In City of Chicago v. Fulton (Fulton), [1] the Supreme Court settled a split among circuits regarding the correct interpretation of § 362(a)(3), which prohibits “any act to obtain possession of property of the estate or of property from the estate or to exercise control over of property of the estate. [2] The Court held that mere retention was not an “act” prohibited under § 363(a)(3). The Court’s holding was based on the plain meaning of the statute and the perception that the majority interpretation rendered the turnover statute, § 542, both surplusage and contradictory to § 362(a)(3). [3] Although the case was decided in the context of cars impounded for unpaid parking tickets by the City of Chicago and the City’s refusal to release the vehicles to the debtors after the filing of chapter 13 petitions, it was considered a victory for secured lenders of personal property, especially vehicles.
Closer examination of the case, however, reveals a narrow holding and, likewise, a narrow victory — perhaps even a pyrrhic victory. Because chapter 13 debtors may be required to bring turnover actions, the costs of recovering vehicles could increase substantially for debtors and creditors. First, note what the Fulton Court did not decide.
What the Fulton Court Declined to Decide
There were two other relevant stay provisions, § 362(a)(4) and (a)(6), which were not presented to the Seventh Circuit, and therefore turnover under them was not considered by the Court. Debtors will certainly raise these provisions in future litigation, but those arguments seem likely to fail under the logic of Fulton, unless property retention is accompanied by a further act. [4] More critically for our purposes, though, the Fulton Court declined to determine whether turnover under § 542(a) is automatic.
The Debtor’s Turnover Burden and Options
Under § 542(a), a creditor must turn over property of the debtor unless it is of inconsequential value to the estate. In a chapter 13 case, the debtor is entitled to possession of property of the estate because the debtor has the rights of a trustee to the use of property under § 363(b). [5] It is undisputed that a debtor is entitled to possession of property repossessed pre-petition and still in the hands of the third party, but as noted above, the Supreme Court declined to hold that the current holder of the property must automatically turn that property over upon receiving notice of the bankruptcy case. Accordingly, the question remains: How does the debtor enforce its undisputed right to possession of this property?
The prevailing view appears to be that turnover requires an adversary proceeding under Rule 7001(1). [6] Such proceedings equate to increased costs for all parties, and, as Justice Sotomayor pointed out in her insightful concurrence, turnover proceedings can be quite slow. [7] However, it is arguable that Rule 7001(1) does not apply in the case of repossessed property, where the only issue is possession and not title or ownership. In this instance, a contested matter under Rule 9014 may suffice, thus limiting the time and expense of the turnover process. Further, the notice requirements of a contested matter proceeding are largely similar to an adversary proceeding, with the exception of a summons requirement, thus negating or diminishing any due process claims. Moreover, if a court enters an order on a contested matter even though an adversary proceeding was the procedurally correct route, the order is effective, provided that the parties have received adequate notice and an opportunity to be heard.[8]
A debtor might have a reason to bring an adversary proceeding to determine issues other than turnover, such as whether the debtor’s interest is in dispute, just as trustees do, but otherwise a simple turnover motion seems to offer adequate notice to the creditor. If notice is a concern for the court, upon filing a petition the debtor might consider serving a written notice on the creditor stating the intent to demand turnover. A proof of insurance could be attached to accelerate a discussion leading to turnover.
It is worth noting that several courts have found that § 542(a) is self-operative, or automatic, and does not require a court order or any action by the debtor or trustee. [9] This position in these courts may lend support for a simplified process in other jurisdictions, and hopefully encourages creditors to voluntarily turn over, or stipulate to turnover of, the property.
The Creditor’s Rights
After Fulton, a creditor need do nothing regarding property repossessed pre-petition. Indeed, a creditor can do nothing in the absence of a court order except retain the property. A creditor cannot demand payment, demand adequate protection (other than, perhaps, proof of insurance) or any other quid quo pro for return of the property without running afoul of the automatic stay.
Most courts will also acknowledge that turnover can be conditioned on the provision of adequate protection. [10] Creditors should be prepared to discuss adequate protection early in the chapter 13 case.
Conclusion
Fulton revised a very narrow set of issues related to the stay and left completely open the question of what happens next. We can undoubtedly expect to see creative litigation on all sides and, hopefully, some guidance from the courts and the Advisory Committee on Rules of Bankruptcy Procedure. Like so many issues in the consumer bankruptcy arena, though, all the interested parties are in this together. The solutions will arrive sooner with cooperation and input from all constituencies.
[1] 141 S. Ct. 585, 201 L. Ed. 2d 384 (2021).
[2] 11 U.S.C. § 362(a)(3). The Courts of Appeals for the Second, Seventh, Eighth, Ninth and Eleventh Circuits held that a creditor’s retention of repossessed property post-petition was an act to “exercise control over property of the estate” and in violation of § 362(a)(3). The remedy under that interpretation was immediate turnover of the property to the debtor. The Fulton Court, in a unanimous 8–0 decision, agreed with the heretofore minority rulings of the Third, Tenth and D.C. Circuits that § 362(a)(3) merely “halts any affirmative act that would alter the status quo at the time of filing of the bankruptcy petition” and that mere retention does not violate the section. Fulton, 141 S. Ct. at 592.
[3] Id. at 591-92.
[4] In fact, in two of the four cases considered in Fulton, the bankruptcy court judgments had relied on § 362(a)(4) and (a)(6). They were subsequently remanded by the Seventh Circuit to the bankruptcy court for further proceedings. In re Fulton, 2021 WL 1345416 at *2 (7th Cir. 2021).
[5] 11 U.S.C. §§ 1303, 1306.
[6] Fed. R. Bankr. P. 7001(1) defines “adversary proceeding” as “a proceeding to recover money or property . . . .”
[7] Fulton, 141 S. Ct. at 594 (Sotomayor, concurring).
[8] See, e.g., United Student Aid Funds Inc. v. Espinosa, 559 U.S. 260, 275 (2010).
[9] See In re Larimer, 27 B.R. 514, 516 (Bankr. D. Idaho 1983); In re Bidlofsky, 57 B.R. 883, 900 (Bankr. E.D. Mich. 1985); In re U.S.A. Diversified Products Inc., 193 B.R. 868, 872 (Bankr. N.D. Ind. 1995).
[10] U.S. v. Whiting Pools Inc., 462 U.S. 198, 211-12 (1983).