 566 F.3d 699, 703 (7th Cir. 2009); In re Fulton, 926 F.3d at 931; In re Knaus, 889 F.2d 773 775 (8th Cir. 1989); In re Del Mission Ltd., 98 F.3d at 1151 (9th Cir. 1996).
[4] See In re Denby-Peterson, 2019 U.S. App. LEXIS 32283, at *10 (3d Cir. Oct. 28, 2019); In re Cowen, 849 F.3d 943, 950 (10th Cir. 2017); United States v. Inslaw Inc., 932 F.2d 1467, 1474 (D.C. Cir. 1991) (“The automatic stay, as its name suggests, serves as a restraint only on acts to gain possession or control….”).
[5] City of Chicago v. Fulton, No. 18-2527 (7th Cir. 2019).
[6] In re Fulton, 18-02860 (Bankr. N.D. Ill. 2018).
[7] 11 U.S.C. § 362(A)(3) (2019).
[8] 11 U.S.C. § 547(A) (2019).