Supreme Court Settles Debate on Passive Retention of Property

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For some time, bankruptcy courts wrestled over whether creditors violated the Bankruptcy Code’s automatic stay provision under 11 U.S.C. § 362(a)(3) by creditors’ passive retention of a debtor’s property once a debtor files for bankruptcy. Last year, in City of Chicago v. Fulton[1] the U.S. Supreme Court issued an opinion that puts this issue to rest.

In examining whether a creditor’s passive retention of estate property after a bankruptcy filing violated the automatic stay, the Supreme Court held that, as long as the property was lawfully seized pre-bankruptcy, it does not.

While the Court provided much needed clarity on this hotly debated issue, the ruling is very narrow and leaves open the question of what precisely a secured creditor is permitted to do with its lawfully repossessed collateral once a debtor files for bankruptcy protection.

When a debtor files for bankruptcy, an “automatic stay” takes immediate effect and a bankruptcy estate is created. The automatic stay prevents creditors from, among other things, taking action against the debtor or property of the bankruptcy estate, which is comprised of all of a debtor’s interests in its property.

For years, courts were split over this issue, and New York courts were among the majority that held that a creditor violated the automatic stay if, after a bankruptcy filing, it retained property of a bankruptcy estate that was lawfully seized pre-bankruptcy.

The Supreme Court in Fulton examined the actions of the City of Chicago, which impounded vehicles after the owners failed to pay fines for parking tickets. Some of these owners later filed bankruptcy petitions and requested that their vehicles be returned. When the City refused to return the vehicles, the debtors filed actions that asserted the City’s retention of their property violated the automatic stay.

The Supreme Court sided with the City and held that the passive retention of the property did not violate the automatic stay.

Examining § 362(a)(3) of the Bankruptcy Code, the Court explained that the language implies, but does not expressly state, that something more than mere retention of bankruptcy estate property is required to violate the automatic stay. Specifically, the Court determined that § 362(a)(3) “prohibits affirmative acts that would disturb the status quo of estate property” when a bankruptcy petition is filed, and “that mere retention of property does not violate the [automatic stay].” City of Chicago v. Fulton, 592 U.S. (2021) at *3.

The Supreme Court in Fulton focused on the automatic stay provision of §362(a)(3), a fundamental protection to debtors when deciding that a secured creditor may now lawfully repossess property, e.g., a vehicle, without violating the automatic stay. But it did not opine on the interplay with other provisions that may require a creditor to return a debtor’s property, also known as turnover proceedings, under § 542(a).

Creditors should take note of the following implications:

  • An entity is not violating the automatic stay by merely retaining property it lawfully seized pre-petition, but any actions beyond that (i.e., auctioning the property, demanding the debtor make a payment, etc.) will likely violate the automatic stay.
  • The Court did not address whether the secured creditor is obligated to turn over and return the property under 542(a), or whether a trustee and/or a debtor should be required to affirmatively make such a turnover demand.
  • Creditors should consult with counsel to see whether relief from the automatic stay is necessary or whether counsel can assist with adequately protecting their rights.

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[1] S. Ct. 585, 592 (2021).

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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