Introduction

In City of Chicago v. Fulton, the U.S. Supreme Court is poised to rule on whether a creditor must, under the automatic stay provision of the Bankruptcy Code, affirmatively return property to a debtor once she files a petition for relief.

When a debtor files for bankruptcy protection, Section 362 of the code imposes a “stay” of “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.” The question, then, is whether this provision also requires a creditor to return the debtor’s property without a court order, i.e., whether the language of Section 362 mandates that the creditor act to return property of the estate once the creditor is on notice of the debtor’s bankruptcy filing. Interestingly, another provision of the Bankruptcy Code (Section 542: titled “Turnover of Property to the Estate”) requires an entity with possession, custody, or control of property of the estate to return such property; the text of Section 362, on the other hand, contains no such return requirement.

Our various federal appellate courts are divided on whether Section 362(a)(3) creates a mandatory turnover obligation for creditors. While the courts of the Second, Seventh, Eighth, Ninth, and Eleventh Circuits hold that a passive retention of estate property violates the automatic stay, the courts of the D.C., Third, and Tenth Circuits hold otherwise.

Background

In December 2017, the city of Chicago impounded Robbin Fulton’s 2015 Kia Soul for a municipal violation. To retrieve the vehicle, Fulton had to pay all related fees, which included fines, towing and storage fees, and collection costs, in full or under an installment plan. Before making any payment in order to recover her car, Fulton filed a bankruptcy petition under chapter 13 of the Code. During her bankruptcy case, the city of Chicago filed its general unsecured claim.  Following the confirmation of her Chapter 13 plan, Fulton requested that the city return her vehicle. When the city refused to do so, Fulton moved for sanctions, alleging that the city was violating the automatic stay.

The Bankruptcy Court for the Northern District of Illinois held that the city’s passive retention of Fulton’s vehicle violated the automatic stay, and it ordered the immediate return of Fulton’s car. It also imposed a sanction of $100 for each day that the city failed to comply with the court’s order. The city appealed.

The city offered three arguments in support of a reversal of the sanctions order. First, the city contended that Fulton lacked a possessory interest in the vehicle at the time of the bankruptcy filing. Second, the city argued that enforcement of the automatic stay simply required the city to maintain the status quo; it did not, the city urged, require an affirmative act such as returning the car. The city suggested instead that, should Fulton want to get her car back, she would have to pursue a turnover action under Section 542. Third, the city observed that passive retention of Fulton’s car did not constitute an “act” of exercising control under Section 362(a)(3).

The U.S. Court of Appeals for the Seventh Circuit found none of these arguments persuasive. Instead, it found that the city’s stance “ignore[d] the purpose of bankruptcy—to allow the debtor to regain his financial foothold and repay his creditors.” To that end, the court noted that a debtor like Fulton “must be able to use her assets” such as the car to “establish a rehabilitation and repayment plan.”

The court next considered “whether the city was obligated to return a debtor’s vehicle upon her filing of a Chapter 13 bankruptcy petition, or whether the city was entitled to hold the debtor’s vehicle until she pays the fines and costs or until she obtains a court order requiring the City to turn over the vehicle.” The city argued that it maintained a possessory lien on Fulton’s car, and that it risked losing its lien by handing possession back to Fulton. The court had little problem dismissing this argument, noting that the city could maintain its lien even after Fulton got her car back.

The appellate court found that the Kia Soul was property of Fulton’s bankruptcy estate, and that the City’s retention of the vehicle was an “act to exercise control over property of the estate.” As such, it held that the city’s retention of the car violated the automatic stay. In agreeing with a majority of other circuit courts of appeals, the Fulton court made its position clear: upon the filing of a bankruptcy petition, a creditor’s turnover to the estate of a seized asset is compulsory.

Oral Argument at the Supreme Court

The city filed a writ of certiorari, which the Supreme Court granted on Dec. 18, 2019, (City of Chicago v. Fulton, 140 S. Ct. 680 (2019)). The Supreme Court heard oral argument on this case on Oct. 13.

During oral argument, the Justices appeared skeptical of the rationale adopted by the Seventh Circuit Court of Appeals. A few of the Justices seemed unconvinced that the passive retention of a debtor’s property constituted an “act” to exercise control. For instance, Justice Clarence Thomas noted the problem of characterizing retention of a car as “exercising control over it” under Section 362(a)(3). In a similar vein, Justice Neil Gorsuch queried why Congress hadn’t simply drafted language into Section 362 of the code that clearly forbids a creditor from obtaining or retaining possession of estate property, and imposes on that creditor the affirmative responsibility to return the asset to the debtor’s estate.

The justices additionally seemed to suggest that the appropriate provision for achieving turnover of property of the estate should be Section 542 of the code. Chief Justice John Roberts asked Fulton’s counsel why a court “wouldn’t … look to the section of the code entitled ‘turnover of property of the estate,’” to determine whether a creditor must turn over property to the estate. Likewise, Thomas noted that if the automatic stay provision compelled turnover of estate property, Section 542 would seem “superfluous.”

Conclusion

The Supreme Court’s ruling in Fulton will resolve the present circuit split. The consequences of its decision will be significant: the city of Chicago argues that, should the court rule in favor of Fulton, debtors may be emboldened to use a quick bankruptcy filing as a device to retrieve their vehicles, seek and obtain sanctions against the creditor, and then dismiss their cases. Indeed, the Department of Justice, in its as amicus briefing for the city, forewarned that such a ruling “would put a lot more pressure on creditors to surrender property where they believe that they have fair defenses to turnover under Section 542,” which will “force creditors to surrender property they might be very well entitled to hold onto.”

By contrast, should the Supreme Court rule in favor of the city, Fulton’s counsel contends that many Chapter 13 bankruptcy cases will fail because debtors like Fulton will be unable to efficiently recover property necessary to achieve the “fresh start” promised them by the Bankruptcy Code.

That said, a decision in favor of the city will provide less worry for creditors: they’ll be able to retain property they legally obtain from their debtors pre-bankruptcy, knowing that debtors will be required to initiate some formal proceeding in the bankruptcy case in order to achieve a turnover of that property.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors’ rights.

Diane J. Kim, an associate with the firm, practices in the area of business reorganization and financial restructuring. Prior to joining the firm. Kim served as judicial law clerk for the U.S. Bankruptcy Court for the District of Delaware.

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.