On January 14, 2021, the Supreme Court of the United States handed down its opinion in City of Chicago, Illinois v. Fulton, where the Court addressed a single issue: whether an entity in mere possession of property in which a bankruptcy estate has an interest has an affirmative obligation under the Bankruptcy Code’s automatic stay, 11 U.S.C § 362, to return that property to the debtor or trustee immediately upon the filing of the bankruptcy petition.

Background

The case arose from four separate chapter 13 bankruptcy cases in which the debtors sought to regain possession of their vehicles from the City of Chicago, Illinois (“City”), which had seized and impounded the vehicles prepetition due to unpaid parking tickets and similar traffic fines. The bankruptcy court held in each case that, by refusing to return possession of the vehicles to the chapter 13 debtors upon post-petition request, the City had “exercised control” over property of the estate in violation of 11 U.S.C. § 362(a)(3). The bankruptcy court ordered the City to return the debtors’ vehicles and imposed sanctions for the City’s violation of the automatic stay. The cases were consolidated and certified for direct appeal to the U.S. Court of Appeals for the Seventh Circuit. The Seventh Circuit affirmed the bankruptcy court, relying on its prior holding in Thompson v. General Motors Acceptance Corp., that a creditor must return a debtor’s vehicle upon the filing of a petition for bankruptcy to comply with the automatic stay.

Resolution of the case involved interpretation and construction of three related statutory provisions in the Bankruptcy Code, specifically 11 U.S.C. §§ 541, 362, and 542, which govern property of the estate, the automatic stay, and turnover, respectively. Property of the estate includes all property, wherever located and by whomever held, in which the debtor holds any legal or equitable interest as of the petition date. Whether the debtor holds a legal or equitable interest in personal property that has been repossessed prior the petition date is determined by state law, commonly Article 9 of the Uniform Commercial Code.

Property of the estate is subject to the protections of the automatic stay. The automatic stay generally protects property of the estate from the collection efforts of prepetition creditors, and prohibits, among other things, “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.” 11 U.S.C. § 362(a)(3). The clause “or to exercise control over property of the estate” was added to § 362(a)(3) by the Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub. L. No. 98-353, 98 Stat. 333 (“BAFJA”), with little legislative history to offer insight into the purpose of this amendment. Willful violations of the automatic stay entitle an injured debtor to recover actual damages, costs, attorneys’ fees, and, in appropriate circumstances, punitive damages. 11 U.S.C. § 362(k).

An entity in possession, custody, or control of certain property of the estate must account for and turn over such property to the trustee (or debtor) unless such property is of inconsequential value to the estate. 11 U.S.C. § 542(a). Although the turnover provision in the Bankruptcy Code is subject to qualifications and certain defenses, some courts interpret the provision to be automatic and self-executing because it uses the word “shall.” However, Rule 7001(1) of the Federal Rules of Bankruptcy Procedure establishes that a proceeding to recover money or property of the estate requires the filing and prosecution of an adversary proceeding. Therefore, Rule 7001(1) is at odds with any construction of Section 542(a) as “self-executing.”

Circuit Split

The City appealed the Seventh Circuit’s affirmation of the bankruptcy court, and the Court granted the City’s petition for certiorari. The Court’s decision would necessarily resolve a split in the circuit courts. The majority position, adopted by the Second, Seventh, Eighth, Ninth, and Eleventh Circuits, was that turnover is mandated by Section 362(a)(3), because passively retaining possession constitutes an “act” to “exercise control” over property of the estate in violation of the automatic stay. The majority viewed Section 542(a) as self-executing and viewed the addition of the “exercise control” clause to Section 362(a)(3) by BAFJA as a significant enlargement of the scope of proscribed conduct under that subsection. For examples of the majority position, see Weber v. SEFCU (In re Weber); Thompson v. Gen. Motors Acceptance Corp.; and Motors Acceptance Corp. v. Rozier (In re Rozier).

