If you have ever been a creditor involved in a debtor’s bankruptcy, you probably know that most post-bankruptcy actions by a creditor against a debtor or its property violate the Bankruptcy Code’s automatic stay, and are sanctionable. However, in January 2021, the United States Supreme Court, in City of Chicago, Illinois v. Fulton, 141 S. Ct. 585 (2021), held that the mere passive retention of a debtor’s property is not a stay violation. This appeared to change previously common advice to creditors to return property seized pre-bankruptcy – whether consumer or business. This article discusses that issue and the lower courts’ implementation of Fulton in the meantime.
In Fulton, the City of Chicago (the “City”) impounded the Debtors’ vehicles for failure to pay tickets. The Debtors then filed chapter 13 bankruptcy petitions and requested the return of their vehicles, which the City refused. In each case, the relevant bankruptcy court held that the City’s refusal violated the automatic stay, and the Seventh Circuit Court of Appeals affirmed the decisions.
SCOTUS then addressed the issue of “whether an entity violates [the automatic stay] by retaining possession of a debtor’s property after a bankruptcy petition is filed.” The Court concluded that the automatic stay only prohibits affirmative acts that would disturb the status quo of estate property at the time the bankruptcy petition was filed, and that the Bankruptcy Code’s prohibition of the exercise of control over estate assets is implicated by affirmative activity, not just retention: “mere retention of property does not violate [the automatic stay].” In reaching this ruling, the Court addressed 11 U.S.C. § 362(a)(3), which stays acts to obtain possession of or exercise control over estate property. The Court concluded that a debtor did have another way to get its property back – it could initiate a turnover proceeding under another section of the Code – a more time consuming and expensive remedy of which many consumers would not be able to take advantage.
Importantly, there is no indication in the opinion that that the ruling would be limited to municipal enforcement or to consumer cases. This means that, where a creditor has seized collateral, i.e., repossessed equipment, frozen an account, sent account debtor notices, etc., the common advice that the creditor needs to reverse those actions promptly post-bankruptcy to keep from violating the stay seems to have changed. In the nearly eighteen months since Fulton, lower courts have largely interpreted Fulton broadly.
A Pennsylvania bankruptcy court has held that a creditor did not have a post-petition obligation to release bank accounts frozen prepetition, i.e., a prepetition state court attachment.[1] The Supreme Court in Fulton specifically limited its decision to interpreting §362(a)(3)(any act to obtain possession of property of the estate or property from the estate or exercise control over property of the estate). However, the Pennsylvania bankruptcy court held that, because subsections (a)(4) (any act to create, perfect or enforce a lien), (5) (any act to create, perfect or enforce a lien on a prepetition claim), and (6) (any act to collect, assess or recover a prepetition claim) also all begin with the phrase, “any act to,” it follows that Fulton’s reasoning regarding §362(a)(3) can be applied to these other subsections as well.
Another Pennsylvania bankruptcy court held likewise.[2] The creditors there served a prepetition writ of execution on the debtor’s bank, freezing his accounts. When the debtor filed a Chapter 13 petition, the creditors refused to release the funds or otherwise terminate the attachment lien. The bankruptcy court held that Fulton dictated that the creditors’ mere inaction did not violate the automatic stay. The bankruptcy court further considered the other subsections of §362(a) and, like the Kipps court, concluded that although Fulton was specifically limited to §362(a)(3), its reasoning can be applied to the other subsections of §362.
The Ninth Circuit Bankruptcy Appellate Panel held that, where a creditor has executed a prepetition writ of garnishment against a debtor’s bank account, it is under no affirmative obligation to release the funds and need only maintain the status quo.[3]
In contrast, a bankruptcy court in Illinois declined to apply Fulton’s interpretation of §362(a)(3) to the other sections of §362.[4] This court held that, although Fulton held that violation of the automatic stay under §362(a)(3) requires an affirmative act beyond mere retention of bankruptcy estate property, Fulton does not expressly nor impliedly foreclose the Plaintiffs’ claims under §362(a)(4), (6), and (7) (set off of prepetition debt), as a matter of law. Like in Fulton, the Debtors were residents of Chicago whose vehicles were impounded for unpaid fines. After their vehicles were impounded, each Plaintiff commenced a case under Chapter 13 of the Bankruptcy Code and requested that the City return the vehicles to them, but the City declined.
The debtors commenced this proceeding before Fulton but, after that decision, amended their complaint, omitting the cause of action under §362(a)(3) and alleging that the City’s refusal to turn over the vehicles violated other provisions of the automatic stay, namely sections 362(a)(4), (6), and (7). The court held that Fulton is limited to §362(a)(3) and does not require dismissal of the Plaintiffs’ other claims: that inaction combined with other facts might nonetheless violate the automatic stay.
The bottom line here is that if a creditor wishes to take an aggressive stance and decline to reverse prepetition collection activities once it hears about the bankruptcy, there is now significant support for that position. The creditor may still face an adversary proceeding seeking turnover of the property, but the debtor being forced to incur the cost and delay of that proceeding is less likely to come with the threat of sanctions like a stay violation does.
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Stoll Keenon Ogden PLLC’s Bankruptcy & Financial Restructuring practice counsels clients in all aspects of troubled business credit situations, in and out of bankruptcy and other courts. Please contact them for legal advice for all types of business insolvency issues.
[1] Kipps v. Stincavage-Kipps (In re Kipps), Nos. 5:19-01662-MJC, 5:19-00064-MJC, 2022 Bankr. LEXIS 852 (Bankr. M.D. Pa. Mar. 31, 2022).
[2] Margavitch v. Southlake Holdings, LLC (In re Margavitch), Nos. 5:19-05353-MJC, 5:20-00014-MJC, 2021 Bankr. LEXIS 2784 (Bankr. M.D. Pa. Oct. 6, 2021).
[3] Stuart v. City of Scottsdale (In re Stuart), 632 B.R. 531 (B.A.P. 9th Cir. 2021).
[4] Cordova v. City of Chi., Nos. 19bk06255, 19ap00684, 2021 Bankr. LEXIS 3335 (Bankr. N.D. Ill. Dec. 6, 2021).
