Bankruptcy Case Leads to Favorable Ruling for Creditors Holding Property

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The U.S. Supreme Court ruled that mere retention of property does not violate the automatic stay during bankruptcy.

As the first quarter of 2021 wanes, the U.S. has reached the one-year anniversary of a national business shutdown due to the Covid-19 pandemic. While many banking experts make predictions about the numbers of bankruptcies looming ahead, creditors received a favorable ruling about debtor property in a recent U.S. Supreme Court case.

In mid-January, the U.S. Supreme Court decided a creditor did not violate the automatic stay by refusing to turn over the property of debtors who filed for bankruptcy. The decision in this case, City of Chicago v. Fulton (PDF), is generally favorable to creditors holding property of debtors seeking bankruptcy protection.

What are the issues behind the case?

U.S. bankruptcy law temporarily prevents creditors, collection agencies, and others from pursuing debts as soon as the debtor files for bankruptcy. This provision is known as the automatic stay and applies to individuals and businesses in all chapters of the Bankruptcy Code. The automatic stay protects a debtor’s interests by prohibiting “any act to obtain possession of property of the [bankruptcy] estate or of property from the estate or to exercise control over property of the estate.” (Emphasis added.)

Under previous legal precedent, creditors who did not immediately turn over property of a bankruptcy debtor faced potential damages or sanctions for violating the automatic stay.

What were the facts of the case?

In the Fulton case, the City of Chicago impounded motor vehicles when the vehicle owners failed to pay fines. When some of these vehicle owners filed Chapter 13 bankruptcy petitions, they demanded the city return their vehicles under the automatic stay provisions of the Bankruptcy Code.

What was the Court’s ruling?

The Court ruled that holding property, in this case, the City’s continued possession of the impounded vehicles after the commencement of the bankruptcy cases, did not violate the automatic stay since the City did not take affirmative acts with respect to such vehicles that would disturb the status quo. The Court also reasoned the debtors’ arguments would create conflicts between the automatic stay provision and other provisions of the Bankruptcy Code.

In general, this means the automatic stay applies only to affirmative acts changing the status quo. Therefore, a creditor who simply holds the property of a debtor who files a bankruptcy petition may have some leverage over the debtor and other creditors. But, importantly, the Court’s ruling only covers passive possession of property. A creditor that holds property during a bankruptcy may still face liability for violating the automatic stay if it takes actions beyond mere retention.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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