The minority position, adopted by the Third, Tenth, and D.C. Circuits, was that an “act” does not include “passive” conduct such as retaining possession, because Section 362(a) is designed to preserve the status quo on the petition date, not to mandate turnover to the debtor without judicial process. The minority viewed Section 542(a) as conditioned upon the initiation of an adversary proceeding, and found little significance in the BAFJA addition of the “exercise control” clause to Section 362(a)(3) due to the sparse legislative history surrounding the amendment and doubt that Congress would enact a sweeping turnover obligation implicitly, rather than explicitly. For examples of the minority position, see In re Denby-Peterson and WD Equip., LLC v. Cowen (In re Cowen).

The Court’s Decision

In an 8-0 opinion (Justice Barrett took no part in the consideration or decision of the case), the Court vacated the judgment of the Court of Appeals and remanded the case for further proceedings. In its opinion, the Court largely adopted the minority position espoused by the Third, Tenth, and D.C. Circuits, although it did not reach many of the broader issues presented, including whether Section 542(a)’s turnover obligation is self-executing or not.

The Court held that “mere retention of property does not violate §362(a)(3).” To reach this outcome, the Court first construed the operative words in Section 362(a)(3), and then considered the interaction between Section 362(a)(3) and the turnover provision, Section 542(a). First, the Court held that the most natural reading of the terms “stay,” “any act,” and “exercise control,” appearing in Section 362(a)(3) was that this subsection prohibited “affirmative acts that would disturb the status quo of estate property as of the time when the bankruptcy petition was filed.” Next, the Court found that its interpretation of Section 362(a)(3) was bolstered by the separate turnover provisions contained in Section 542(a) of the Bankruptcy Code.

Construing Section 362(a)(3) to create an affirmative turnover obligation on creditors, the construction urged by the debtors, “would create at least two serious problems.” First, construing Section 362(a)(3) as a “blanket turnover provision” would render the turnover provision in Section 542(a) mere surplusage, since a creditor would be forced to turnover estate property immediately to avoid “exercising control” over it, notwithstanding the provisions of Section 542. Second, and relatedly, construing Section 362(a)(3) to mandate turnover in every case would create a contradiction between that section and Section 542(a), which excuses a person from turning over property if, among other exceptions, it is of inconsequential value to the estate. As the Court noted, “it would be ‘an odd construction’ of §362(a)(3) to require a creditor to do immediately what §542 specifically excuses.” Finally, the Court agreed with the City of Chicago that the insertion of the phrase “or to exercise control over property of the estate” into Section 362(a)(3) by BAFJA in 1984 “simply extended the stay to acts that would change the status quo with respect to intangible property and acts that would change the status quo with respect to tangible property without ‘obtain[ing]’ such property.”

Having concluded that mere retention of estate property following the petition date did not violate Section 362(a)(3), the Court vacated the judgment of the Court of Appeals and remanded the case. It expressly declined to decide “how the turnover obligation in §542 operates.” It also did not analyze subsections (a)(4) and (a)(6) of Section 362, which the bankruptcy court in one of the four original bankruptcy cases had held that the City had also violated, since the Court of Appeals had also not reached that issue.

Justice Sotomayor filed a separate opinion concurring in the judgment and the Court’s analysis of § 362(a)(3). In a largely policy-based argument, Justice Sotomayor focused on the impact that the City’s traffic fine enforcement behavior had on debtors in this case, and in the Chicago area over time. She expressed concern that the turnover procedures created by Section 542(a) and Rule 7001 of the Federal Rules of Bankruptcy Procedure were too onerous and time-consuming to be of any real benefit to debtors struggling to make plan payments and get to work without the benefit of their vehicle. She concluded that the Advisory Committee on Rules of Bankruptcy Procedure should “consider amendments to the Rules that ensure prompt resolution of debtors’ requests for turnover under §542(a), especially where debtors’ vehicles are concerned,” and also called on Congress to act to address the issue.

Conclusion

By resolving the circuit split, the Court added much-needed clarity to an issue that has sharply divided lower courts for decades. Creditors may now rest assured that, so long as their passive retention of collateral seized prepetition is consistent with maintaining the status quo as of the petition date, they will not run afoul of the automatic stay. However, Fulton leaves open the question of whether the same creditor has any affirmative turnover duties under Section 542(a), or whether it is entitled to await service of a summons and complaint in an adversary proceeding seeking turnover.

January 26, 2021/by Bankruptcy