Retention of Debtor’s Property Does Not Violate the Automatic Stay

Creditors who garnished funds or repossessed collateral prior to a debtor’s bankruptcy frequently ask whether the continued retention of that property violates the automatic stay. The consequences of that decision are significant because creditors who willfully violate the automatic stay may be subject to monetary sanctions.

It is well known in the financial community that the filing of a bankruptcy petition triggers an automatic stay on efforts to collect pre-petition debts. Included among the automatic stay provisions in the Bankruptcy Code is a prohibition against “any act … to exercise control over property of the bankruptcy estate.”[1] At issue is whether this language places an affirmative obligation on creditors to return property that was seized, or held, prior to bankruptcy. Stated another way, does the continued retention of such property constitute a violation of the automatic stay?

Supreme Court’s Holding

In a recent opinion, City of Chicago, Illinois v. Fulton, et al., the United States Supreme Court held that retention of seized property was not a stay violation. In that case, the City of Chicago impounded the vehicles of several individuals for failure to pay fines. The individuals subsequently filed for bankruptcy and requested that the City surrender the seized vehicles. The debtors argued that by continuing to retain the vehicles, the City exercised control over property of the bankruptcy estate and hence violated the automatic stay.

In support of its holding, the Court concluded that the automatic stay provision at issue, 11 U.S.C. §362 (a)(3), prohibits affirmative acts to exercise control over estate property. The Court then found that by merely retaining the vehicles, and maintaining the status quo, the City did not engage in an “affirmative act” to exercise control over estate property. The Fulton Court also highlighted that the Bankruptcy Code includes a separate provision, section 542, that explicitly outlines procedures to compel the turnover of estate property. The Court then noted that if the automatic stay provision places an affirmative duty on a creditor to surrender the property, the turnover provision would be rendered superfluous. The Court viewed that result as being inconsistent with Congressional intent.

Fulton’s Lessons

While Fulton may not be described as a home run for creditors, the opinion offers some measure of comfort. First and foremost, creditors who repossessed collateral or garnished funds pre-bankruptcy will no longer face the immediate threat of sanctions for “exercising control” over bankruptcy estate property. Further, even assuming that the debtor seeks the return of its property through a turnover action, the creditor may be entitled to adequate protection of its interest in that property. Fulton may also alter the negotiation dynamic between creditors and debtors insofar as debtors will be required to incur the expense and delay associated with prosecuting a turnover action.

For those financial institutions with both a lending and deposit relationship with a debtor, Fulton raises the question of whether the bank may refuse to allow the debtor to withdraw from the account unless adequate protection is provided. Arguably, Fulton, when read together with the Supreme Court’s opinion in Citizens Bank of Maryland v. Stumpf,[2] stands for the proposition that the account may remain frozen until either the debtor pursues a turnover action or the lender moves for relief from the automatic stay to effectuate any right of setoff.

Lastly, it is important to note that the Supreme Court’s holding is limited to one of the several automatic stay provisos prohibiting certain enforcement actions against a bankrupt. As highlighted in the opinion, the Court did not consider whether the retention of property seized pre-bankruptcy would violate other subsections of the automatic stay provisions in the Bankruptcy Code. Specifically, at issue is whether the continued retention of property would violate section 362(a)(4)(prohibiting acts to create, perfect or enforce liens against estate property) or section 362(a)(6)(prohibiting acts to collect, assess or recover a pre-petition claim against the debtor).

For more information, please contact John C. Kilgannon or the Stevens & Lee attorney with whom you regularly work.

This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.

[1] 11 U.S.C. §362(a)(3).
[2] 516 US 16, 116 S.Ct. 286, 133 L.Ed 2d 258 (1995).