Most lenders know that a bank cannot repossess collateral after a borrower files bankruptcy unless the bank first obtains relief from the automatic stay. But can a bank retain collateral that it repossessed before the bankruptcy? Bankruptcy Judge Robert D. Martin of the Western District of Wisconsin recently said “no,” and held a bank in contempt for “willfully” violating the stay.

Background
The bank made a loan that was secured by several pieces of equipment. After the borrower defaulted on the loan, the bank sued, obtained a replevin order, repossessed five pieces of equipment, and placed them in an auction house. The borrower then filed a Chapter 13 bankruptcy. At the time of the filing, the bank had not disposed of the collateral through an Article 9 foreclosure sale, but still maintained possession of the collateral at the auction house. The borrower demanded a return of the equipment, but the bank refused. As a result, the borrower filed a motion in Bankruptcy Court to hold the bank in contempt for willfully violating the automatic stay.

Violation of Automatic Stay
The Bankruptcy Court granted the borrower’s motion for contempt, reasoning that the Bankruptcy Code stops “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate” (emphasis added). Because the borrower’s interests in the equipment had not yet been foreclosed through an Article 9 sale, the Court concluded that the equipment still constituted property of the borrower’s bankruptcy estate. The Bankruptcy Court also found that the bank continued to exercise control over the property of the estate by refusing to return the collateral to the borrower. The Court held that this exercise of control violated the automatic stay.

Willful Violation
To make matters worse, the Bankruptcy Court also held that the bank’s violation of the automatic stay was “willful.” The Court noted that a willful violation of the automatic stay does not require specific intent to violate the stay. Rather, a violation is willful, the Court opined, if “the creditor takes questionable action despite the awareness of a pending bankruptcy proceeding.” It is irrelevant, the Court stated, whether the creditor believed in good faith that it had the right to retain possession of the collateral. Thus, a bank’s violation of the automatic stay may be “willful,” even if a bank believes that its actions were justified. The Court also stated that, upon proof of reasonable costs and attorneys’ fees incurred by the borrower in bringing the motion for contempt, damages in that amount would be assessed against the bank.

Conclusion
Despite the outcome of this particular case, the Bankruptcy Court’s decision does not necessarily mean that a bank must return collateral remaining in its possession every time a borrower files for bankruptcy. Lenders who remain in possession of collateral when a borrower files for bankruptcy should immediately consult with a bankruptcy attorney to determine whether the collateral must be returned.

If you have questions, contact one of Winthrop & Weinstine’s attorneys practicing in the areas of Creditors’ Remedies and Bankruptcy Law; Commercial Lending; or Community Banking.